IFRS 18 - the devil is in the detail (again)

Here is a selection of non-exhaustive requirements of IFRS 18 which are not immediately obvious at first sight for entities that do not have a specified main business activity of providing finance to customers or investing in particular types of assets.

1. Costs of holding assets

If an entity does not have a specified main business activity of investing in assets, it might nonetheless have assets that generate cash flows independently of operating assets.  Examples could include a company that is not an investment property company, but nonetheless has an investment property; or a company that is not an investment trust company (or similar), but nonetheless invests surplus cash in financial assets.  Whilst certain items of income and expense related to such assets - for example changes in fair value, rental or investment income generated by the asset, and profits and losses on disposal - are presented in the investing category of the income statement, costs of holding such assets are not.  So, in the case of an investment property, expenses such as repairs and renewals, property taxes, and buildings insurance (and any service charge income generated from recharging such costs to tenants) would be presented in the operating not investing category of the income statement.  Similarly, fees paid to a fund manager for managing investments would also be presented in the operating category.

2. Profits and losses on disposal of non-current assets

The cash flows arising on buying and selling non-current assets such as intangible fixed assets or property, plant and equipment used in the business are presented as investing cash flows for the purposes of the cash flow statement.  The profits and losses on disposal of such assets, by contrast, are presented in the operating category of the income statement.  Given depreciation, amortisation and impairment losses are also presented in the operating category of the income statement arguably this makes sense, especially because such profits and losses on disposal are often nothing more than adjustments to reflect revisions to previously estimated residual values and useful lives.  Nonetheless, it does highlight that there isn’t always consistency in the presentation for both cash flow statement and income statement purposes.  However, when the asset concerned is, say, owner-occupied land and buildings whose sales price (and hence profit or loss on disposal) is driven more by movements in market prices then you could be forgiven for assuming (incorrectly) that such gains and losses would instead be presented in the investing category of the income statement.

That said, when it comes to equity-accounted investments in associates and joint ventures, both the periodic share of the investee’s results and any profits and losses on disposal are presented in the investing category.

3. Contracts with customers with significant financing components

When an entity receives consideration from customers significantly in arrears (or in advance) of providing the goods and services under a contract, IFRS 15 Revenue from Contracts with Customers requires the transaction price to be adjusted to reflect the financing given (or received).  Therefore, in a contract where the customer pays significantly in arrears some of the consideration  is presented as interest income rather than revenue, whereas if the customer pays significantly in advance, the amount of revenue recognised is ultimately greater than the consideration received, which is offset by the recognition of interest expense.  IFRS 18 requires interest expense on the liability recognised as a result of receiving consideration in advance to be presented in the financing category.  However, interest income recognised on an asset as a result of receiving consideration in arrears of recognising revenue is presented by default in the operating category, not as interest income in the investing category.  Under current IAS 1, the standard which will be replaced by IFRS 18, such interest income would typically be presented in a line item below operating profit adjacent to finance expense.

4. Disclosure of expenses by nature

Many entities present their income statement using a “by function” approach to categorise operating expenses on the face of the income statement (i.e. separate line items for cost of sales, selling expenses, administrative expenses, and R&D costs).  IAS 1, which will be replaced by IFRS 18, has always required additional note disclosure about the nature of expenses (e.g. staff costs, depreciation and amortisation) when a “by function” presentation of operating expenses has been applied.  However, such “by nature” note disclosure has only ever been needed in total.  IFRS 18 goes a step further, requiring disclosure of the amount of each of those “by nature” expenditure that is included in, or relate to, each of the “by function” line items presented.

5. Tax-effecting Management-defined Performance Measures (MPMs)

Many companies make use of different profit measures to communicate its financial performance.  Such alternative measures of profit are termed management-defined performance measures (or MPMs for short) by IFRS 18, the use of which will drive additional disclosures for each such MPM in a single-dedicated note.

MPMs are sometimes pre-tax measures of profit.  As well as reconciling such MPMs to the most directly comparable profit measure required by IFRS Accounting Standards, IFRS 18 also requires the income tax effect of each reconciling item to be disclosed.

6. Foreign exchange gains and losses

Foreign exchange gains and losses are presented in the same category as the income and expenses from the items that gave rise to them.  For example, foreign exchange gains and losses on a foreign currency denominated loan would be presented in the financing section of the income statement along with the interest expense on such a loan.  The foreign exchange gains and losses on a trade payable and receivable, by contrast would be presented in the operating category of the income statement along with the expense and revenue associated with the contract.

In some cases, however, a transaction could impact more than one income statement category, in which case the question then arises as to which category any foreign exchange gain or loss should be presented.  For example, above we noted that the purchase of a good or service on deferred terms could result in recognition of a finance expense to be presented in the financing section.  This is notwithstanding that the expense related to the underlying purchase would be presented in the operating category.  Such a transaction would have a third income statement impact if the purchase is denominated in a foreign currency, i.e. there would likely be a foreign exchange gain or loss to recognise on the associated payable. The question therefore arises as to which section should the foreign exchange gain or loss be recognised – operating or financing?  In such cases management is required to apply judgement to determine whether the foreign exchange difference relates to the amount classified in the financing category, and allocate it accordingly.

Sometimes it might take undue cost or effort to make the judgement, in which case the foreign exchange gain and losses is presented in the operating category.

7. Use the word “other” with caution

IFRS 18 requires items to be labelled and described in a way that faithfully represents its characteristics.  This principle applies throughout the primary financial statements and notes, not only the income statement. Specifically, if an item is an aggregation of multiple balances, IFRS 18 only permits the use of the word “other” to describe that aggregation if it cannot find a more informative label for the item in question. Even in that case the word “other” should be used in conjunction with other words to describe the item as precisely as possible, e.g. “other operating income” (to distinguish such income from more specifically described income items) or “other debtors” (to distinguish such debtors from more specifically described debtors).  Use of the word “other” is by no means prohibited, but taking “other debtors” as an example,  perhaps a good rule of thumb would be to ensure that:

• more than one class of debtor is included in  “other debtors” (be it a line presented on the face of the balance sheet or one item in the debtors note disaggregating a larger debtor balance presented on the face of the balance sheet).  For example, if the amount presented as “other debtors” comprises only staff loans, then describe the balance as staff loans instead of “other debtors”.
• the amount presented as “other debtors” is the last in the list of more precisely described debtor balances; and
• each debtor included in the aggregate balance for “other debtors” balance is smaller in amount that any specifically labelled debtor balance not included in that aggregate.

Although even applying this rule of thumb, additional information might be needed about what is included in an aggregated balance described as “other”.