Presenting operating expenses under IFRS 18 by nature, by function, or both?

In previous editions of Corporate Reporting Insights, we discussed how IFRS 18 Presentation and Disclosure in Financial Statements, the new financial statements presentation standard that replaces IAS 1 Presentation of Financial Statements, will result in entities having to classify income and expenses in the statement of profit or loss in one of five categories, with special rules for the investing and financing categories of entities with specified main business activities.

The five categories for classifying income and expenses in the statement of profit or loss are:

• Operating (this is a residual category if items don’t belong in any of the other four categories)
• Investing
• Financing
• Discontinued operations
• Income taxes.

Is a mixed presentation of expenses allowed under IFRS 18?

Yes. In the operating category, entities must classify and present expenses in different line items so that they provide the most useful structured summary of expenses. This can be done using one or both of the following characteristics:

• Nature of the expenses, or
• Function of the expenses within the entity.

If certain line items are material, entities can provide additional disaggregated information in the notes to the financial statements.

What do we mean by ‘nature’ or ‘function’?

The table below explains the difference between ‘nature’ and ‘function’ expense disclosure briefly:

	Nature	Function	Mixed presentation
Description	Allocation of expenses is based on the nature of the economic resources consumed to accomplish the entity’s activities without reference to the activities in relation to which the economic resources were consumed.	Allocation of expenses based on the activity to which the consumed resources relate.	An entity may present an analysis of operating expenses where some expenses are classified by nature and others by function.
Examples	Salaries and wages, depreciation, inventories expensed, etc.	Cost of goods sold, research and development, occupancy expenses, administrative expenses, etc.

How to decide which presentation format to use

An entity does not have a free accounting policy choice when determining the presentation basis for operating expenses.

Factors to consider	Example
What line items provide the most useful information about the main components or drivers of the entity’s profitability?	Use of cost of sales by a retail entity, as it provides relevant information about whether the revenue generated from the sale of goods covers what, for retailers, are mainly direct costs, and by what margin.
What line items most closely represent the way the business is managed and how management reports internally?	An entity with multiple major functions may classify expenses by those functions, whereas an entity with a single function (e.g. a lender) may classify expenses by nature.
What standard industry practice entails?	If certain industries have a common practice in how operating expenses are classified, using the industry accepted approach may make comparison easier between entities.
Whether the allocation of particular expenses by function would be arbitrary to the extent that the line item presented would not provide a faithful representation of the function?	Allocating impairment of a large group of assets (e.g. property, plant and equipment, right-of-use assets, etc.) by function (e.g. research and development, administration, etc.) may be arbitrary, as assets may be used in multiple functions

Consistency from period to period

Once the entity decides on the appropriate presentation for expenses in the operating category as either by nature, by function, or a mixed format, it should stick with this to ensure consistency in presentation from one period to another. It can only change the basis if things change, such as:

• When there is a significant change in the nature of the entity’s operations
• When the entity reviews its financial statements and concludes that another presentation would be more appropriate, considering the criteria in IAS 8 Basis of Preparation of Financial Statements, or
• A requirement in an IFRS® Accounting Standard requires a change in presentation.

Presenting operating expenses by nature can be gross or net

If entities present operating expenses by nature, the amounts presented in the operating category in the statement of profit or loss need not be the amounts recognised as an expense for the period. IFRS 18, paragraph B84 notes that they could include amounts that have been recognised as part of the carrying amount of an asset. In such cases, an additional line item must be disclosed in the statement of profit or loss (operating category) for the change in the carrying amount of the relevant asset.

For example, a manufacturer who earns $300 of revenue may incur the following expenses during the year (amounts prior to a portion being recognised in the carrying amount of assets):

• Wages:                              $100
• Electricity:                         $80
• Depreciation:                     $45

A portion of these expenses will be included in the carrying amount of the entity’s unsold finished goods inventories for the period. An entity could, for example, present in the statement of profit or loss as follows:

	$
Revenue	300
Wages	(100)
Electricity	(80)
Depreciation	(45)
	75
Change in the carrying amount of inventories (assumed)	25
Operating profit	100

If, for example, the manufacturer decides to present in the operating category only the amounts recognised as an expense during the period, then the statement of profit or loss may instead be as follows (assuming the change in inventories of $25 comprises $10 for wages, $10 for electricity and $5 for depreciation:

	$
Revenue	300
Wages	(90)
Electricity	(70)
Depreciation	(40)
Operating profit	100

Next month

Next month, we will look at an example of additional disclosures required regarding expenses presented by function.

More information

You can find more articles about IFRS 18 challenges on our IFRS 18 topic page. Additionally, our publication and webinars will help you on your IFRS 18 implementation journey.

Need help

Our recent articles on IFRS 18 demonstrate the complexity of applying IFRS 18 in practice. Reach out to our team for assistance with understanding the latest requirements in IFRS 18.