The changes introduced by AASB 18 Presentation and Disclosure in Financial Statements are mainly aimed at improving the consistency and comparability of performance reporting by entities. In practical terms, this means the income statement is about to undergo a facelift.
Current accounting requirements in AASB 101 Presentation of Financial Statements are not overly prescriptive when it comes to the structure of the income statement. New guidance in AASB 18 will promote a more standardised approach to presentation of financial performance which will support more meaningful analysis and improve comparability across entities.
In this instalment of our AASB 18 guidance, our focus will be on the requirement to categorise income and expenses into one of five classifications, three of which are new, based on the entity’s main business activities.
Categorising income and expenses
Under AASB 18, there are now five categories of income and expenses:
Operating, investing and financing are new categories. These categories are also used in AASB 107 Statement of Cash Flows, however it should be noted that these do not align. As an example, proceeds received on the sale of an item of property, plant and equipment (PP&E) are classified as an investing activity in the cash flow statement while the gain or loss is classified in the operating category for purposes of the income statement. The reason for this is that property, plant and equipment does not generate an individual return independently of the entity’s other resources. Instead,
it is used in conjunction with the entity’s other resources as part of its main business activities.
Classifying income and expenses into one of the five categories above requires considering the nature of the transactions from which they stem and their relationship to the entity’s main business activities.
Specified main business activities
Before an entity classifies its income and expenses into the three new categories introduced by AASB 18, it must consider its main business activities. Where these include specified main business activities, certain income and expenses will be classified as operating whereas they would normally be classified as investing or financing.
AASB 18 describes specified main business activities as being:
- Investing in particular types of assets (e.g., an investment property entity); or
- Providing financing to customers (e.g., a bank).
The general indicator of the existence of a specified main business activity is whether an entity uses a subtotal akin to gross profit that includes income and expenses from that business activity as an important indicator of its operating performance.
Assessing whether an entity has specified main business activities is a matter of fact, not simply an assertion. Making this determination often requires professional judgement, informed by the entity’s particular facts and circumstances at the time, and must be supported by appropriate evidence. If this assessment changes, income and expenses are then classified and presented applying the revised assessment on a prospective basis. That is, amounts presented prior to the change are not reclassified.
Operating category
The operating category is a residual category since income and expenses will only fall into this category when none of the other categories apply. As a result, the operating category (and therefore operating profit) will typically include income and expenses relating to the main business activities. An exception to this is income and expenses from equity-accounted investments which are always classified as investing, even if they arise from the entity’s main business activities.
Examples of income and expenses that will typically fall into the operating category for entities without specified main business activities include:
- Revenue from the sale of goods
- Depreciation, impairment and impairment reversals of PP&E and intangible assets
- Gains and losses on disposal of PP&E and intangible assets
- Expenses arising from inventories
- Expenses related to trade receivables and contracts assets
- Contract modifications arising under AASB 15 Revenue from Contracts with Customers
- Modification gains and losses on lease liabilities.
Entities with either or both specified main business activities will have additional income and expenses that fall into the operating category such as rental income from investment property, dividends on financial assets, interest income from loans to customers and interest expense related to borrowing.
Investing category
AASB 18 is very specific about which income and expenses may be classified as investing. Firstly, they must relate to a specifically defined set of ‘non-operating assets’, and secondly, the income and expense must be explicitly allowed to be classified as investing under AASB 18.
The three non-operating asset classes for which certain income and expenses are classified as investing are:
- Investments in associates, joint ventures and unconsolidated subsidiaries;
- Cash and cash equivalents; and
- Other assets if they generate a return individually and largely independently of other resources.
The table below shows the specific income and expenses related to the above three classes of assets that may be classified as investing:
Remember that entities with one or both specified main business activities will have to classify some of the above income and expenses in the operating category.
Financing category
The classification requirements for the financing category focus on liabilities, with income and expenses from liabilities to be classified as indicated below (for entities that do not have specified main business activities):
Distinguishing between ‘financing liabilities’ and ‘other liabilities’ is important since income and expenses from these two types of liabilities are classified as either operating or financing. AASB 18 sets out a principle for entities to apply when making the distinction between the two. In transactions that give rise to ‘financing liabilities’ (i.e., liabilities that involve only the raising of finance), an entity:
- Receives finance in the form of cash, or an extinguishment of a financial liability, or receipt of the entity’s own equity instruments; and
- Will return cash or its own equity instruments in exchange, at a later date.
Again, entities with one or both specified main business activities will have to classify some of the income and expenses identified in the table above in the operating category.
Presenting finance costs under AASB 18
AASB 101 currently requires a separate line item to be presented in the income statement for finance costs, however this requirement has not been carried over into AASB 18. There is also no explicit requirement to present a subtotal for all items classified in the financing category.
Entities will need to apply judgement in determining the appropriate line items to present in the financing category that supports a useful structured summary of income and expenses for users. If expenses classified in the financing category are presented as a single line item, it will be necessary to disclose disaggregated information about that line item in the notes, if such information is material.
While entities currently include expenses such as foreign exchange gains and losses, gains and losses on derivatives and gains and losses on derecognition of financial instruments in the finance costs line item, the new classification requirements of AASB 18 will need to be applied which may result in these types of gains and losses not being classified in the financing category.
Our next article will continue to explore the amendments introduced by AASB 18 that will change the architecture of the income statement, specifically the introduction of newly defined subtotals and changes to the analysis of operating expenses.
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This article is part of our series exploring the key changes introduced by AASB 18 and what they mean for entities.
Click the links below to explore the rest of the series:
Part 1: An overview of the new disclosure standard
Part 3: New subtotals and operating expense analysis requirements