NZ IFRS 18 will improve how information is communicated in your financial statements, particularly in the statement of profit or loss and notes to the financial statements. Previously, NZ IAS 1 lacked detailed requirements for:
- the classification of income and expenses in the statement of profit or loss
- the presentation of subtotals in the statement of profit or loss, and
- the aggregation and disaggregation of information presented in the primary financial statements or disclosed in the notes.
This led to entities defining their own subtotals and performance measures, which made comparison of financial performance between entities difficult for investors.
What’s new in NZ IFRS 18?
In addition to the impact on the statement of profit or loss and notes to the financial statements, there are also limited changes to specific requirements set out in NZ IAS 7, ‘Statement of Cash Flows’. Only minimal changes were made to the disclosures required for the statement presenting comprehensive income, the statement of changes in equity, and the statement of financial position. And while NZ IFRS 18 still comprises a lot of the requirements in NZ IAS 1, there are some key changes you need to be aware of.
Presentation requirements in the statement of profit or loss
The main change introduced by NZ IFRS 18 is the way in which your statement of profit or loss is structured. Firstly, the standard introduces two new defined subtotals:
- Operating profit, and
- Profit before financing and income taxes
These will increase comparability by ensuring information presented for investors is consistent across different entities. Additionally, you will be required to classify all income and expenses into one of five categories:
Investing
Your entity should include income and expenses from investments in associates, joint ventures, and unconsolidated subsidiaries, as well as from cash and cash equivalents within this category. The investing category should also include income and expenses from assets that generate returns separately from your entity’s other resources such as debt or equity investments, and investment properties.
Financing
This is where you make the distinction between transactions that are exclusively for the purpose of raising finance, and those that are not. It includes income and expenses from all liabilities that result solely from raising finance, along with some elements of interest income or expense recognised by applying other reporting standards. By providing the subtotal for profit before financing and income taxes, investors can also see your organisation’s performance before the impact of any borrowing.
Income taxes and discontinued operations
These two categories include income and expenses resulting from the application of NZ IAS 12 ‘Income Taxes’ and any related foreign exchange differences, and NZ IFRS 5 ‘Non-current assets held for sale and discontinued operations’ respectively. The use of these subtotals should provide relief for most preparers because you will not be required to split discontinued operation and tax balances separately between the operating, financing and investing categories.
Operating
Finally, the operating category includes all other items of income and expense that are not allocated to one of the other four categories. It is a default category, so it is important to note it will include income and expenses from your organisation’s main business activities, regardless of whether the income or expenses are volatile or unusual. The operating profit subtotal provides not only a measure of past performance, but also a starting point for forecasting an entity’s future cash flows.
Your current accounting systems may need to be adjusted so you can classify or tag the income and expenses that fall under each of these categories. This process will involve varying degrees of complexity based on the nature of your business, particularly if it has diverse operations, multiple main business activities or multiple reporting systems.
Foreign exchange differences
NZ IFRS 18 requires foreign exchange differences to be classified in the same category of the statement of profit or loss as the income and expenses from items that caused the foreign exchange differences. For example, foreign exchange differences on bank loans would be classified in the financing category. However, if this involves undue cost or effort, you can classify them in the operating category. Careful attention should be given to specific requirements for classifying income and expenses from hybrid contracts and fair value gains and losses on derivatives.
Entities with specified main business activities
NZ IFRS 18 can be complicated for businesses like investment firms, financial institutions and insurers where their main business activities (e.g., investing in assets, or providing financing to customers) would also fall into the definition of investing or financing activities.
If your entity invests in assets as a main business activity, income and expenses are split between the investing category and operating category, depending on how the underlying assets are accounted for. For all assets accounted for using the equity method, income and expenses are included in the investing category, and for all other assets income and expenses are included in the operating category.
If your organisation provides financing to customers as its main business activity, you should classify income and expenses from liabilities relating to this service in the operating category.
The assessment of your entity’s main business activities is going to be a key judgement which may significantly impact the geography of where items appear in your statement of profit or loss. This is likely to prove particularly challenging for mixed groups and groups of reporting entities which provide multiple services.
New requirements for the notes to the financial statements
In addition to those carried forward from NZ IAS 1, NZ IFRS 18 also introduces two new disclosures to supplement the primary financial statements:
- Management-defined performance measures, and
- Specified expenses by nature
Management-defined performance measures
To address the significant diversity in practice currently seen when it comes to so-called ‘alternative performance measures’ and any non-GAAP performance measures, NZ IFRS 18 introduces the concept of a ‘management-defined performance measure’ (MPM).
MPMs are subtotals of income and expenses other than those listed by NZ IFRS 18 or specifically required by another reporting standard your entity uses:
- in public communications outside financial statements, and/or
- to communicate management’s perspective about aspects of the entity’s financial performance as a whole.
Alongside any MPMs that are disclosed, you will also be required to disclose:
- a reconciliation between the MPM and the most directly comparable NZ IFRS 18 subtotal, total or subtotal required by another NZ IFRS
- a description of how the MPM communicates management’s view and how it is calculated
- an explanation of changes to the MPMs disclosed or to how any of the measures are calculated, and
- a statement indicating measures used to reflect management’s view of the financial performance of the entity as a whole and that the measure may not always be directly comparable to any measures sharing similar labels and descriptions provided by other reporting entities.
These disclosures will be required for any measure that meets the definition of a MPM, and when applicable they must be included in a single note in your financial statements.
Your management and investor relations teams will need to work together to identify which MPMs are being used within public communications, and assess which additional disclosures need to be included in the financial statements.
Updated guidance for the aggregation and disaggregation of information
The standard provides specific guidance to ensure aggregation and disaggregation in your financial statements is consistent and provides investors with the information they need for their own analysis. The basic principles set out in NZ IFRS 18 require entities to:
- aggregate or disaggregate items based on whether they share similar characteristics or have different characteristics
- ensure the method of grouping items does not obscure material information or reduce understanding, and
- apply aggregation or disaggregation based on characteristics in both in the primary financial statements and the notes to the financial statements.
Changes to how expenses in the operating category are presented
Like NZ IAS 1, NZ IFRS 18 requires an entity to present its operating expenses based either on their nature or their function in a structured and meaningful way. If your entity is presenting expenses classified by function, the standard requires you to disclose the amount of depreciation, amortisation, employee benefits, impairment losses and write-down of inventories included in each line in the operating category of the statement of profit or loss.
Consequential changes made to other standards
Consequential changes have been made to the standard on cash flow statements. NZ IAS 7 now requires entities to use the operating profit total as defined in NZ IFRS 18 as the starting point for reporting cash flows from operating activities using the indirect method.
The previous interest and dividend presentation alternatives have also been removed to simplify practice and reduce the diversity in their preparation.
Elsewhere, NZ IAS 33 ‘Earnings per Share’ (EPS) requirements have been amended to permit an entity to disclose additional EPS information over and above reporting basic and diluted EPS amounts. However, additional amounts can only be included in the EPS calculation if the numerator is either a total or subtotal identified in NZ IFRS 18 or a MPM. NZ IAS 34 ‘Interim Financial Reporting’ has also been updated to require disclosure of information about MPMs in interim financial statements and guidance is now provided on how subtotals should be dealt with.
When does NZ IFRS come into effect?
The standard is effective from annual reporting periods beginning on or after 1 January 2027, allowing you and your auditors time to properly prepare for the transition to NZ IFRS 18. Early adoption of the standard is permitted, however NZ IFRS 18 must be applied retrospectively, so restatement of all comparative information is required when the standard is adopted.
Next steps
In terms of what to disclose now, Tier 1 reporters will need to disclose the impact of NZ IFRS 18 or state the entity has not yet applied the standard.
While the effective date is a while away, you should begin planning for the transition to this new standard sooner rather than later, especially considering the potential impact the new NZ IFRS 18 disclosures and definitions may have on existing loan covenants and remuneration contracts. And of course, you will be delivering the benefits of easier comparisons of financial statements to your investors.
