Tuesday, May 28, 2024

IFRS Accounting Standard Will Support Better Investment Decisions

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IFRS 18 Presentation and Disclosure in Financial Statements will usher in the most significant change to the statement of profit or loss since IFRS Accounting Standards were introduced more than 20 years ago to make the financial statements of public companies consistent and transparent.  

The new Standard responds to investors’ concerns about challenges in comparing companies’ financial performance. Today, companies’ statements of profit or loss vary considerably in content and structure. IFRS 18 will give investors more transparent and comparable information about companies’ financial performance and support better investment decisions.

IFRS 18 is not effective until 1 January 2027, but companies can apply the Standard early. Regardless, there are several steps they should take to prepare. Companies can assess necessary changes to internal systems and processes, for example. And they can consider how to communicate changes in reported information to investors. It is possible that early adopters of IFRS 18 will share some of this information with the market next year.

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IFRS 18 responds to market demand for greater comparability and transparency with a focus on information about financial performance in the statement of profit or loss. And all companies that apply IFRS around the world will be expected to use the new Standard beginning in 2027.

IFRS 18 introduces three sets of new requirements, comprising:

  • two new subtotals in the statement of profit or loss;
  • disclosures about management-defined performance measures (MPMs); and
  • enhanced guidance on the grouping of information in the financial statements.

Subtotals in the Statement of Profit or Loss

IFRS 18 improves the comparability of information in the statement of profit or loss by introducing:

  • three new defined categories — operating, investing, and financing; and
  • two new required subtotals to enable analysis — operating profit and profit before financing and income taxes.

Among the challenges that investors face in comparing companies’ financial performance is the inconsistency in reporting operating profit. Operating profit is one of the most frequently used subtotals. However, companies apply various definitions to this subtotal because, until now, IFRS had not defined operating profit. For example, in a sample of 100 companies, 61 presented operating profit using at least nine different definitions.

The structure of the statement of profit or loss set out in IFRS 18 requires companies to consistently classify their income and expenses as operating, investing, or financing. These requirements are illustrated in Figure 1 for a company that presents its operating expenses predominantly by function. The subtotals highlighted in dark grey are required by IFRS 18 and the subtotals in light grey are additional subtotals that are presented to provide a useful structured summary of the company’s income and expenses.

Figure 1. Companies that present operating expenses predominantly by function.

The operating category, together with the operating profit or loss subtotal:

  • consists of all income and expenses not classified in the other categories;
  • provides a complete picture of a company’s operations; and
  • serves as a starting point for the statement of cash flows.

The investing category:

  • includes income and expenses from cash and cash equivalents and stand-alone investments, i.e., rentals from an investment property or dividends from shares in other companies;
  • also includes shares of profits or losses from equity-accounted associates and joint ventures; and
  • enables investors to analyse returns from these investments separately from a company’s operations.

The financing category, together with the profit before financing and income taxes subtotal:

  • includes income and expenses on financing liabilities such as bank loans and bonds;
  • also includes interest expenses on any other liability, i.e., lease and pension liabilities; and
  • allows investors to analyse the performance of a company before the effects of its financing.

IFRS 18 also includes specific requirements to ensure that, for all companies, operating profit includes the income and expenses from a company’s main business activities. These requirements will mean that some companies like banks and insurers would otherwise classify some income and expenses in the operating category, rather than the investing or financing categories.

Management-Defined Performance Measures

Companies often provide company-specific measures, commonly referred to as alternative performance measures or non-GAAP measures. IFRS 18 requires companies to disclose company-specific measures related to the statement of profit or loss in the notes to their audited financial statements, along with accompanying explanations and reconciliations.

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Not all company-specific measures will be required to be disclosed in the financial statements. Only those measures that meet the definition of management-defined performance measures (MPMs) will be disclosed. MPMs are subtotals of income and expenses, such as adjusted operating profit, that are included in a company’s public communications outside financial statements and communicate management’s view of the company’s performance.

Companies will be required to disclose information about MPMs in a single note. A crucial aspect of the disclosures is that each MPM will be required to be reconciled to the most directly comparable subtotal or total defined in IFRS Accounting Standards. Figure 2 illustrates the reconciliation of adjusted operating profit (MPM) to IFRS 18 operating profit and adjusted profit from continuing operations (MPM) reconciled to IFRS 18 profit from continuing operations.

Figure 2. MPM disclosure.

These reconciliations will increase investors’ understanding of how MPMs compare with subtotals defined by IFRS Accounting Standards. The package of disclosure about MPMs will bring transparency and discipline to these measures. Companies are also required to provide:

  • explanations of why each MPM is reported and how it is calculated;
  • for each adjusting item, the amount included in each line item in the statement of profit or loss together with the tax effect and effect on non-controlling interests; and
  • explanations of any changes to reported MPMs.

Companies welcome the disclosure requirements for MPMs because they can provide their view of performance in the financial statements, and investors like them because they expect greater transparency about management’s view.

Grouping Information

IFRS 18 introduces enhanced guidance on grouping information in the financial statements, otherwise known as aggregation and disaggregation. Companies will be required to reconsider how they group information in the financial statements. They will be required to consider:

  • whether information should be presented in the primary financial statements (to provide useful structured summaries of income, expenses, assets, liabilities, equity, and cash flows), or disclosed in the notes (if material);
  • how to label items meaningfully and to disclose information about items labelled as other; and
  • how to present or disclose operating expenses by nature or by function.

These requirements respond to investors’ concerns that the way companies group information in financial statements does not always provide the information investors need for their analysis. An example of investor frustration is that some information is not shown in enough detail while other information is obscured with too much detail.

More information about how IFRS 18 will provide investors with more transparent and comparable information about companies’ financial performance, can be found at https://www.ifrs.org/news-and-events/news/2024/04/new-ifrs-accounting-standard-will-aid-investor-analysis-of-companies-financial-performance/

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.


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