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 the previous segment of our AASB 18 guidance, we explored the requirement to categorise income and expenses into one of five classifications based on the entity’s main business activities. In this instalment, we continue to focus on the changes affecting the architecture of the income statement, specifically the introduction of newly defined subtotals and changes to the analysis of operating expenses.
New mandatory income and expense subtotals
One of the more visible changes introduced by AASB 18 is the introduction of two newly defined subtotals that entities will be required to present on the face of the income statement: operating profit or loss, and profit or loss before financing and income taxes.
The five mandatory subtotals sit within a newly structured profit or loss statement in which every item of income and expense must be classified into one of five categories: operating, investing, financing, income taxes and discontinued operations. The classification of income and expense items into these five categories is used to produce the mandatory subtotals required by AASB 18.
Operating profit or loss
Under AASB 101, presenting ‘operating profit’ was optional and this subtotal was inconsistently defined by reporting entities. AASB 18 addresses this by formally defining ‘operating profit or loss’, prescribing the income and expense categories that make up this subtotal (those classified in the ‘operating’ category), and prohibiting entities from redefining it internally.
Operating profit or loss is intended to give users a clear, comparable picture of the profit generated from an entity’s main business activities, excluding the effects of investing and financing.
Profit or loss before financing and income taxes
Profit or loss before financing and income taxes represents the total of operating profit or loss and all income and expenses classified in the investing category.
This subtotal has been introduced because investors often assess an entity’s performance separately from its financing structure. An entity may generate strong operating profits yet report an overall loss due to high borrowing costs. Isolating financing costs from operating results gives users clearer insight into underlying performance and enables more meaningful comparisons between entities regardless of how they are financed.
Entities that provide financing to customers as a main business activity (such as banks, other lending institutions and finance lessors) and elect under AASB 18 to classify all income and expenses from cash and cash equivalents and ‘financing liabilities’ in the operating category, are prohibited from presenting this required subtotal. They may, however, present an additional subtotal after the operating profit subtotal but before the financing category, if the additional subtotals criteria are met. Any such subtotal must be labelled to accurately reflect the amounts included and must not imply the exclusion of financing items.
Additional income and expense subtotals
Like AASB 101, AASB 18 allows entities to present additional subtotals in the income statement but only within a clear set of guardrails designed to ensure comparability and faithful representation. The new standard does not prescribe a list of acceptable subtotals but instead provides principles that additional subtotals must meet. Specifically, additional subtotals must:
- Comprise amounts recognised and measured under Australian Accounting Standards (i.e., no ‘adjusted’ or non-IFRS numbers presented on the face of the income statement);
- Be compatible with the statement structure used to provide a useful structured summary;
- Be presented consistently from period to period; and
- Not be displayed more prominently than required totals and subtotals.
AASB 18 highlights several additional income and expense subtotals that are widely used and are expected to continue in practice provided they meet AASB 18’s presentation principles. These can be presented on the face of the income statement as long as they meet the criteria for additional subtotals listed above.
We will cover management-defined performance measures (MPMs) in a future instalment, but it is worth mentioning here that the commonly used subtotals listed in AASB 18 are not considered MPMs and therefore are not subject to the disclosure requirements for MPMs.
Analysis of operating expenses by function or nature (or both!)
Beyond new subtotals, AASB 18 also reshapes how entities present operating expenses, introducing clearer expectations and new flexibility. Within the operating category, expenses must be classified and presented in line items so as to provide the most useful structured summary of those expenses.
Similar to AASB 101, expenses can be presented either by function or by nature. What is new is that AASB 18 explicitly allows entities to use a combination of both function and nature for the purpose of presenting operating expense line items in the income statement.
Note that the requirement to present operating expenses by nature, function or on a mixed basis only applies to the expenses classified in the operating category, not the other four categories (investing, financing, income taxes and discontinued operations).
Selecting which method to use when it comes to analysing operating expenses is not a free choice under AASB 18. The standard contains guidance to consider when determining which method provides the most useful information.
Presentation of operating expenses by nature
As outlined above, an entity may choose to present its operating expenses based on their nature. This approach provides insight into the types of economic resources consumed in delivering the entity’s activities, rather than the activities to which those resources relate. Examples of nature-based expense categories include raw material costs, employee benefits, and depreciation and amortisation.
Presentation of operating expenses by function
Entities can allocate and aggregate operating expenses according to the activity to which the consumed resource relates – this is analysis by function.
Presenting expenses by function requires entities to allocate costs arising from the same type of economic resource across multiple functional line items. For example, employee benefits may be split between cost of sales and research and development. Conversely, a single functional line item may combine expenses that relate to several different types of economic resources.
AASB 18 does not define ‘function’, however it does provide guidance on how entities consider the level of aggregation for operating expenses that provides the most useful structured summary. Entities must establish their own definition of function and then apply this consistently.
Where any line items are presented by function on the face of the income statement, a separate cost of sales line item must be presented (if the entity has such a function). While cost of sales is not defined in AASB 18, the standard does clarify that inventory expense recognised under AASB 102 Inventories must be included therein.
Furthermore, if an entity presents at least one or more line items of operating expense by function, specific information for the five nature expenses listed below must be provided in a single note:
- Depreciation (for property, plant and equipment, investment property and right-of-use assets)
- Amortisation
- Employee benefits
- Impairment losses/reversals, and
- Write-downs/reversals of inventories.
Change in the analysis of operating expenses
The method of analysing operating expenses is an accounting policy choice therefore entities must apply it consistently from period to period. Any change in the basis of presentation – for example, a revised judgement about how operating expenses are analysed and presented – is treated as a change in accounting policy and therefore requires restatement of comparative information.
A change in accounting policy is only permitted when it results in financial statements that provide more reliable and more relevant information about the effects of transactions, events or conditions on the entity’s financial position, performance or cash flows. Entities should therefore carefully consider how they classify operating expenses in the first year of applying AASB 18, as changing the method in a subsequent period would require demonstrating that the new approach better meets the ‘relevant and reliable’ criteria.
In our next instalment on AASB 18, we will shift our focus to management-defined performance measures, or MPMs, including what qualifies as an MPM and how these measures must be disclosed.
________________________________________________________________________________________________
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 2: Categorising income and expenses