Income statement presentation: IFRS compared to US GAAP

From the IFRS Institute - Nov 15, 2018

The IFRS presentation guidelines for annual financial statements are generally less prescriptive than SEC regulation, but may still surprise US private companies. IFRS preparers have some flexibility in selecting their income statement format and which line items, headings and subtotals are to be presented on the face of the statement. In this article we highlight key considerations affecting preparers when choosing the structure, format and contents of the income statement and other presentation matters.

Single statement vs. two statements

Under IAS 1[1], the income statement is the primary financial statement used to provide an understanding of a company’s performance and operations over a defined period of time. Because of its importance, its format is often debated and scrutinized by preparers, users, regulators, standard setters and others.

Under IFRS, the income statement is labeled ‘statement of profit or loss’. Like US GAAP, the income statement captures most, but not all, revenues, income and expenses. Other items of comprehensive income (OCI) do not flow through profit and loss. Examples include the fair value remeasurement of certain equity instruments, remeasurements of defined benefit plans, and the effective portion of cash flow hedges change in fair value.

Items of profit and loss and OCI can be presented as:

• a single statement: the ‘statement of comprehensive income’; or
• two separate statements: an income statement displaying profit or loss followed immediately by a separate statement of comprehensive income.

The selected structure is applied consistently.

Format and content of the income statement

Although the format of the income statement is not prescribed, certain items require presentation, if material, either on the face of the income statement or disclosed in the notes to the financial statements. Here we highlight certain items common for commercial or industrial companies and how they should be presented in the income statement.

Common items 'requiring'  presentation on the face of the income statement

• Revenue, presenting separately interest revenue
• Finance costs
• Impairment losses related to financial instruments
• Share of the profit or loss of associates and joint ventures
• Tax expense

Common items that may be presented on the face of the income statement 'or'  disclosed in the notes to the financial statements

• Writedowns of inventories to net realizable value or property, plant and equipment to recoverable value, as well as reversals of such writedowns
• Restructurings of the activities of an entity and reversals of any provisions for the costs of restructuring
• Gains or losses on disposals of items of property, plant and equipment
• Gains or losses on disposals of investments
• Litigation settlements

Presentation of expenses by function or nature

Another accounting policy election is the presentation of expenses by either their function or nature. This determination should be based on which approach is most relevant and reliable and often depends on the company, the industry in which it operates and its users’ needs.

When expenses are presented by function they are allocated to, for example, cost of sales, selling or administrative activities. At a minimum, under this method companies present cost of sales separately from other expenses. This election requires the use of IT systems, defined processes and internal controls to make sure the allocations are appropriate. In our experience, most US companies present their expenses by function.

The presentation of expenses by nature is less complex. For example, expenses may be disaggregated as purchases of materials, transport costs, depreciation and amortization, personnel costs and advertising costs. A mixed presentation is not permitted. This means, for instance, that it’s not possible to present impairment losses on nonfinancial assets or amortization and depreciation in separate line items in a presentation by function.

Regardless of the approach used, companies need to ensure the presentation is not misleading and is relevant to the understanding of the financial statements. Lastly, if presenting expenses by function, companies are required to include additional information on the nature of expenses (e.g. depreciation, amortization and staff costs) in the notes to the financial statements.

Presenting additional line items, headings and subtotals

IAS 1 allows companies to use additional line items, headings and subtotals in the income statement “if such presentation is relevant to an understanding of the company’s financial performance.” The standard allows for judgment when determining what to present and how to present it, rather than prescribing a format or specifying all the possible items.

Given that IFRS does not define gross profit, operating results or many other common subtotals, there’s flexibility when adding and defining new line items in the income statement. Many companies disclose ‘operating profit‘ or ’results from operating activities‘ as a subtotal before profit or loss in the income statement. As a general rule, all additional line items and subtotals should be clearly labeled and presented, made up of items recognized and measured using IFRS, and calculated consistently across periods. Further, items shouldn’t be displayed with more prominence than other items required in the income statement.

Unusual or exceptional items

IFRS does not describe events or items of income or expense as ‘unusual’ or ‘exceptional’. However, the presentation, disclosure or characterization of an item as extraordinary is prohibited.

We believe it is possible to characterize items as unusual or exceptional under certain conditions. This should be infrequent and reserved for items that justify a prominence greater than that achieved by separate presentation and disclosure – e.g. a natural disaster. Those items should also be classified by nature or function, in the same way as usual or non-exceptional amounts. Lastly, companies should provide an explanation of the nature of the amount and why the item has been classified in this manner.

Given the significant judgment involved, companies should exercise caution when presenting items as unusual or exceptional. For example, although often infrequent and significant, the costs associated with a restructuring event generally wouldn’t qualify.

Offsetting

Items of income and expense are only offset when it is required or permitted by IFRS, or when gains, losses and related expenses arise from the same transaction or event or from similar individually immaterial transactions and events. For example, finance costs and finance expenses are generally presented gross; so are other income and expenses.

Non-GAAP financial measures

Non-GAAP financial measures (NGFMs) – also sometimes referred to outside the United States as alternative performance measures – are not defined in IFRS. In practice, investors are increasingly looking to, and companies are increasingly presenting, NGFMs. These are generally achieved by adding subtotals, such as EBIT or EBITDA, to the income statement. Such measures can be helpful in linking a company’s financial statements to explanations of its business performance.

When NGFMs are presented, companies are expected to:

• identify and define the NGFMs presented and the components included in such measure;
• provide the basis of calculation and how such measures reconcile to the IFRS financial statements; and
• be consistently presented over time.

Read our May 2017 article, Non-GAAP financial measures are thriving.

Income statement presentation – the takeaway

Most income statement items are consistently presented with little or no ambiguity as to their terminology or order. However, there is flexibility in terms of adding line items, using non-GAAP financial measures and formatting options. Therefore, companies need to be thoughtful when exercising their presentation choices, develop detailed accounting policies and ensure consistent application of such policies with full and transparent disclosures. Companies with the intention of going public should be prepared to respond to future challenges based on these considerations.

The IASB is conducting a standard-setting project on the primary financial statements to provide clarity on subtotals in the income statement, non-GAAP financial measures and unusual or infrequent items. This project is intended to provide guidance so that companies’ alternative performance measures will be more transparent and comparable. The FASB is also conducting a standard-setting project on the presentation of financial statements.

We believe the presentation of items in the income statement will continue to be a heightened area of focus and subject to future change.

1. IAS 1, Presentation of Financial Statements
   
2. Regulation S-X Rule 5-03, Income Statements, which applies to commercial or industrial companies