Transcription
Hello everybody. Today we're going to talk about IFRS 18, which is a new accounting standard talking about the presentation of financial statements. More specifically, the presentation of the P&L, profit and loss statements.
Now, before you start running towards the hills thinking, "Oh no, another accounting standard's my way." Let me make it very simple for you. This is an accounting standard which is not changing how you calculate your profit. It is not telling you how to value your assets. It is not changing any measurement criteria. It is simply telling you how to present your P&Ls going forward.
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Going forward from when? Going forward from 1st of January 2027. So, if you are a student, if you are an accountant or CFO or somebody who is an investor and reads the financial statements, then this one is for you.
So, the question naturally is that what is the problem that IFRS 18 is actually trying to solve for? So, there are essentially three things. One is weak comparability. If you remember, under IAS 1, financial statements were giving relaxed rules. So, one company would present their P&L in a certain structure, the other company would present in a different structure. One would show operating profit, the other one would not show operating profit. One would show expenses in one way, the other one would show in a different way. And therefore, as an investor, it was very difficult for you to compare the P&Ls. So, that's the first problem.
The second problem is management-defined metrics. So, many managements of different companies would present their own metrics. Like somebody would present an EBITDA, adjusted EBITDA, normalized earnings just to highlight certain areas of performance which they wanted the investors or the users to read. So, that was also not structured or governed with certain rules. People could [music] do it the way they wanted to do it.
And the third was weak groupings. Now, IAS 1 did not define exactly how things need to be grouped into certain categories. So, certain expense line items would be plugged into certain groupings which would not make good sense to a reader. So, all three of these problems have been addressed by IFRS 18 and I'll tell you how.
So, now having defined the problem, let's try to compare IAS 1 versus IFRS 18 side by side. So, if we see in IAS 1, the P&L structure was quite flexible, but under IFRS 18, there is a defined structure of the P&L. It has told you exactly how P&L would look like. So, now as an investor, when I compare multiple P&Ls, I would not have any confusion while comparing them.
Number two, required subtotals. Under IAS 1, there were no mandatory subtotals for certain profit lines like operating profit or profit before interest and tax, but under IFRS 18, they have told you certain mandatory subtotals that you have to present. One is for the operating The other one is for operating profit before financing and income taxes. So, those are some required subtotals.
The third and the most important thing that they've addressed is the adjusted measures. So, as I said, previously, management used to have certain measures that they wanted to present to the investors like EBITDA, normalized earnings, operating profit before tax, or whatever it may be. Now, IFRS 18 had some put put has put some rules around that. They have said you're allowed to discuss and disclose MPMs, which is management performance measures, but then you have to give clear reconciliations as to how it is derived from your accounting profit. So, for example, if I'm showing EBITDA, I need to show that how did I arrive at EBITDA from my net profit. If I'm showing normalized EBITDA, then I have to show all the normalization adjustments that I have thought about. So, previously, this wasn't the case, and the companies could present a normalized EBITDA or a normalized profit without essentially telling what has been taken away from the net profit to arrive at that.
And then there are some grouping guidance. So, previously, there was some general presentation guidance as to how you are going to group expenses. Now, you have stronger aggregation and disaggregation principles.
From a transition perspective, as I said already, IFRS 18 applies from 2027, and that's how it's going to be applied.
In IFRS 18, let's try to dissect the structure of the P&L. So, essentially, they have asked you to structure your P&L, and it would have five major buckets. So, the first section on the P&L is going to be the operating activities. Here in this section, you will present all your core operating activities, revenue less cost of goods sold, less admin, selling, operating expenses to arrive at your operating profit. So, that's the first section.
The second section is the investing section, the investing activities section. Here, you would present any income or any expense related to your investing activities. For example, your share of profit from associate, share of profit from joint ventures, or interest income made from any investments or deposits that you have made as a business.
The third would be the financing section. Here, you would show things like interest expense on your loans, on your overdraft facilities, or interest expense relating to the IFRS 16, which is the lease related expenses. All of those things would be shown over here. So, now you have carved out three specific sections, operating, investing, and financing.
After these three, you would then show your income taxes, and finally, you would show anything to do with your discontinued operations at the bottom. And finally, you would arrive at your net profit at the end. So, that is the broad strokes of your structure of your new P&L.
Now, once we have understood the structure of the P&L, let me talk to you about three mandatory subtotals that you have to present on your P&L. The first one is the operating profit. This comes after the operating sections, you know, revenue minus cost of goods sold minus expenses, operating profit. That total has to be shown on every single P&L. From there onwards, you adjust your, you know, investing activities, you know, the interest income received, etc., and you arrive at a next mandatory subtotal, which is called profit before interest and taxes. This is the second mandatory subtotal. Thereafter, you deduct your interest expense, you deduct your income taxes, and you deduct all of the rest of the things until the time you arrive at the net profit figure. So, these are three mandatory subtotals that every P&L needs to have. One, the operating profit. Two, operating profit before interest and taxes. And three, the net profit.
The next item is the MPMs, which is management defined performance measures. Now, previously, the accounting standard were quite silent, and companies could present their own performance measures as they deemed fit. Things like normalized earnings, things like EBITDA, adjusted EBITDA, and there were no governance around that. What IFRS 18 has done is that it has put a set of guardrails around it to say that you can still present those subtotals that you like, such as adjusted EBITDA, normalized earnings, but with certain rules. First, for example, you have to explain what is this measure. Why is it useful for your business? How is the measure calculated? And then you have to show a reconciliation from the nearest IFRS subtotal to this measure that you have calculated. For example, if I am showing normalized EBITDA as a line item in my P&L, then I have to present a note separately which shows a full reconciliation that how this adjusted EBITDA was arrived at. So, for example, I took my profit before interest and taxes, I added back certain one-off items, certain one-off legal cost, maybe one-off restructuring cost, other one-off items that I deemed fit, so that it is absolutely clear to the reader of the financial statements or any other stakeholders like banks as to how have you calculated that measure. At the same time, you have to explain the tax effect of those measures. And then, if you have changed the calculation methodology in the future periods, then you also have to explain what has changed. I think this is a very, very important change which previously didn't exist.
Now, let's talk about how to group line items on your P&L. And if there are any knock-on effects of IFRS 18 on other accounting standards. So, the first thing is the grouping. The principle is quite simple. IFRS 18 says that you have to group together items which are of similar nature, but you cannot group together items which are of different nature. So, that's the first thing.
The second thing it says that when presenting expenses, you still have the option of presenting expenses by nature of expense or by the function. If you are presenting expense by function, function means selling and admin expenses, marketing expenses, then you still have to talk about their nature in a separate note. But if you're bringing the nature on the face of the P&L, then of course you don't need to have a separate note explaining which functions does it come from. So, that's about the grouping.
When we talk about the other knock-on effects, the one of the most important knock-on effects is on IAS 7, which used to tell us how to write up a cash flow statement. And there it says that the cash flow statement has now it has to start with the operating profit.
So, the next question is when does it apply from? So, as I said already, IFRS 18 starts from accounting periods beginning on or after 1st Jan 2027, which means that the year ended 2027, let's suppose if a company's year end is December, December 2027 will be the first period when you will present your financial statement using IFRS 18. The application has to be retrospective, which means the previous period, which is going to be the 2026, also needs to be adjusted to present based on IFRS 18.
So, in this last slide, I've put together a real-world example how a IAS 1 P&L would look under IFRS 18. So, on the left-hand side, you can see a published IAS 1 format P&L starts from revenue, cost of sales, there's gross profit, other income, then there is other line items such as selling and admin expenses, impairment loss, operating profit, and all the rest of the line items. Now, if you see on the right-hand side, the illustrative IFRS 18 format is quite different. First of all, it has three defined sections, operating section at the top, investing section in the middle, and then there's a financing section at the bottom. And within within these three sections, there are three mandatory subtotals to be presented, which are highlighted in red circles. There's a mandatory total for mandatory subtotal for operating profit, operating profit before financing and income taxes, and finally profit for the year.
So, the key takeaway from IFRS 18 is that the economics of your business are not changing. The measurement criteria are not changing. The way you value your assets are not changing. It's just the presentation which is changing, which is just to help investors and other stakeholders to compare one P&L from the other P&L. To make sure that if management is trying to present any other management performance measures like EBITDA, like normalized earnings, then there are sound bases for doing that. And that's pretty much about it.
So, if you are an accountant, if you are a CFO, if you are somebody who's running a company which uses IFRS as the basis of their accounting, then you have to start preparing from now. The preparation might be that you have to think about how your chart of accounts has to be structured, how your reporting has to be structured, how your investor communication needs to go about. I don't think the changes are a lot that they would require a heavy lifting, but I think it's worth keeping that on top of your mind.
If this is useful for you, please share it and let me know if you found it useful. Until next time, take care. Cheers.