IFRS 18 operating expenses analysis requires entities to present operating expenses on the face of the income statement using by-nature, by-function, or mixed presentation methods. Operating expenses analysis under IFRS 18 represents a fundamental shift from IAS 1 by mandating face-of-statement presentation and explicitly permitting mixed presentation approaches. The operating expenses analysis eliminates the previous option to disclose this information solely in the notes to financial statements.
IFRS 18 introduces two major changes regarding the analysis of operating expenses. First, entities must present the analysis on the face of the income statement rather than having the option to disclose it only in the notes. Second, entities receive explicit permission to present operating expenses on a mixed basis, combining both nature and function line items on the face of the income statement.
See also
In this article we looked at all the key changes from IAS 1 to IFRS 18.
The selection of presentation method requires entities to assess which approach provides the most useful structured summary of operating expenses to financial statement users, applying specific factors outlined in the standard.
Presentation Methods: Nature, Function, and Mixed
IFRS 18 permits three distinct methods for presenting operating expenses on the face of the income statement: by-nature, by-function, and mixed presentation.
By-Nature Presentation classifies expenses according to their nature, showing line items such as purchases of materials, transport costs, depreciation, and employee costs. Revenue is reduced by these nature-based expense categories to arrive at operating profit.
By-Function Presentation classifies expenses according to their function within the entity, showing line items such as cost of goods sold, research and development expenses, and administrative expenses. Revenue less cost of goods sold equals gross profit, which is then reduced by functional expenses to arrive at operating profit.
Mixed Presentation combines both nature and function line items on the face of the income statement. For example, an entity might present cost of goods sold by function, followed by specific nature line items such as impairment expenses and administrative expenses.
Key Requirement
The selection of presentation method is not a free choice. Entities must select the method that provides the most useful structured summary of operating expenses, considering multiple factors outlined in IFRS 18.
Selecting the Most Useful Structured Summary
IFRS 18 requires entities to assess which method provides the most useful structured summary of operating expenses to financial statement users. The standard outlines specific factors to consider in this assessment, though it does not assign weighting to individual factors.
Main Components or Drivers of Profitability: For a retailer, cost of sales may be a main driver of profitability, making by-function or mixed presentation relevant for showing direct costs and profit margins. For a service provider, by-nature presentation of staff costs may be more relevant.
Business Management and Internal Reporting: A manufacturer managed on the basis of major functions may find by-function presentation provides more useful information. An entity with a single predominant function, such as providing financing to customers, may find by-nature presentation most useful.
Industry Practice: Using similar methods to peers in the same industry increases comparability and may influence the selection of presentation method.
Allocation Arbitrariness: If allocating particular expenses to functions would be arbitrary, those expenses should be classified by nature. This factor often leads to mixed presentation being the most appropriate approach.
By-Nature Presentation
By-nature presentation shows operating expenses according to their fundamental nature rather than their function within the entity. The income statement presents revenue followed by nature-based expense categories such as purchases of materials, transport costs, depreciation, and employee costs, arriving at operating profit.
When all operating expenses are presented by nature on the face of the income statement, no additional disclosure about nature expenses is required in the notes. This represents a significant practical advantage of full by-nature presentation, as entities avoid the detailed nature expense disclosures required when any functional presentation is used.
By-nature presentation may be most useful for entities where understanding the fundamental cost structure provides the most relevant information to users. Service providers with predominantly staff-related costs or entities with a single predominant function often find by-nature presentation most appropriate.
By-Function Presentation
By-function presentation classifies operating expenses according to their function within the entity. The income statement typically shows revenue less cost of goods sold to arrive at gross profit, which is then reduced by functional expenses such as research and development expenses and administrative expenses to arrive at operating profit.
Each entity establishes its own definition of function and applies this definition consistently. IFRS 18 does not define function but provides guidance on appropriate aggregation levels. Costs related to administrative activities such as human resources, information technology, legal and accounting, selling activities, and research and development activities may be sufficiently dissimilar to require separate line items for a useful structured summary.
When any operating expenses are presented by function on the face of the income statement, entities must provide detailed disclosures about the five specific nature expenses in the notes to the financial statements.
Cost of Sales Requirement
If an entity presents any line items by function on the face of the income statement and has a cost of sales function, IFRS 18 explicitly requires cost of sales to be presented separately from other expenses.
Mixed Presentation
IFRS 18 explicitly permits mixed presentation of operating expenses on the face of the income statement, combining both nature and function line items. Mixed presentation may provide the most useful structured summary in two main scenarios.
First, when by-function presentation would provide the most useful structured summary overall, but allocating certain expenses to functions would be arbitrary, those expenses can be presented by nature while others are presented by function.
Second, when an entity has two different types of main business activities, each requiring a different presentation method to provide the most useful structured summary of expenses from each business activity.
When presenting operating expenses on a mixed basis, entities must describe the resulting line items clearly to identify which expenses are included in each line item. For example, if employee benefits are split between function and nature line items, the nature line item description must clearly identify it does not include all employee benefits, such as 'employee benefits other than those included in cost of sales.'
Mandatory Nature Expense Disclosures
If any operating expenses are presented by function on the face of the income statement, IFRS 18 requires specific disclosures about five nature expenses in a single note. The five specific nature expenses are:
- depreciation of property, plant and equipment, investment property, and right-of-use assets;
- amortisation of intangible assets;
- employee benefits;
- impairment losses and reversals; and
- write-downs and reversals of inventories.
For each of the five nature expenses, entities must disclose:
Total Amount Recognised: The total amount recognised and disclosed under the applicable IFRS Accounting Standard. This amount can include amounts both expensed in the period and capitalised to assets.
Operating Category Breakdown: For each total, the amount related to each line item in the operating category. If this amount includes both expensed and capitalised amounts, entities must provide a qualitative explanation identifying the assets involved.
Other Categories: For each total, a list of any line items outside the operating category that also include amounts relating to the total, such as depreciation of investment property not invested in as a main business activity.
The amounts disclosed need not be limited to amounts recognised as an expense in the current period. They can include amounts recognised as part of the carrying amount of an asset, with appropriate qualitative explanation.
Cost of Sales Requirements
IFRS 18 explicitly requires that if any items are presented by function on the face of the income statement, cost of sales must be presented separately from other expenses if an entity has a cost of sales function. This requirement ensures consistent presentation of this key performance measure when functional presentation is used.
IFRS 18 does not define cost of sales, allowing entities flexibility in establishing their own definition. However, the standard clarifies that cost of sales must include the total inventory expense required to be disclosed by IAS 2 Inventories. This ensures a minimum level of consistency in what entities include within cost of sales.
Entities apply their own definition of cost of sales consistently once established. The level of detail and specific items included may vary based on the nature of the entity's operations and what provides the most useful structured summary to users.
Changes from IAS 1
IFRS 18 introduces several significant changes from IAS 1 regarding operating expenses analysis.
Location Requirements: IAS 1 permitted a choice between presenting operating expenses analysis on the face of the income statement or in the notes. IFRS 18 requires presentation on the face of the income statement, eliminating the notes-only option.
Mixed Presentation: IAS 1 did not explicitly prohibit mixed presentation, provided by-nature information was included somewhere in the financial statements. IFRS 18 explicitly allows mixed presentation and requires separate presentation of cost of sales if any operating expenses are presented by function.
Selection Basis: IAS 1 required selecting whichever method provides information that is reliable and more relevant to users. IFRS 18 requires selecting whichever method provides the most useful structured summary, with specific factors to consider in this assessment.
Nature Expense Disclosures: IAS 1 required additional information on the nature of expenses including depreciation, amortisation, and employee benefits when using by-function presentation. IFRS 18 requires disclosure in a single note of specific qualitative and quantitative information for each of the five specific nature expenses.
These changes may significantly affect entities previously prohibited from using mixed presentation, entities presenting operating expenses analysis only in the notes, or entities whose previous presentation method may not provide the most useful structured summary under IFRS 18's criteria.
Practical Examples
Example 1: Retailer Using Mixed Presentation
A large retailer determines that cost of sales is a main driver of profitability, making functional presentation of this item valuable to users. However, allocating impairment expenses and certain administrative costs to functions would be arbitrary.
The retailer presents the following on the face of the income statement:
- Revenue
- Cost of goods sold (function)
- Gross profit
- Impairment expenses (nature)
- Administrative expenses (nature)
- Operating profit
The retailer provides the required nature expense disclosures in a single note, showing the breakdown of depreciation, amortisation, employee benefits, impairment losses, and inventory write-downs across the operating category line items.
Example 2: Service Provider Using By-Nature Presentation
A consulting firm with a single predominant function (providing consulting services) and predominantly staff-related costs determines that by-nature presentation provides the most useful structured summary.
The consulting firm presents the following on the face of the income statement:
- Revenue
- Employee costs
- Depreciation
- Technology costs
- Occupancy costs
- Operating profit
No additional nature expense disclosures are required in the notes since all operating expenses are presented by nature on the face of the income statement.
Example 3: Manufacturer Using By-Function Presentation
A manufacturer managed on the basis of major functions determines that by-function presentation provides the most useful structured summary, and allocation of expenses to functions is not arbitrary.
The manufacturer presents the following on the face of the income statement:
- Revenue
- Cost of goods sold
- Gross profit
- Research and development expenses
- Selling expenses
- Administrative expenses
- Operating profit
The manufacturer provides nature expense disclosures in a single note showing, for example:
Nature Expense Disclosures (amounts in thousands):
Depreciation:
- Total amount recognised in the period: 72
- Cost of goods sold: 50
- Administrative expenses: 3
- Research and development expenses: 15
- Total amount related to operating category: 68
- Note: The difference between total recognised and operating category relates to depreciation of investment property included in the investing category.
- Note: Depreciation amount includes amounts capitalised to inventory.
Conclusion
IFRS 18 operating expenses analysis requirements represent a significant evolution from IAS 1, mandating face-of-statement presentation and explicitly permitting mixed presentation approaches. Entities must carefully assess which presentation method provides the most useful structured summary of operating expenses, considering factors including profitability drivers, business management approaches, industry practice, and allocation practicability.
When functional or mixed presentation is selected, entities must provide comprehensive disclosures about the five specific nature expenses in a single note. The transition to IFRS 18 requires entities to reconsider their current presentation approach and ensure it aligns with the standard's requirements for providing useful structured summaries to financial statement users.
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