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IFRS 18 - Insights for financial services companies
What is the issue?
On 9 April 2024, the IASB issued a new standard – IFRS 18, ‘Presentation and Disclosure in Financial Statements’ – in response to investors’ concerns about the comparability and transparency of entities’ performance reporting. Read the related blogpost for an overview of the changes IFRS 18 introduces.
The key changes introduced by IFRS 18 for financial services entities relate to:
- Structure of the statement of profit or loss.
- Disclosures related to management-defined performance measures.
- Aggregation and disaggregation
- Foreign currency derivatives
This publication provides an overview of the requirements for each of these aspects, alongside focus areas for the financial services industry.
Structure of the statement of profit or loss
Classification categories
IFRS 18 introduces a defined structure for the statement of profit or loss. The goal is to reduce diversity, so as to help investors understand the information and make better comparisons between entities. The structure is composed of categories and required subtotals.
Items in the statement of profit or loss will be classified into one of five categories: operating; investing; financing; income taxes and discontinued operations. IFRS 18 provides guidance for entities to classify the items among these categories. Operating, investing and financing are the three main categories.
IFRS 18 requires entities to assess whether their main business activities include investing in assets and/or providing financing to customers. If so, some specific income and expenses that would otherwise be outside of the operating category are classified in the operating category.
Accordingly, for entities (such as insurers and investment funds) for which investing in assets is a main business activity, we expect that the required categories will generally reflect the following:
PwC Observation - investments in associates and joint ventures
Some insurers invest in associates and joint ventures as part of the assets that back their insurance liabilities, so presenting the results from such investments outside the operating category would create a classification mismatch. To address this issue, IFRS 18 provides an option on transition to IFRS 18. Applying that option, if an entity was eligible to account for an associate or joint venture in accordance with IFRS 9 (applying paragraph 18 of IAS 28), but previously elected not to do so, it can change that election on transition to IFRS 18.
For entities (such as banks) for which investing in assets and providing financing to customers are both main business activities, we expect that the required categories will generally reflect the following:
PwC Observation - main business activity assessment
The assessment of main business activity is performed at the reporting entity level. This means that the conclusion at group level might differ from that at the subsidiary level, resulting in some income and expenses needing to be reclassified on consolidation.
Required subtotals
IFRS 18 requires entities to present specified totals and subtotals. The main change is the mandatory inclusion of ‘Operating profit or loss’, which is defined as the result from the operating category. The other required subtotals are ‘Profit or loss before financing and income taxes’ and ‘Profit or loss’, as shown in the Illustrative examples on Viewpoint3. However, the ‘Profit or loss before financing and income taxes’ subtotal is not permitted for an entity that provides financing to customers as a main business activity and chooses to classify income and expenses as operating for all liabilities that involve only the raising of finance, regardless of whether those liabilities relate to providing financing to customers.
PwC Observation - additional line items and subtotals
Entities should also present additional line items and subtotals if they are necessary for the primary financial statements to provide a useful structured summary. Among other requirements, any subtotals that the entity presents must be consistent from period to period, and they must not be displayed with more prominence than the required totals and subtotals.
As part of the transition to IFRS 18, entities will need to assess the line items and subtotals that they currently present, to determine whether those items meet this IFRS 18 requirement, and whether any changes might be needed.
Disclosures related to management-defined performance measures
Management might define its own measures of performance, sometimes referred to as ‘alternative performance measures’ or ‘non-GAAP measures’. IFRS 18 defines a subset of these measures that relate to an entity’s financial performance as ‘management-defined performance measures’ (‘MPMs’). An MPM is a subtotal of income and expenses that:
- is used in public communications outside the financial statements;
- communicates an aspect of the financial performance of the entity as a whole; and
- is not specifically required to be presented applying an IFRS® Accounting Standard or is otherwise explicitly excluded from the scope of IFRS 18.
A financial ratio is not an MPM because it is not a subtotal of income and expenses. However, if a subtotal of income and expenses is the numerator or the denominator of a financial ratio, that subtotal might be an MPM (if the subtotal meets the definition of an MPM on a stand-alone basis). In such situations, the MPM disclosure requirements apply to the numerator or denominator that meets the definition of an MPM, but not to the ratio as a whole.
PwC Observation - balance sheet or gross measures
As compared to most other industries, financial institutions can often have more alternative performance measures based on balance sheet metrics, gross aggregations of income or expenses and regulatory measures, rather than subtotals of income and expenses.
Accordingly, many of the alternative performance measures currently used by financial services entities (for example, the loan-to-deposit ratio for banks, or the solvency capital ratios for insurance entities) will not be within the scope of the new disclosure requirements.
Information related to MPMs should be disclosed in the financial statements in a single note, including a reconciliation between the MPM and the most similar specified subtotal in IFRS Accounting Standards. This will effectively bring a portion of non-GAAP measures into the audited financial statements.
PwC Observation - MPM disclosures
Judgement might be required to determine which measures meet the definition of an MPM. Additionally, the new disclosure requirements might go beyond what is typically disclosed today for an entity’s alternative performance measures. Entities should begin the process of identifying their MPMs now to prepare for any process or internal control changes that might be required to comply with the new requirements.
Foreign exchange differences, derivatives and designated hedging instruments
IFRS 18 requires foreign exchange differences to be classified in the same category as the income and expenses from the items that resulted in the foreign exchange differences, unless doing so would involve undue cost or effort.
As an example, foreign exchange differences arising on a foreign currency-denominated liability that arises from a transaction that involves only the raising of finance (for an entity that does not provide financing to customers as its main business activity) would be classified in the financing category.
For derivatives used to manage identified risks (which includes economic hedges), gains and losses are classified in the same category as the income and expenses affected by the risks that the derivatives are managing. The same requirement applies to non-derivatives designated as a hedging instrument in accordance with IFRS 9 or IAS 39.
Gains and losses on derivatives that are not used to manage identified risks are typically classified in the operating category. However, there are additional considerations for some transactions that relate to the raising of finance that might result in some gains and losses being classified in the financing category.
1 Income and expenses from investments in associates and joint ventures that an entity elects to measure at fair value through profit or loss (FVTPL) applying the exception in paragraph 18 of IAS 28, that are invested in as a main business activity, are classified in the operating category. In contrast, if the share of profit or loss of associates and joint ventures is accounted for using the equity method, that share of profit or loss is required to be classified as investing.
2 An entity that provides financing to customers as a main business activity can choose to classify income and expenses as operating for all liabilities that involve only the raising of finance, regardless of whether those liabilities relate to providing financing to customers.
3 Viewpoint subscription required
The International Accounting Standards Board (IASB) has issued IFRS 18 'Presentation and Disclosure in Financial Statements' in April. IFRS 18 will replace IAS 1 and will have a significant impact on the statement of profit or loss. This article provides related insights for financial services companies.
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