IFRS 18
In early April 2024, the IASB issued IFRS 18, a new international accounting standard that will become effective in 2027. This landmark standard introduces significant and unprecedented changes to the presentation of financial statements, replacing IAS 1. Its main objective is to enhance transparency, comparability, and decision-usefulness of financial reporting for investors.
IFRS 18 reshapes the structure of the statement of profit or loss, dividing it into three main categories:
- Operating activities
- Investing activities
- Financing activities
The standard also introduces three mandatory subtotals:
- Operating profit
- Profit before financing and income taxes
- Net profit
This structure mirrors the layout of the statement of cash flows and aims to provide a clearer understanding of the sources of income and expenses.
Under the new definition, operating profit is determined residually, that is, it includes all income and expenses not classified as investing or financing. This residual approach prevents companies from excluding “unfavorable” items from operating profit and thereby enhances comparability across entities.
For example, retail companies that previously reported credit card fees under financing costs will now be required to classify them as selling expenses, reducing their reported operating profit.
Investing Activities
The investing category includes income and expenses that represent a return on assets that operate independently of the entity’s main business resources. Examples include:
- Rental income
- Fair value gains on investment property
- Interest income
- Changes in fair value of financial assets
- Share of profit from equity-accounted investments (associates and joint ventures)
This change will particularly affect holding companies, which must now present equity method results below operating profit—potentially lowering their operating performance measures.
Financing Activities
The financing category includes all income and expenses related to raising debt or equity, such as:
- Interest expense on bank loans and bonds
- Interest in lease liabilities
- Unwinding of discount on present value-based obligations (e.g., actuarial employee benefit liabilities)
It is crucial to distinguish between investing and financing:
- A loss on investment securities is reported under investing,
- Whereas interest on borrowings falls under financing.
This clear separation of the three categories — operating, investing, and financing — provides a more transparent depiction of how a company generates income and incurs expenses.
Management-Defined Performance Measures (MPMs)
A groundbreaking feature of IFRS 18 is the requirement to disclose “Management Performance Measures” (MPMs) within the notes.
These include non-GAAP metrics like Adjusted Operating Profit or Adjusted EBITDA, which companies often disclose outside the financial statements.
For each MPM, companies must provide:
- A clear explanation of how the measure is calculated,
- A statement that reflects management’s view of performance, and
- A reconciliation to a defined line item in the income statement.
This aims to increase transparency, consistency, and reliability of performance measures and to give investors a fuller and more accurate picture of company performance.
Impact on Holding Companies and Financial Institutions
- Holding companies must classify equity-accounted results as investing activity, likely reducing their operating profit.
- Financial institutions, by contrast, will present income and expenses from credit provision to customers under operating activities, reflecting their core business nature.
Changes to the Statement of Cash Flows (IAS 7)
IFRS 18 also amends IAS 7, aligning the statement of cash flows with the new presentation model:
- The starting point for the indirect method will now be operating profit (rather than profit before tax or net profit).
- Interest and dividends received will be classified under investing cash flows.
- Interest and dividends paid will be presented under financing cash flows.
These changes promote consistency across financial statements and enhance users’ understanding of cash flow sources and uses.
A Milestone in IFRS Evolution
IFRS 18 represents a historic milestone in the IFRS framework.
It significantly improves the relevance, transparency, and comparability of financial information and helps investors better assess companies’ financial performance.
The standard provides companies with an opportunity to improve communication with investors and to create more reliable cross-industry comparisons, aligning financial reporting more closely with modern business realities.