Explore the new IFRS 18 and its impact on company reporting

Garreth Hanley:
This is With Interest, a business, finance, and accounting news podcast, brought to you by CPA Australia.

Tiffany Tan:
Welcome to With Interest podcast. My name is Tiffany Tan. I'm the external reporting and assurance lead at CPA Australia. In today's show, we'll be diving into an important topic, IFRS 18, the new standards that bring significant changes to financial reporting. As many of you know, IFRS 18 replaces IAS 1 and is a shift that will affect preparers, auditors, and stakeholders alike.

IFRS 18 presentation and disclosure in financial statements mark a major shift in accounting standards, replacing the old standards and changing how profit and loss statement is presented. These changes are expected to impact entities of all sizes and industry, prompting a closer look at what they mean for financial reporting. IFRS 18 is effective from 1st January 2027. However, this date may differ across jurisdiction and types of entity.

Joining us today's show are David Hardidge FCPA, and Shaun Steenkamp CPA. David is the financial reporting expert and the former chair of the External Reporting Centre of Excellence at CPA Australia. Shaun is a member of the External Reporting Centre of Excellence at CPA Australia. Shaun wears many hats and works for large corporates inc. such as Transurban, NAB, KPMG, and was previously a standard setter. Welcome to With interest, David and Shaun.

Shaun Steenkamp:
Good to be here. Thanks, Tiff.

David Hardidge:
Thanks very much for having me, Tiff.

Tiffany Tan:
No worries. I'm going to jump into our first question now. For our listener who may not be aware of these changes, Shaun and David, could you please give us an overview of the main changes introduced with IFRS 18 compared to the previous standard IAS 1? I may start with Shaun first and then we might go to David for additional thoughts on this topic.

Shaun Steenkamp:
Thank you, Tiff. IFRS 18 creates a fundamental shift in how the primary financial statement for income and loss is presented. So previously, entities would've chosen to present profit and loss by nature or function, which going forward is now going to show categories of income and expense.

So as you might know, those categories are operating, investing, and financing, plus of course, we've got income tax and discontinued operations, which people would already be familiar with. Further introduced is the concept of management-defined performance measures.

Entities can now disclose those. They also have additional disclosure requirements in how those measures are defined and also how they reconcile to other IFRS information.

Tiffany Tan:
Thanks, Shaun. I wonder, David, Shaun has gave quite a good overview. Is there anything else you can add about the changes here?

David Hardidge:
Not a lot. I'd let people know that with the split in between operating, finance, and investing, there's actually an operating profit figure to be disclosed and that's going to help analysing companies. Also, when you look at financial statements and profit and loss statements, the list of expenses is sort of really higgledy-piggledy from one entity to another.

So this split operating, financing, investing will pull out things like interest, which might be at the bottom of the list. It might be near the bottom, it might be in the middle, but it'll be put into a consistent category and that will help analysis a lot.

Tiffany Tan:
Thank you, both. I thought that was a really insightful overview for the main differences between IFRS 18 and IAS 1. It is clear that the new standard brings some significant shift that will impact how organisation approach their financial statements.

Now, before we dive even deeper into IFRS 18, I want to start with we know that IFRS 18 aims to improve comparability across different entity and make reading financial statement easier for investors. I wonder, will this change achieve this goal? So if I may just start with David this time. What are your thoughts on this topic, David?

David Hardidge:
Yes. I think the split operating, financing, investing the operating profit will help a lot with comparability. In terms of the standard in the public sector, in particular not for profits, we've still got to look at this in a bit more detail. So we've got another year on top of the 1st of January two thousand twenty seventh, at least in Australia. We've got a year's extension to look at how this is going to work.

Tiffany Tan:
And Shaun, what's your view on this?

Shaun Steenkamp:
So I'm a little less bought into the concept that this will improve comparability significantly across entities. I think it does introduce more information to the statement of profit and loss that will allow individuals or users to make their assessments, but I'm not entirely convinced that there's going to be a big step change in usability as a result. I think that there are a number of judgments involved in how you classify items of income and expense that will differ significantly across various entities.

And I think you might find consistency or comparability within sectors. But I think once you start moving outside and do cross-sector comparisons, some of that benefit will be reduced. Now, if you might ask me then to say, "Well, what does that then mean compared to what we have today?" I think these are challenges we have today, and I don't think IRFS 18 will make substantial differences there. I think there'll be improvements, but it's not going to be significant.

Tiffany Tan:
That's a good point. So I did hear you talk about, I think there's a slight difference between comparability and consistency. And from what I'm listening, you're thinking more like, "Yes, there will be comparability, but at the end of the day, consistency is quite important for a particular entity." So you do not want to, one year be reporting a particular expense in operating, the next year, you're slotting them into financing, so that would not be the outcome of the standard.

That's good. Good to know. Thanks for that, David and Shaun. It's certainly a promising goal to improve comparability regardless and also the accessibility for investors and it will be interesting to see how this will all play out over time. Now let turn to another key element of IFRS 18. The new requirement for management-defined performance measure, or I'm going to shorten this, NPM, because it's too long.

Now it is interesting. One, some people say NPMs provide valuable insights into a company's performance while others feel like concern about potential misuse or misinterpretation. And for the listener who aren't familiar with NPMs, I'll repeat the long name, management-defined performance measure. Can you give a quick overview of what they are? Maybe we'll start with Shaun on your thoughts about what they are and then I might go to the next question later.

Shaun Steenkamp:
Sure. So management-defined performance measures or NPMs, some might be more familiar with terminology such as underlying profit or EBITDA or cash earnings. All those would be management-defined performance measures and entities have used them quite a lot in history in their reporting outside of the financial report. And they really do also form a basis and they're important because they form a basis in what entities use in, say, their incentive plans for executives.

So they're significant measures, they're very important measures, and they've been missing from financial reports. And I think what investors are really looking for is to bring those into the financial reports to allow them to link those measures with what's in the financial report and is being audited and see that story play out into all their other publications that these entities make, like investor packs and investor day presentations and all those sorts of information.

Tiffany Tan:
Yeah, I think it makes sense because I think a lot of those measure NPMs sits in OFR. I know that a lot of jargon in this podcast, but other financial information, right? So it makes sense to have some sort of reconciliation back. And I wonder, David, do you have any other perspective to add in this respect or maybe I can go straight to the next question about how will reporting NPM potentially impact financial analysis?

David Hardidge:
Well, I think most of the discussion with NPMs links to the private sector and underlying profit and look over here, rather than the statutory profit and executive remuneration. In the public sector, they're less common. So I've seen it a few times in universities. I potentially see it, and this is possibly an unintended consequence or intended consequence in, for example, local governments and they get a lot of their money from Commonwealth government funding. And that Commonwealth government funding is often given for the next financial year, but it might be before the start of the next financial year.

It might be literally 28th, 29th, 30th of June. And the way the accounting standards are written, that has to be recognised when received and not deferred until the next year. And so the Commonwealth government also changes how much they pay in advance from 25 to 50%. So I have seen local governments say, "Well, if only we had different payments, our profit would've been X." And potentially, that becomes a management-defined performance measure that then brings into account the disclosures and the auditing of those disclosures in the notes.

Tiffany Tan:
And Shaun, do you have anything to add on top of those, complexity or concern?

Shaun Steenkamp:
Yeah, so I think what we're going to find is, and as David illustrated here with just local governments and state governments, is different entities have different performance measures. And I think as you work through how that's going to be adopted across the private sector, you'll find something might be called underlying profit for one entity and it's the calculation of it and the reconciling items are entirely different to another entity.

So if you're looking for comparability in management-defined performance measures to try to assess the performance of an entity in the way that management intends to disclose it, you're not going to get comparability even with the additional disclosures just because of the fact that it is a management lens to the performance of the entity.

Tiffany Tan:
Yeah, makes sense. All right. Thank you for all those insight on NPMs. It's clear that while they offer a tailored view into the company's performance, they're also valid concern about ensuring their use responsibly and consistently. This leads us to another mixed area of opinions around IFRS 18. Now the topic is about the impact of financial transparency.

Some people believe that the standard will enhance transparency for investors while others feel it may add unnecessary complexity and noise to the financial statements. I'd love to hear your perspective on this.

Do you think if IFRS 18 ultimately bring greater transparency or does it risk making financial reports more cumbersome for user? Maybe this one is for you, Shaun? What's your thought on this?

Shaun Steenkamp:
Sure. So I think the question really is about whether you think more disclosure equals more transparency, right? So in my view, you can have a financial report that contains far too much disclosure. Realigning how the income statement looks can help and it really does allow a user to have a look at that operating income subtotal and assess from normal business transactions what is the income of my entity that I'm looking at?

I think what's going to be interesting is how users attempt to reconcile operating income to operating cash flows. I don't think that they're necessarily reconcilable and that is where transparency can become a bit murky. So for me, I think, look, I don't believe there's necessarily a step change, again, in transparency. I think this doesn't hurt. It's certainly something that's going to present something different for the future and it may or may not be useful to users.

Tiffany Tan:
Yep, yep. Got it. And David, I'll turn it to you as well and give you a chance to have some input on this topic if you like?

David Hardidge:
For transparency, I'd look at it from a couple of angles and it's under the broad topic of aggregation and disaggregation and it's probably the least sexiest sounding term of all the different changes, doesn't have fancy acronyms and names like management-defined performance measures. So aggregation and disaggregation is about getting all the thousands, tens of thousands, hundreds of thousands of transactions at the general ledger and the subsidiary ledgers into a one-page profit and loss statement and a one-page balance sheet and the accompanying notes.

So you've got to aggregate things that are similar and disaggregate things that are dissimilar and you're supposed to not have anything what we call "large others." Now, in the current accounting standard, people tell me and ask, "Prove to me I've got to split this out." And well, it's sort of there and you're supposed to do the right thing. But in a lot of cases, over my many years of history is that they don't necessarily do that.

So there's now rules, specific rules of pulling things out and if there's any large others, if you do end up with that, you've actually got to disclose what the largest other is in there or just say everything's very, very small. The other part with this aggregation, disaggregation, I think it's going to give us less risk of surprises. So a few years ago, there was a controversy regarding supplier finance arrangements and that's also called reverse factoring.

It's been around for years. But what happened was that some companies were adopting this approach and there was some problems with how they applied it because essentially, they were pushing costs and financing costs into their supply chain. But what was happening was that a non-bank financial intermediary was inserted between the customer and the supplier and in particular, one very large one, Greensill, for those who remember collapsed multi-billion dollar company around the world.

And all of a sudden, large companies that had adopted this approach had to scramble to try and get extra financing and people were saying, "Well, why didn't you tell me you were doing this thing and tell me about the risks." And so hopefully, this disaggregation of dissimilar arrangements would've enabled that to have been separately disclosed at the time. And what happened was that they actually had to modify the standards specifically for this type of arrangement. You really don't want to do that all the time and pick things up. So hopefully, the aggregation, disaggregation will avoid those situations in the future.

Tiffany Tan:
Thank you, both, for sharing your perspective on transparency. I think it's definitely a balancing act between providing clear, comparable information and avoid the excessive complexity in this area. Now let's turn to something more practical. We're talking about adopting IFRS 18 now. Transitioning to the new standard comes with its own costs. We all know that, from direct expenses to time, resources required for implementation. What are the anticipated costs associated with adopting IFRS 18, and do you believe these benefits ultimately will outweigh the cost? I think, Shaun, you will be best placed in this, given that you are in the thick of things, hey?

Shaun Steenkamp:
Yes. So I have implemented a number of standards in my time. We've had a flurry of them recently. So I think the cost of implementing the standard is going to vary depending on the kind of entity you are and how large you are. So I believe if you're looking at an entity that's transitioning now, they're at the top end of town, ASX 50, for example. They will have a lot of this information at hand because of all the additional information that they publish alongside their financial reporting.

So for them, incorporating that into the financial statements is probably the hardest part. I'm not saying it's going to be easy, but it is going to be necessary for them to step through what the requirements are, what information they have, is it auditable, what support do they have for it because it's now being incorporated into the financial report. I think for your other entities that may not be publishing as much non-financial information outside of the financial reports.

They're going to see quite a significant increase in cost for transition. And I'm very, very specific here about transition because that's where the time is spent in resources and consultants coming in and helping you understand what the requirements are and how your financial report needs to be redesigned, which can involve your software vendors who are helping you with your financial statements. It can involve your auditors.

It can involve your stakeholders like your board, other investors, financiers, and so on. Take them on the journey of transition. Once it's BAU, I think then it's probably the costs will become more comparable to what we have today. But I think it's very important that entities of all sizes don't underestimate the transition effort that's going to be necessary for the standard.

Tiffany Tan:
Thanks, Shaun. And David, you come from a different sector, the government sector. Do you see that a slightly different approach from what Shaun just explained?

David Hardidge:
Well, I think we've all got a similar sort of transition cut, so agree with everything Shaun said. What I'd like to highlight to people is something that I think has been missed in a number of summaries and that's to do with additional disclosures and it relates to the classification of expenses. And most people are used to classification by nature, which is the nature of the expense, employee expenses, depreciation, and amortisation and classification of expenses by function, which is how the business operates.

That could be cost of goods sold, selling expenses, R&D, and just normal admin. Now the difference is that cost of goods sold and cost of sales will have depreciation and amortisation employee expenses. So will the selling costs and so will the research and development costs. So at the moment, if you disclose by function, you're supposed to disclose those expenses by nature, depreciation and amortisation and employee expenses, and that was what the proposals were going to be.

However, it hasn't come out like that. So for various reasons, the International Accounting Standards Board has decided not to require disclosure of expenses by nature, if you disclose by function. What they're requiring is that for each line item, for each functional line item disclosed like cost of sales and selling and R&D, you have to give a breakdown of five particular expenses: depreciation, amortisation, employee expenses, and a couple of impairments and reversals.

But each one, cost of goods sold, depreciation, amortisation, employee expenses, the two impairments. Selling expenses, depreciation, amortisation. So that's going to be something very new and quite possibly going to be some work to try and extract that data and I'm not seeing that brought out in a number of the summaries. It's sort of hidden in the more in-depth publications that people need to concentrate on.

Tiffany Tan:
That also sound like explosion of the length of the notes to the financial statement by the sound of it. Can you imagine you have to reconcile all the line item, but another five line item at the notes?

David Hardidge:
Yeah. Yes. If you look at the illustrative examples that accompany the standard, it's sort of like a page long, yes.

Tiffany Tan:
Yes. I think it's clear from the discussion so far that adopting IFRS 18 will require a substantial investment regardless what type entity you are, the size, or the sector. Beyond this initial expenses, the new standard introduced a few additional complexities. So building on this, I would like to explore a bit more about the other consideration that we need to think about. Thanks, David, for bringing out about this function and nature.

You know how you prepare that. But also, I want to dig a bit deeper about maybe there's a lot of talk also about identifying main business activities. So maybe we can talk a bit about that and what are the extra considerations that we need to ensure that the organisation will be interpreting and applying this particular requirement accurately. So I might start that with Shaun.

Shaun Steenkamp:
Yep, exactly. So I think the judgement you mentioned there are main business activities is going to be quite important. For a lot of entities, I think it's going to be straightforward, but there will be entities that have multiple main business activities as the standard acknowledges. It sounds a bit counterintuitive, main business activity.

You've got five of them. But I think that drives a key judgement within the standard where it has classification requirements for entities with specified main business activities. So for example, entities that might have a financing function as well as their ordinary trade functions. So a car manufacturer, dealer might do this, for example.

They provide finance, plus they sell cars. Where you have those two main business functions, you have to classify interest differently depending on which main business activity's driving it and then the question then arises, "Well, do I have to split, say, interest income by interest I'm earning on just standard business deposits versus interest I'm earning on finances and how do I split that out?"

So I think that's going to be an important discussion. The other one that I just want to add as well is the interplay between IFRS 18's management-defined performance measures and ASIC's regulatory guide on non-IFRS financial information. So I think someone is going to have to... I think ASIC is going to have to spend some time thinking about that guide and entities that are transitioning to IFRS 18 will need to think about how those two sets of requirements come together.

Tiffany Tan:
Good point. I completely missed that one, actually, the ASIC one. So I hope ASIC is listening. And David, do you have any perspective on this particular topic as well that you want to share?

David Hardidge:
Yeah, I think it's the practical application of the standard. So if you look at banks, they've got interest income and interest expense from all the different funds and deposits that they use. Well, that doesn't quite work with operating, financing, investing because their operating is interest, which would normally be financing and what have you. And Shaun gave the example of the car dealer. Where you’ve got potentially manufacturing cars as well as selling cars as well as financing the cars.

And we've got to try and put this into the operating, financing, investing split. And there's all these choices and requirements that companies have to follow to make all this operating, financing, investing work. So that's going to involve a fair bit of work and also involves asset managers as well. That's another particular area that people need to look at. So yes, it's going to be a fun one for those affected.

Tiffany Tan:
Thank you for highlighting the added complexity around identifying main business activities. Clearly, applying this aspect of IFRS 18 requires careful judgement to align with the standard's intention. This brings us to an important question. How do company perceive the benefits of IFRS 18 compared to the challenges? What are some of the perceptions around whether the standard's advantages makes the added complexity worthwhile? And Shaun, I might go to you first because you might have this insight to share as well and your thoughts about this particular perception out there.

Shaun Steenkamp:
So I think if you look at the standard in two aspects, right? You've got obviously the change to the profit and loss statement and then you have the introduction of management-defined performance measures coming into the financial report. I think companies are going to be very keen to bring management-defined performance measures into the financial report because it allows them to create enhanced connectivity between the financial report and additional investor reporting that they produce. That is going to allow them to tell a consistent story across all their documents and allow investors in particular and other interested parties, perhaps, to understand how you translate from financial reports to the management view of the entity's performance.

Tiffany Tan:
Fabulous. And David, do you have some thoughts about this as well to share?

David Hardidge:
Well, I guess in a concentrating on the public sector that doesn't have a lot of these management performance measures and unless they're unintended consequences that I mentioned before, it's just going to be seen, I think, as a pain to try and reformat profit and losses and what have you to meet the new requirement, particularly as you don't have direct investors that you're already reporting to. But I think overall, it will help a little bit with making things a little bit easier to compare with operating, financing, investing splits and the operating profit figure as well.

Tiffany Tan:
Yeah, yeah. Good thoughts there. I think this leads us to possibly one of the last questions I have, actually. So Australia currently has a simplified disclosure system known as Tier 2 for smaller companies and other countries may have IFRS for SME. So we know we don't adopt IFRS for SME in Australia, but other jurisdictions do. So do you think that these changes in IFRS 18 should also apply to these smaller entities? Maybe David, share your thoughts about this, it would be good.

David Hardidge:
Well, I guess the good news is that the International Accounting Standards Board will look at IFRS for SMEs. They issued the standard. They're not going to look at this for another five years. They're already going through a process of updating the standard as it is. It's been going for five years. They're not going to look at another change for at least another five years. So while it may not be mandatory, you might find that some of the entities in IFRS for SMEs may want to copy what the larger companies are doing.

In Australia for Tier 2, we've got reduced disclosures or simplified disclosures that follows, but not necessarily line for line, IFRS for SMEs. So that'll need to be looked at and the Australian Accounting Standards Board is currently going to be looking at that over the next year or so. So we'll see. I can see some benefits, but not the classification expenses by nature and function and forcing that onto smaller entities. You mentioned Tier 3 that's currently in production.

It's at the moment nominated to apply to private sector not for profit, but hopefully, that will be able to be expanded to the public sector for smaller entities, not necessarily micro entities, but smaller entities and the same for smaller private sector for-profit entities as well. I think there's some aspects that we could probably pick up in Australia, but not all of it.

Tiffany Tan:
And Shaun, I wonder if you have anything else to add on this topic?

Shaun Steenkamp:
Yeah, so I've got a slightly different viewpoint to David when it comes to Tier 2 entities. So I think primary financial statements need to be the same across tiers. So while I agree there may not be much benefit to a Tier 2 entity classifying lines of income and expense by those categories, I believe that all primary statements produced by all tiers of entities need to follow a consistent format.

That's primarily because entities may shift between tiers, so having that already prepared is important. And I also think even though Tier 2 entities don't have public accountability, they'll have financiers and they'll have entities, other users who may be interested in it. They may have independent board members who would be wanting to understand how that entity is performing and if they're looking at a traditional profit and loss statement versus what is going to become the new format, that's going to create questions and unnecessary burden on the Tier 2 entity, oddly enough, for them to explain how they reconcile their financial statements to what would be prepared by a Tier 1 entity.

Tiffany Tan:
Now, before we close our podcast, I would like to give our expert a last chance for their final thoughts. I might go to David first and then we'll go to Shaun. David?

David Hardidge:
Yes. So at the very start, there was a mention of this start date being 1st of January 2027. And that sounds a very long way away, but you've been given the extra time for a reason, so don't blow it. Choose to make the transition easier. Don't leave it to the last minute. And for those in the public sector, yes, you've got another year, but yes, follow what's happening, and also, again, decide to make your life easier by doing this on a slowly but steady basis.

Tiffany Tan:
Good advice. And Shaun.

Shaun Steenkamp:
I have the same advice and I think it's really important right now to think about IFRS 18 and how you're going to transition, even though I know a lot of entities are spending a lot of time and effort on sustainability reporting. You don't want to get to December 2026 and think about it then and go, "Whoops, I've totally missed this new standard."

Tiffany Tan:
Yep. Good stuff. David and Shaun, a big thank you to both of you for taking the time to talk to us and share your knowledge today. It was a great conversation and some really good tips for our listener. CPA Australia has also developed resource on IFRS 18, which we will share in our show notes.

David Hardidge:
Thanks very much for having me.

Shaun Steenkamp:
Thanks for having me. Tiff.

Tiffany Tan:
Thank you. For more information on IFRS 18, you can find the links to the show notes for this episode. With Interest is a regular podcast, so if you enjoyed today's show, please subscribe by searching for CPA Australia With Interest podcast. Thank you for tuning in, and we'll catch you next time.

Garreth Hanley:
You've been listening to With Interest, a CPA Australia podcast. If you've enjoyed this episode, help others discover With Interest by leaving us a review and sharing this episode with colleagues and clients or anyone else interested in the latest finance, business, and accounting news. To find out more about our other podcasts and CPA Australia, check the show notes for this episode and we hope you can join us again for another episode of With Interest.