IFRS 18 will not change a company’s underlying economics. It could change how investors, lenders and boards interpret its performance.
Imagine two companies in the same industry. Each reports revenue of $500 million and operating profit of $120 million.
The first company also highlights adjusted operating profit of $145 million. To arrive at that figure, management excludes restructuring costs, an impairment loss and acquisition-related expenses. The second company presents only its IFRS operating profit.
On the face of it, the first company appears to have another, higher measure of performance. Yet both companies reported the same $120 million operating profit under IFRS. The additional $25 million comes from management’s decision to separate certain expenses when explaining how it believes the business performed.
This is one of the areas IFRS 18 addresses.
The standard replaces IAS 1 and applies to annual reporting periods beginning on or after 1 January 2027. It changes the way financial performance is presented and explained in the financial statements. The underlying rules used to recognise revenue, measure assets and account for liabilities remain elsewhere in IFRS.
For someone reading a set of accounts, two parts of IFRS 18 are particularly useful to understand. It gives the statement of profit or loss a more consistent structure, including a defined operating profit subtotal, and it introduces disclosure requirements for certain performance measures created by management.
A more consistent income statement
One of the most visible changes under IFRS 18 is the way the statement of profit or loss is structured. For most companies, income and expenses will be organised around three main categories that are particularly important for analysing performance: operating, investing and financing.
The operating category will contain the income and expenses that are not classified elsewhere and, for most non-financial companies, will include much of what readers think of as the main business. For a manufacturer, that could include revenue from selling goods, production costs, employee costs and administrative expenses.
The investing category separates income and expenses from certain investments, while the financing category captures specified income and expenses associated with financing. The classifications work differently for businesses such as banks and insurers, where investing or providing finance may form part of the main business.
This is a significant change because IFRS 18 also requires two defined subtotals that give investors clearer reference points in the income statement:
- operating profit or loss; and
- profit or loss before financing and income taxes.
Operating profit or loss is built from the income and expenses classified in the operating category. It gives investors a defined IFRS subtotal before moving into the investing and financing parts of the statement.
Profit or loss before financing and income taxes goes further. It brings operating profit together with the investing category before the effects of financing and income tax are included. For many companies, this gives readers another useful point from which to examine how the underlying business and investments performed before financing costs enter the picture.
Under IAS 1, companies had more flexibility in the subtotals they presented, and operating profit was widely used without being defined consistently by IFRS. IFRS 18 gives readers a more structured route through the income statement and makes those reference points more comparable between companies.
Suppose the two companies in our example each report revenue of $500 million, operating expenses of $380 million and operating profit of $120 million. Under IFRS 18, that $120 million is not simply a figure management has chosen to label operating profit. It is a required IFRS subtotal produced from the new classification structure.
Management may still believe that $120 million does not fully explain the performance of the business and may present an adjusted figure alongside it. IFRS 18 deals separately with certain measures of that kind through its requirements for Management-defined Performance Measures.
Why companies present adjusted profit
Adjusted operating profit is a measure created by management rather than an IFRS-defined subtotal. Management begins with a reported figure and adjusts it for items it believes should be considered separately when assessing the performance of the business.
Using the earlier example:
Table 1. Illustrative reconciliation from IFRS operating profit to adjusted operating profit
| Performance measure | $ million |
|---|---|
| Operating profit under IFRS | 120 |
| Add back restructuring costs | 12 |
| Add back impairment loss | 8 |
| Add back acquisition-related costs | 5 |
| Adjusted Operating profit | 145 |
Nothing has happened to the $120 million IFRS operating profit. It remains the reported subtotal. Management has created a second figure by excluding $25 million of expenses.
There can be useful information in doing this. Consider a manufacturer that closes a factory it has operated for several decades. The closure may create substantial restructuring costs in one year, and investors may want to see the results of the remaining operations separately from those costs.
The analysis becomes more difficult when similar adjustments appear year after year. A company may describe restructuring expenses as exceptional even though restructuring has become a regular feature of the business. Acquisition-related costs may also be removed from adjusted profit even where acquisitions form an established part of the company’s growth strategy.
The accounting therefore gives investors two pieces of information. IFRS operating profit shows the result under the required reporting framework. The adjusted figure shows how management prefers to interpret part of that result. Understanding the difference requires knowing exactly what management removed and why.
Management-defined performance measures
IFRS 18 calls certain measures of this kind Management-defined Performance Measures, usually shortened to MPMs.
Not every number presented by management is an MPM. Broadly, the measure has to be a subtotal of income and expenses, be used in public communications outside the financial statements, communicate management’s view of an aspect of financial performance, and not already be a subtotal specified by IFRS.
In our example, operating profit of $120 million is not an MPM because IFRS 18 itself requires that subtotal.
The $145 million adjusted operating profit could qualify as an MPM if management uses it publicly to explain its view of the company’s performance.
Where a measure falls within the MPM requirements, the company has to disclose it in a single note to the financial statements. That note includes a reconciliation between the management-defined figure and the most directly comparable IFRS subtotal.
Using the simplified example, investors would be able to see that the difference between $120 million and $145 million consists of:
- $12 million of restructuring costs;
- $8 million of impairment losses; and
- $5 million of acquisition-related expenses.
The company also has to explain why management believes the measure provides useful information about financial performance and provide the required information about the tax and non-controlling interest effects of the adjustments.
This gives the reader something more useful than a headline adjusted-profit number on its own. An investor can look at the reconciliation and decide whether the exclusions are persuasive.
One investor may regard a factory closure as genuinely unusual and focus more heavily on the adjusted result. Another may decide that repeated restructuring is part of the cost of running the business and place greater weight on IFRS operating profit. IFRS 18 does not need those investors to reach the same conclusion. The disclosures give them more information on which to base that conclusion.
The same applies to boards and lenders. If management regularly discusses an adjusted measure when presenting performance, the reconciliation makes it easier to see how far that measure has moved from the IFRS result and which expenses are responsible for the difference.
IFRS 18 therefore leaves judgement in financial reporting. Management will still decide how it explains the business, and users of the accounts will still decide how much weight to give particular adjustments.
What changes is the framework around those judgements. Investors get a more consistent structure for the statement of profit or loss, including a defined operating profit subtotal, while certain management-defined measures have to be accompanied by enough information to show how they were constructed.
For the two companies at the beginning, the economics remain the same: each reported $120 million of operating profit. The first company can still tell investors that it regards $145 million as a useful measure of performance. IFRS 18 makes it easier to see what sits between those two numbers and decide whether management’s interpretation is convincing.