Two companies can earn the same profit and still present their income statements so differently that an investor cannot compare them. One shows cost of sales, another shows expenses by nature. A third shows an “operating profit” that means something different from everyone else’s. International Financial Reporting Standard (IFRS) 18 was issued in 2024 to fix this.
It replaces International Accounting Standard (IAS) 1 and gives the statement of profit or loss a more standard structure, with defined subtotals, five categories of income and expense. Rules for management’s own performance measures.
You have been using the IAS 1 layout in the earlier topics. This topic explains what changes, so that you can recognise the new presentation in an exam question. It follows IAS 8, and the next topic starts the statement of cash flows, where IFRS 18 also changes how dividends and interest are classified. The statement of financial position format does not change.
In 30 seconds
IFRS 18 replaces IAS 1 and takes effect on 1 January 2027, with early adoption allowed. Income and expenses go into Five categories: operating, investing, financing, income taxes and discontinued operations. Two new Defined subtotals must be shown: Operating profit and Profit before financing and income taxes. Management-defined performance measures (MPMs), such as adjusted earnings before interest, tax, depreciation and amortisation (EBITDA), must be disclosed in one note with a reconciliation.
Expenses may be shown by nature, by function or a mix. The statement of financial position and statement of changes in equity keep their IAS 1 layout. For cash flows, interest paid and dividends paid are now financing, and interest and dividends received are investing.
The objective and the three big changes
The objective of IFRS 18 is to give relevant and comparable information about assets, liabilities, equity, income and expenses, by standardising the structure of the income statement, improving comparability, communicating performance better to investors and strengthening the disclosure of subtotals and management-defined measures. It makes three sets of changes:
- Defined subtotals in the statement of profit or loss: operating profit, and profit before financing and income taxes.
- Disclosure of management-defined performance measures in the notes.
- Better rules for aggregation and disaggregation: items are grouped or split so that the statements give useful summaries without hiding material detail.
These subtotals make statements easier to compare. They do not change how total profit is measured. The primary financial statements are the statement of financial position, the statement of profit or loss, the statement of comprehensive income, the statement of changes in equity and the statement of cash flows. The notes are secondary but essential.
The five categories
Every item of income and expense is classified into one of five categories.
| Category | What it contains |
|---|---|
| Operating | The default category: income from main business activities, and anything not classified in the other four. It is not limited to recurring items. |
| Investing | Returns from stand-alone investments: income from investment property, dividends, interest on bonds, share of profit and gains on disposal of associates and joint ventures, and income from cash and cash equivalents. |
| Financing | Costs of pure financing: interest on bank loans, bonds and other borrowings, and interest on leases and pension liabilities. |
| Income taxes | Current and deferred tax under IAS 12, and related exchange differences. |
| Discontinued operations | Results of operations classified as discontinued or held for sale under IFRS 5. |
Special cases. Banks, insurance companies and property companies carry on investing or financing as their main business, so those items are operating for them. A bank’s interest on loans, deposits and borrowings is operating, so a bank often omits the “profit before financing and income taxes” subtotal.
An insurer’s investment income on assets backing its liabilities is operating, and a property company’s rental income and gains on property disposals are operating, though they would normally be investing.
The layout of the statement
For an entity without a specified main business activity, the statement is laid out as follows.
| Section | Lines |
|---|---|
| Operating | Revenue; cost of sales; Gross profit; other operating income; selling expenses; research and development; general and administrative expenses; goodwill impairment; other operating expenses. Subtotal: operating profit. |
| Investing | Share of profit of associates and joint ventures and gains on disposal; rental income from investment property; dividends; income from bonds. Subtotal: profit before financing and income taxes. |
| Financing | Interest on borrowings, lease liabilities and pension liabilities. Subtotal: profit before income taxes. |
| Taxes and the rest | Income tax expense; Profit from continuing operations; loss from discontinued operations; Profit for the period; other comprehensive income. |
Nature, function or a mix
Expenses may be presented by Nature (the resource consumed: raw materials, labour, depreciation, electricity, advertising) or by Function (cost of sales, distribution, administration). An entity may use one method throughout or a mixed approach if that better reflects its operations. A manufacturer might show raw materials, labour and production overheads by nature and other costs by function. Banks, insurers and property companies may adapt the layout to their main business.
Management-defined performance measures
A management-defined performance measure (MPM) is a subtotal of income and expenses used in public communications, such as management commentary, press releases and investor presentations, to convey management’s view of the entity’s overall performance. Oral statements and social media posts are excluded. Examples are adjusted profit or loss, adjusted EBITDA, adjusted operating profit and adjusted profit from continuing operations.
Common adjustments are impairments and gains or losses on disposals of property, plant and equipment and intangibles.
The following are Not MPMs: subtotals of only income or only expenses, financial position measures, ratios such as return on equity, liquidity and cash flow measures such as free cash flow, and non-financial indicators.
One note must disclose, for each MPM:
- a statement that it reflects management’s view
- a warning that MPMs may not be comparable between entities
- a clear label
- the items added or subtracted
- how the tax effect of the adjustments is determined
- a reconciliation to the most directly comparable IFRS subtotal
- a reconciliation for the previous period
Effect on the statement of cash flows
Because of the new income-statement structure, IAS 7 is amended. Interest paid and dividends paid are generally financing cash flows, and interest received and dividends received are generally investing cash flows. The earlier option to show them in operating activities is no longer allowed. The next two topics use this.
The ideas in more depth
What stays the same. The statement of financial position keeps its IAS 1 format. Its line items include property, plant and equipment, investment property, intangible assets, inventories, receivables, cash, financial liabilities, provisions and trade payables. The statement of changes in equity also keeps its IAS 1 structure. Candidates at this level are not normally tested on discontinued operations or on other comprehensive income, apart from the revaluation of non-current assets.
Background. The profit for the period is the same under IFRS 18 and IAS 1, because only the grouping and subtotals change. For a trading company with no investments, nothing is investing and the statement reduces to operating profit, financing costs, tax and profit. Until an entity adopts IFRS 18, IAS 1 still applies, so use the IAS 1 layout unless the question asks for IFRS 18 categories.
Worked example: Kaduna Steel Ltd
Scenario. Kaduna Steel Ltd has no specified main business activity. For the year it reports (₦000): revenue 8,000; cost of sales 5,200; other operating income 120; selling expenses 600; general and administrative expenses 750; research and development 180; goodwill impairment 90; share of profit of an associate 160; dividends received 70; interest on borrowings 210; interest on lease liabilities 40. Income tax is 25% of profit before income taxes.
Required: the statement of profit or loss under IFRS 18, and an adjusted operating profit that excludes the goodwill impairment.
- Gross profit.
8,000 − 5,200 = 2,800. - Operating profit.
2,800 + 120 − 600 − 750 − 180 − 90 = 1,300. - Investing.
160 + 70 = 230.
Profit before financing and income taxes = 1,300 + 230 = 1,530. - Financing.
210 + 40 = 250.
Profit before income taxes = 1,530 − 250 = 1,280. - Tax and profit.
25% × 1,280 = 320.
Profit for the period = 960. - MPM.
Adjusted operating profit = 1,300 + 90 = 1,390.
It must be labelled, reconciled to the IFRS operating profit of 1,300, with the tax effect of the adjustment explained.
Common mistakes in the exam
- Calling the first subtotal “profit before tax”. Under IFRS 18 the subtotals are operating profit, then profit before financing and income taxes.
- Classifying dividends or interest received as operating.
- Putting interest on loans in the operating category for an ordinary company.
- Treating ratios or free cash flow as management-defined performance measures.
- Forgetting that a bank, insurer or property company reclassifies investing and financing items into operating.
- Thinking IFRS 18 changes the statement of financial position.
- Believing that IFRS 18 changes the profit for the period.
Quick revision
- IFRS 18 replaces IAS 1 from 1 January 2027. Five categories: operating, investing, financing, income taxes, discontinued operations.
- Two new subtotals: operating profit, and profit before financing and income taxes.
- MPMs: disclose in one note with a reconciliation. Ratios and cash flow measures are not MPMs.
- Cash flows: interest and dividends paid are financing, received are investing.
- Expenses by nature, function or a mix.
Practice questions
These are original questions in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one first.
Section A style: multiple choice
Question 1. IFRS 18 replaces:
- IAS 8
- IAS 1
- IAS 7
- IAS 16
Show the answer
B. IFRS 18 replaces IAS 1 Presentation of Financial Statements.
Question 2. IFRS 18 becomes effective for periods beginning on or after:
- 1 January 2024
- 1 January 2025
- 1 January 2027
- 1 January 2030
Show the answer
C. It takes effect on 1 January 2027, with early adoption permitted.
Question 3. Which of these is NOT a category of income and expenses under IFRS 18?
- Operating
- Investing
- Financing
- Equity
Show the answer
D. The five categories are operating, investing, financing, income taxes and discontinued operations.
Question 4. The two new defined subtotals are:
- Operating profit, and profit before financing and income taxes
- Gross profit, and net profit
- EBITDA, and free cash flow
- Profit before tax, and profit after tax
Show the answer
A. These two subtotals are required in the statement of profit or loss.
Question 5. In the statement of cash flows, dividends received are generally classified as:
- Operating
- Investing
- Financing
- Not shown
Show the answer
B. Interest and dividends received are investing, and interest and dividends paid are financing.
Question 6. Interest on a bank loan is in which category for an ordinary company?
- Operating
- Investing
- Discontinued operations
- Financing
Show the answer
D. Interest on borrowings is a financing item.
Question 7. A management-defined performance measure is:
- Any financial ratio
- A statement of financial position measure
- A subtotal of income and expenses used in public communications to convey management’s view of performance
- A cash flow measure
Show the answer
C. Ratios, financial position measures and cash flow measures are excluded.
Question 8. Which of these is a management-defined performance measure?
- Adjusted operating profit
- Return on equity
- Free cash flow
- Total assets
Show the answer
A. Adjusted operating profit is a subtotal of income and expenses. The others are a ratio, a cash flow measure and a position measure.
Question 9. Rental income from investment property for a company with no specified main business activity is:
- Operating
- Financing
- Income taxes
- Investing
Show the answer
D. It is a return from a stand-alone investment. For a property company it would be operating.
Question 10. Under IFRS 18, expenses are presented:
- Only by function
- By nature, by function, or a mix that better reflects operations
- Only by nature
- In any order the auditor chooses
Show the answer
B. An entity may use either method or a mixed approach.
Section B style: written questions
Question 11 (10 marks). (a) List the five categories of income and expenses under IFRS 18 and state what the investing and financing categories contain. (6 marks) (b) Define a management-defined performance measure and state three of the disclosures required. (4 marks)
Question 12 (20 marks). Minna Holdings Ltd has no specified main business activity. For the year it reports (₦000): revenue 6,000; cost of sales 3,900; selling expenses 420; general and administrative expenses 510; research and development 150; other operating income 90; rental income from investment property 110; dividends received 40; interest on borrowings 160; interest on pension liabilities 30. Income tax is 30% of profit before income taxes.
(a) Prepare the statement of profit or loss under IFRS 18, showing the two defined subtotals. (12 marks) (b) The company announces “adjusted operating profit” excluding a restructuring cost of ₦60,000 included in general and administrative expenses. Calculate it and state how it must be disclosed. (4 marks) (c) State how dividends received and interest paid are classified in the cash flow statement. (4 marks)
A further written question
Question 13 (10 marks). Classify each item into the IFRS 18 category for an ordinary entity:
- (i) interest on a bank loan
- (ii) dividends received from shares held
- (iii) salaries of administrative staff
- (iv) profit of a segment sold during the year and classified as discontinued
- (v) current income tax
- (vi) rental income, for a company whose main business is property letting
(10 marks)
Model answers
Show the model answer to Question 11
(a) Operating, investing, financing, income taxes and discontinued operations. Investing contains returns from stand-alone investments: investment property income, dividends, interest on bonds, share of profit and gains on disposal of associates and joint ventures, and income from cash and cash equivalents. Financing contains the costs of pure financing: interest on bank loans, bonds and other borrowings, and interest on leases and pension liabilities.
(b) An MPM is a subtotal of income and expenses used in public communications such as management commentary, press releases and investor presentations, to convey management’s view of the entity’s overall performance.
Disclosures, in one note:
- a statement that it reflects management’s view
- a warning that it may not be comparable between entities
- a clear label
- the items added or subtracted
- how the tax effect is determined
- a reconciliation to the most directly comparable IFRS subtotal
- a reconciliation for the previous period
Show the model answer to Question 12
(a) Revenue 6,000. Cost of sales (3,900). Gross profit 2,100. Other operating income 90. Selling expenses (420). General and administrative (510). Research and development (150). Operating profit 1,110 (2,100 + 90 − 420 − 510 − 150). Investing: rental income 110, dividends 40, total 150. Profit before financing and income taxes 1,260. Financing: interest on borrowings (160), interest on pension liabilities (30), total (190). Profit before income taxes 1,070. Income tax 30% × 1,070 = (321). Profit for the period 749. (b) Adjusted operating profit = 1,110 + 60 = ₦1,170,000.
It is disclosed in a single note with a statement that it reflects management’s view, a warning that it may not be comparable, a clear label, the item adjusted, the tax effect of the adjustment, and a reconciliation to operating profit of 1,110, with a comparative reconciliation. (c) Dividends received are an investing cash flow. Interest paid is a financing cash flow.
Show the model answer to Question 13
(i) Financing. (ii) Investing. (iii) Operating. (iv) Discontinued operations. (v) Income taxes. (vi) Operating, because a property company classifies its rental income as operating, although it would be investing for an ordinary entity.
Pathfinder on IFRS 18: presentation and disclosure in financial statements
These are the ICAN Pathfinder questions that test this topic. ICAN owns the questions and the suggested solutions, so we point you to them and do not copy them. Open your Pathfinder, attempt each question under exam conditions, then check your answer against the notes above.
From the previous syllabus. Asks you to state the components of financial statements under IAS 1, which IFRS 18 now calls the primary financial statements and the notes.
Revise first: The objective and the three big changes
Asks you to state and explain the relationships among the main components of financial statements.
Revise first: The objective and the three big changes
IFRS 18 is a new syllabus item taking effect in 2027, and no past diet asks for it directly. Expect items on the five categories, the two defined subtotals, management-defined performance measures and the cash flow classification of interest and dividends. Check Section A of every diet you practise.
Revise first: The five categories
Source: ICAN Pathfinder, Financial Accounting. Diets covered: May Diet, 2022 and November Diet, 2023. IFRS 18 is a new syllabus item and no past diet asks for it directly. Diets before November 2014, and November Diet, 2024 onwards, are not covered here.
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