Introduction to IFRS 18 Categories
Under IFRS 18, entities must present income and expenses across five categories: operating, investing, financing, income taxes, and discontinued operations. The operating, investing, and financing categories are newly defined, while income taxes and discontinued operations follow existing presentation rules.
The new standard does not change net profit, but it promotes a more structured income statement that provides investors with clearer, more comparable information about an entity's financial performance. This structure centers on classifying income and expenses based on an entity's main business activities and presenting newly required profit subtotals, including operating profit.
Did you know?
IFRS 18 requires all entities to present an operating profit subtotal, but the composition of operating profit will vary depending on an entity's main business activities. A manufacturer's operating profit will look very different from a bank's operating profit.
The Three New Categories
IFRS 18 requires entities to classify all income and expenses into five categories: operating, investing, financing, income tax, and discontinued operations. The first three categories are new and form the core of the restructured income statement.
1. Operating Category
The operating category typically includes income and expenses from an entity's main business activities and any income and expenses not classified in other categories. This category functions as a "default" or "residual" category, meaning entities classify income and expenses here unless specific requirements direct them to another category.
The operating category does not exclude volatile, unusual, or non-recurring items. Its purpose is to provide a complete picture of an entity's operations, capturing all aspects of how the business generates value through its main activities.
2. Investing Category
The investing category includes income and expenses from investments made individually and largely independently of the entity's main business activities. These investments generate returns independently rather than in combination with the entity's other resources.
Common items in this category include share of profit or loss from equity-accounted investees, interest and dividends from financial assets, and rental income from investment property (unless investing in property is a main business activity).
3. Financing Category
The financing category captures income and expenses relating to obtaining finance to fund the entity's main business activities and investing activities. This includes interest on borrowings, fair value changes on debt instruments, and related transaction costs.
The financing category specifically distinguishes between "financing liabilities" (liabilities that involve only the raising of finance) and "other liabilities" (liabilities from transactions not solely about raising finance).
See also
In this article we looked at all the key changes from IAS 1 to IFRS 18.
Assessing Main Business Activities
A critical foundation of IFRS 18's classification framework is determining whether an entity has either or both of two "specified main business activities": investing in assets or providing financing to customers. This assessment drives how entities classify many items of income and expenses.
What Constitutes a Main Business Activity
Whether an entity has specified main business activities is a matter of fact rather than assertion. The assessment requires judgment based on individual facts and circumstances and must be supported by evidence. An entity may have more than one main business activity—for example, both manufacturing and providing customer financing.
Key Evidence and Indicators
IFRS 18 identifies several indicators that investing in assets or providing financing to customers is likely a main business activity:
Use of gross profit-type subtotals: If an entity uses a subtotal similar to gross profit that includes income and expenses which would be classified in the investing or financing category (absent the main business activity designation), this provides strong evidence. The subtotal must be used as an important indicator of operating performance, either externally to investors or internally for assessment and monitoring.
Segment reporting information: If a reportable segment under IFRS 8 comprises a single business activity, this indicates that activity is a main business activity. For operating segments, additional judgment is required to determine whether the segment's performance is an important indicator of overall operating performance.
External communication: How an entity describes and communicates its business model and operating performance to investors provides important context for the assessment.
Performing the Assessment
The assessment is performed from the perspective of the reporting entity itself. In consolidated financial statements, this means assessing from the group's perspective, which may differ from the parent's assessment in separate financial statements or a subsidiary's assessment in its own statements.
For example, a subsidiary operating as an investment property company would conclude that investing in property is a main business activity in its own financial statements. However, if this subsidiary is part of a larger manufacturing group where property investment is not central to group operations, the consolidated financial statements might reach a different conclusion.
Changes in Assessment
Entities assess whether they have specified main business activities based on facts and circumstances at the time. If an entity reassesses and determines its main business activities have changed, it applies the change prospectively without reclassifying comparative amounts. This differs from general presentation changes under IFRS 18, which are applied retrospectively.
Operating Category Requirements
The operating category captures the complete picture of an entity's operations. Its scope depends on whether the entity has specified main business activities.
General Requirements
For all entities, the operating category includes:
Income and expenses from operating assets: These are assets that do not generate returns individually and largely independently of other resources. Examples include revenue from sales, depreciation and impairment of property, plant and equipment, amortization of intangibles, and gains or losses on disposal of these assets.
Income and expenses from other liabilities: With limited exceptions, income and expenses from liabilities that do not involve solely raising finance are classified in operating. Examples include expenses for purchased goods and services recorded as trade payables, current and past service costs from defined benefit plans, and remeasurements of contingent consideration.
Default classification: Any income and expenses not specifically required to be classified in another category default to the operating category.
Important Exclusions
Two significant exclusions apply even when items arise from main business activities:
Equity-accounted investments: Income and expenses from equity-accounted investments are always classified in the investing category, without exception. This applies even when investing in associates or joint ventures is a main business activity.
Certain insurance-related items: Insurance finance income and expenses under IFRS 17, and income and expenses from issued investment contracts with participation features under IFRS 9, are always classified in the operating category regardless of main business activities.
Impact on Current Practice
The classification requirements may significantly change how entities report operating results, depending on current presentation practices. Entities currently reporting operating profit may need to reassess what income and expenses they include. Entities not currently presenting operating profit will need to develop new processes for classification and presentation.
Investing Category Requirements
The investing category captures income and expenses from specific types of assets that generate returns individually and largely independently of an entity's other resources.
Assets Generating Investing Category Income
Three categories of assets generate income and expenses classified in the investing category (subject to main business activity considerations):
Equity-accounted investments: Investments in associates, joint ventures, and unconsolidated subsidiaries accounted for under the equity method always generate income and expenses classified in investing, regardless of whether investing in these is a main business activity.
Cash and cash equivalents: Interest income from cash and cash equivalents is classified in investing, unless the entity invests in financial assets as a main business activity or provides financing to customers as a main business activity (with certain policy choices available).
Other non-operating assets: This includes debt and equity investments, investment property, and related receivables. Income and expenses from these assets are classified in investing unless the entity invests in these assets as a main business activity.
Specific Income and Expenses
The following specific types of income and expenses from the above assets are classified in the investing category:
- Income generated by the assets (interest, dividends, rental income)
- Income and expenses from initial and subsequent measurement (fair value gains and losses, impairment losses and reversals)
- Incremental expenses directly attributable to acquisition and disposal (transaction costs)
- Income and expenses from derecognition or classification as held-for-sale
Distinction from Cash Flow Statement
The investing category in the income statement is not aligned with investing activities in the statement of cash flows under IAS 7. The terms have different definitions, and items may be classified differently in each statement. For example, proceeds from selling property, plant and equipment are investing cash flows, but the gain or loss is classified in the operating category of the income statement.
Financing Category Requirements
The financing category includes income and expenses relating to obtaining finance to fund main business activities and investing activities.
Financing Liabilities
"Financing liabilities" are liabilities that arise from transactions involving only the raising of finance. In these transactions, an entity receives finance (cash, extinguishment of a liability, or receipt of own equity instruments) and later returns cash or own equity instruments.
Examples include debt instruments settled in cash, bonds settled through variable numbers of own shares, and obligations to purchase own equity instruments. Income and expenses from these liabilities classified in the financing category include interest expenses, fair value gains and losses, dividends on shares classified as liabilities, and transaction costs.
Other Liabilities
"Other liabilities" arise from transactions that do not involve solely the raising of finance. Examples include trade payables, lease liabilities, defined benefit pension liabilities, and provisions.
For these liabilities, only specific types of income and expenses are classified in the financing category:
- Interest income and expenses that IFRS Standards require to be identified
- Effects of changes in interest rates that IFRS Standards require to be identified
Other income and expenses from these liabilities are classified in the operating category. For example, the expense for goods purchased is operating, but interest on extended payment terms is financing.
Key Exclusions
Two important items are excluded from the financing category and always classified in operating:
- Income and expenses from issued investment contracts with participation features under IFRS 9
- Insurance finance income and expenses recognized in profit or loss under IFRS 17
Hybrid Contracts
Special rules apply to hybrid contracts containing embedded derivatives. If the embedded derivative is separated, income and expenses from the host follow the liability classification guidance, while the derivative follows derivative classification guidance. If not separated, treatment depends on the nature of the host and whether it involves only raising finance.
Special Rules for Specified Main Business Activities
Entities with specified main business activities—investing in assets or providing financing to customers—classify additional income and expenses in the operating category that would otherwise be classified in investing or financing.
Investing in Assets as a Main Business Activity
Entities investing in assets as a main business activity classify the following in operating rather than investing:
Investments in associates, joint ventures, or unconsolidated subsidiaries (not equity-accounted): Income and expenses from these investments are classified in operating when investing in them is a main business activity. However, if they are equity-accounted, classification remains in the investing category without exception.
Other non-operating assets: For entities like investment property companies investing in non-financial assets, or insurers investing in financial assets, income and expenses from these investments are classified in operating.
Cash and cash equivalents: Entities investing in financial assets as a main business activity also classify income and expenses from cash and cash equivalents in operating rather than investing.
Providing Financing to Customers as a Main Business Activity
Entities providing financing to customers as a main business activity (banks, finance companies, manufacturers offering customer financing, finance lessors) classify additional items in operating:
Interest income from customer loans: Classified in operating rather than investing.
Income and expenses from financing liabilities and cash equivalents related to customer financing: These are classified in operating rather than financing or investing.
Accounting Policy Choices
For entities providing financing to customers as a main business activity, important accounting policy choices apply:
Cash and cash equivalents unrelated to customer financing: Entities can choose to classify income and expenses from cash and cash equivalents that do not relate to providing financing to customers either in the operating or investing category. However, this choice is not available if the entity also invests in financial assets as a main business activity—in that case, all cash and cash equivalents income and expenses must be classified in operating.
Financing liabilities unrelated to customer financing: Similarly, income and expenses from financing liabilities that do not relate to providing financing to customers can be classified either in operating or financing as an accounting policy choice. The accounting policy for financing liabilities must be consistent with the policy for cash and cash equivalents. If an entity cannot distinguish items relating to customer financing from those that do not, all such income and expenses must be classified in operating.
Exceptions and Limitations
Important limitations apply even for entities with specified main business activities:
- Equity-accounted investments always remain in the investing category
- Interest expenses from "other liabilities" (like lease liabilities) always remain in the financing category, even if these relate to main business activities
Practical Application Guidance
Foreign Exchange Differences
Foreign exchange differences are classified in the same category as the income and expenses from the items that gave rise to them. For example, foreign exchange differences on trade receivables are classified in operating, while those on issued bonds are classified in financing (unless the entity provides financing to customers as a main business activity).
However, if this classification involves undue cost or effort, entities may classify affected foreign exchange differences in the operating category. This "undue cost or effort" threshold is lower than the "impracticable" threshold under IAS 8, but entities still need to make reasonable efforts before invoking this relief.
For "other liabilities" that generate income and expenses in multiple categories (interest in financing, other amounts in operating), judgment is required to determine the appropriate category for foreign exchange differences, with no allocation permitted between categories.
Derivatives and Hedging Instruments
Classification of gains and losses on derivatives and hedging instruments depends on their purpose and designation:
Designated as hedging instruments: Gains and losses are classified in the same category as the income and expenses affected by the hedged risk, unless this involves grossing up gains and losses (in which case, classify in operating).
Used for risk management but not designated: Derivatives follow the same classification as designated hedging instruments unless doing so involves undue cost or effort. Non-derivatives apply general classification requirements.
Not used for risk management: Derivatives are classified in the financing category if they relate to transactions involving only raising finance, otherwise in the operating category (subject to adjustments for entities providing financing to customers as a main business activity).
Derecognition and Classification Changes
Income and expenses from derecognition of an asset or liability are classified in the same category as income and expenses from that item immediately before derecognition. This principle also applies to:
- Classification as held-for-sale
- Subsequent measurement while held for sale
- Changes in use without derecognition
For groups of assets and liabilities, income and expenses from derecognition are classified in operating unless all assets in the group (other than income tax assets) generated income and expenses classified in the investing category immediately before the transaction.
Group Considerations
In consolidated financial statements, the assessment of main business activities is performed from the group's perspective. This may require consolidation adjustments when subsidiaries have different assessments in their own financial statements. Additional complexities arise in preparing consolidated statements of cash flows, which may require similar adjustments for consistency.
Conclusion
IFRS 18 establishes clear classification principles for presenting income and expenses in the statement of profit or loss. Key takeaways are:
- Operating category: captures main business activities and residual items not elsewhere classified.
- Investing category: reflects returns from assets held independently of core operations, including equity-accounted investments.
- Financing category: includes income and expenses from raising and servicing finance.
- Specified main business activities: investing in assets or providing financing to customers may shift certain items between investing/financing and operating.
- Five categories total: operating, investing, financing, income taxes, and discontinued operations.
Entities now classify income and expenses according to these principles, ensuring consistency across different types of businesses while maintaining the same net profit.
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