Is IFRS 18 is good news for investors?

The introduction of IFRS 18, “Presentation and Disclosure in Financial Statements,” is poised to significantly enhance the quality of financial reporting, thereby benefiting investors. By addressing common concerns about comparability, transparency, and the structure of financial statements, IFRS 18 aims to provide investors with more relevant and reliable information for making informed investment decisions. Below are the key ways in which IFRS 18 is good news for investors.

Improved Structure of Financial Statements

One of the most notable changes introduced by IFRS 18 is the requirement for a more structured presentation of financial statements. The standard mandates that companies categorize their income and expenses into three defined categories: operating, investing, and financing. This structured approach enhances the clarity of financial statements and allows investors to better understand a company’s financial performance.

• Example: Previously, companies had the discretion to define their own subtotals, leading to inconsistencies in how operating profit was calculated. Under IFRS 18, all companies will report a standardized operating profit, providing investors with a consistent starting point for analysis. This uniformity simplifies comparisons across companies and industries, enabling investors to make more informed assessments of performance.

Enhanced Disclosure of Management-Defined Performance Measures (MPMs)

IFRS 18 requires companies to disclose management-defined performance measures (MPMs) that relate to the income statement. This change addresses the common practice where companies provide alternative performance measures without sufficient explanation, making it difficult for investors to understand how these measures relate to traditional financial metrics.

• Example: A company may report an adjusted EBITDA figure as an MPM. Under IFRS 18, the company must provide a clear reconciliation of this measure to its operating profit, including an explanation of how it is calculated. This increased transparency enhances the credibility of MPMs and allows investors to assess their relevance and reliability.

Better Alignment with Investor Needs

The changes brought about by IFRS 18 are designed to align financial reporting more closely with the needs of investors. By requiring additional disaggregation and clearer presentation of financial information, the standard aims to provide investors with the data they need to evaluate a company’s performance effectively.

• Example: Companies will be required to present operating expenses in a manner that allows investors to distinguish between different types of expenses (e.g., fixed vs. variable costs). This level of detail helps investors understand the cost structure of a business and assess its operational efficiency.

Consistency in Cash Flow Reporting

While IFRS 18 primarily focuses on the presentation of the income statement, it also introduces changes that improve the consistency of cash flow reporting. The standard requires that interest expenses and dividend income be reported outside of the operating category in the cash flow statement, either in investing or financing activities.

• Example: Previously, companies had flexibility in where to present interest expenses, leading to a lack of comparability in cash flow subtotals. Under IFRS 18, all companies will present interest expenses consistently, improving the reliability of cash flow data for investors.

Addressing Investor Concerns

IFRS 18 responds directly to investor concerns regarding the challenges in comparing financial performance across companies. By standardizing the presentation of financial statements and enhancing disclosure requirements, the standard aims to reduce confusion and improve the overall quality of financial information available to investors.

• Example: Investors often encounter difficulties when analyzing companies with different reporting practices. IFRS 18 mitigates this issue by establishing a common framework for financial reporting, making it easier for investors to evaluate and compare companies’ financial health and performance.

IFRS 18 impact the way companies present their cash flow statements

IFRS 18 will have a significant impact on how companies present their cash flow statements, particularly in the areas of interest expense and dividend income classification, as well as the starting point for indirect operating cash flow reconciliation. Here are the key changes:

1. Interest Expense and Dividend Income Classification

Currently, IFRS allows companies flexibility in where they present interest expense and dividend income in the cash flow statement – either in or outside the operating category. This has led to a lack of comparability of cash flow subtotals across companies.IFRS 18 now requires that:

• Interest expense must be reported outside of the operating activity section, in either investing or financing as appropriate.
• Dividend income must also be reported outside of operating, in either investing or financing.

This change will enhance comparability of cash flow subtotals between companies.

2. Indirect Operating Cash Flow Reconciliation

When using the indirect method to calculate operating cash flow, companies must now start the reconciliation with the newly defined “operating profit” subtotal from the income statement.Previously, companies started the indirect operating cash flow calculation with a variety of profit measures, including operating profit, pre-tax profit, and net income. This inconsistency was confusing for investors.Under IFRS 18, all companies will use the same starting point – operating profit. While this does not change the final operating cash flow figure, it provides a common basis for the reconciliation that is more understandable for investors.

Benefits for Investors

These changes to cash flow statement presentation will be beneficial for investors in several ways:

1. Improved comparability of cash flow subtotals between companies due to the consistent classification of interest and dividends.
2. Greater relevance and understandability of the operating cash flow metric specifically, as it will be calculated from a common starting point.
3. Reduced confusion that currently exists due to the variety of starting points used in indirect operating cash flow reconciliations.

Below are practical examples illustrating how IFRS 18 will impact the presentation of cash flow statements, particularly focusing on the classification of interest expenses and dividend income, as well as the reconciliation of operating cash flow.

Example 1: Interest Expense Classification

Scenario: Company A has the following cash flow statement items for the year:

• Interest Expense: $200,000
• Operating Profit: $1,000,000
• Cash Flow from Operations (Indirect Method): $900,000

Under Previous IFRS Standards:

Company A had the flexibility to classify interest expenses either in the operating section or the financing section of the cash flow statement. Suppose Company A chose to classify it as an operating cash flow:

Cash Flows from Operating Activities:

Under IFRS 18:

Now, Company A must report the interest expense outside of operating activities, which improves comparability with other companies

Under IFRS 18:

Company B must now report the dividend income outside of operating activities, which enhances the clarity of cash flow reporting.Cash Flow Statement (IFRS 18):

Cash Flows from Operating Activities:

Example 3: Indirect Operating Cash Flow Reconciliation

Scenario: Company C uses the indirect method to calculate its cash flow from operations. The company has the following figures:

• Net Income: $600,000
• Depreciation: $100,000
• Changes in Working Capital: $50,000
• Interest Expense: $30,000

Under Previous IFRS Standards:

Company C may have started its reconciliation with net income or operating profit, leading to inconsistencies in how operating cash flow is reported.

Cash Flow Statement (Previous Standards)/ IFRS 18

Under IFRS 18:

Company C must now start its reconciliation with the operating profit, providing a consistent basis for all companies.

How does IFRS 18 improve the comparability of financial data for investors

1. Standardized Classification of Income and Expenses

IFRS 18 mandates that all companies categorize their income and expenses into three defined categories: operating, investing, and financing. This standardization will result in a more structured presentation of financial statements, enabling investors to easily identify and compare financial performance across different companies.

• Example: Previously, companies had the discretion to define their own subtotals and classifications, leading to variations in how operating profit was calculated. Under IFRS 18, all companies will report operating profit using a consistent definition, allowing investors to make more meaningful comparisons.

2. Defined Subtotals and Enhanced Disaggregation

The standard introduces specific subtotals that companies must present, such as “operating profit or loss” and “profit or loss before financing and income taxes.” This requirement enhances the clarity of financial statements and provides investors with consistent metrics for analysis.

• Example: A company might previously report operating profit differently than its competitors, using various calculations that could include or exclude certain items. With IFRS 18, all companies will have to provide a defined operating profit, making it easier for investors to assess operational efficiency across the sector.

3. Improved Transparency of Management-Defined Performance Measures (MPMs)

IFRS 18 requires companies to disclose management-defined performance measures that relate to the income statement, along with clear reconciliations to the closest IFRS measure. This change addresses the common practice of companies providing alternative performance measures without sufficient context, which has often led to confusion among investors.

• Example: If a company reports an adjusted EBITDA figure as an MPM, it must now provide a reconciliation to operating profit, including an explanation of how the measure is calculated. This increased transparency helps investors understand the relevance and reliability of these measures.

4. Consistent Starting Point for Cash Flow Reporting

The new standard also impacts the cash flow statement by requiring that companies start the reconciliation of operating cash flow with the newly defined operating profit. This change eliminates the previous flexibility that allowed companies to use various profit measures as starting points, which often resulted in confusion.

• Example: A company might have previously started its cash flow reconciliation with net income or pre-tax profit, leading to inconsistencies. Under IFRS 18, all companies will begin with operating profit, providing a uniform basis for comparison.

5. Enhanced Guidance on Aggregation and Disaggregation

IFRS 18 provides enhanced guidance on how companies should aggregate or disaggregate items in their financial statements. This requirement ensures that financial data is presented in a manner that is useful for investors, avoiding the pitfalls of overly summarized or excessively detailed information.

• Example: Companies will be required to present operating expenses in a way that allows investors to distinguish between different types of expenses, such as fixed versus variable costs. This level of detail helps investors assess the cost structure of a business and its operational efficiency.

6. Addressing Investor Concerns

The changes brought about by IFRS 18 directly respond to investor concerns regarding the challenges of comparing financial performance across companies. By standardizing the presentation of financial statements and enhancing disclosure requirements, the standard aims to reduce confusion and improve the overall quality of financial information available to investors.

• Example: Investors often struggle to analyze companies with different reporting practices. IFRS 18 mitigates this issue by establishing a common framework for financial reporting, making it easier for investors to evaluate and compare companies’ financial health and performance.

How have companies like Apple or Amazon adapted their financial statements to comply with IFRS 18

IFRS 18 has not yet been implemented, as it is effective for annual reporting periods beginning on or after January 1, 2027. However, we can speculate on how companies like Apple and Amazon may need to adapt their financial statements to comply with the new standard based on the key changes introduced by IFRS 18:

Standardized Classification of Income and Expenses

IFRS 18 requires companies to classify all income and expenses into operating, investing, or financing categories. This may require Apple and Amazon to reclassify certain items in their income statements.For example, Apple currently presents “Other Income/(Expense), Net” which includes items like interest and dividend income, as well as gains/losses on the sale of marketable securities. Under IFRS 18, these items would likely need to be reclassified into investing or financing categories rather than operating.

New Subtotals and Defined Terms

IFRS 18 introduces specific subtotals that must be presented, such as “operating profit or loss” and “profit or loss before financing and income tax”. Apple and Amazon would need to ensure they are calculating and presenting these subtotals consistently.

Disaggregation of Expenses

The new standard requires companies to disaggregate expenses in the income statement by nature (e.g. employee benefits expense, depreciation) or by function (e.g. cost of sales, selling expenses). This may require changes to the expense line items presented by Apple and Amazon.

Management Performance Measures (MPMs)

If Apple and Amazon report any alternative performance measures, IFRS 18 requires reconciliations to the closest IFRS subtotal and explanations of how the MPMs are calculated. This could lead to additional disclosures.

Cash Flow Statement Changes

While IFRS 18 focuses mainly on the income statement, it also impacts the cash flow statement by requiring interest and dividends to be classified consistently as either operating, investing or financing activities. This may require reclassifications in the cash flow statements of Apple and Amazon.In summary, while the fundamental financial information reported by Apple and Amazon is unlikely to change under IFRS 18, the presentation and classification of items in their primary financial statements and disclosures will need to be adapted to comply with the new requirements. This may impact the calculation of key metrics and ratios used by investors to analyze the companies’ financial performance.