IFRS 18 and the New Shape of Operating Profit

When a reader opens a statement of profit or loss, the first question is usually straightforward: how did the business itself perform?

Under IAS 1, many companies reported an operating profit, but the term was not defined and similar businesses could calculate it differently. IFRS 18 addresses that inconsistency.

For annual reporting periods beginning on or after 1 January 2027, the Standard introduces a common structure for the statement of profit or loss and requires the subtotals operating profit or loss and profit or loss before financing and income taxes.

The change is mainly about presentation and disclosure; it does not generally alter how income and expenses are recognised or measured.

Understanding the Language of IFRS 18

The most important starting point is the language.

IFRS 18 refers to the operating, investing and financing categories in the statement of profit or loss, rather than operating, investing and financing activities.

Income and expenses are actually classified into five categories, because income taxes and discontinued operations are also presented separately.

For most entities, management should first identify items that meet the requirements of the investing, financing, income taxes or discontinued operations categories. The remaining income and expenses fall into operating.

Operating is therefore the default category, but that does not make it a miscellaneous category. It is intended to present a complete picture of the entity's operations during the period.

Operating Does Not Simply Mean "Core" or "Recurring"

This means that operating profit is not limited to amounts that management regards as core, recurring or normal.

A restructuring charge, an impairment loss or a litigation expense does not move outside operating simply because it is unusual.

A gain or loss on the disposal of production equipment will also normally remain operating because the equipment was used with the entity's people, processes and other assets to generate revenue.

The classification question is not whether an item is exceptional.

The question is whether IFRS 18 requires it to be classified elsewhere.

This discipline prevents operating profit from becoming a selectively adjusted measure of sustainable earnings.

A Practical Example: Calculating Operating Profit

Consider a Kuwait manufacturer with:

• Revenue of KD 10.0 million
• Cost of sales of KD 6.4 million
• Selling and administrative expenses of KD 1.7 million
• A restructuring charge of KD 0.2 million
• A KD 0.05 million gain on the sale of a machine previously used in production

All five amounts are operating, producing operating profit of KD 1.75 million.

The restructuring charge is non-recurring and the disposal gain is not revenue, yet both remain part of the operating result because neither belongs to another category.

What Falls Under the Investing Category?

The investing category separates returns from assets that generate returns individually and largely independently of the entity's other resources.

Assume that the manufacturer earns:

• KD 0.05 million of interest on surplus bank deposits\
• KD 0.12 million of rental income from a stand-alone investment property
• KD 0.08 million as its share of profit from an associate

These amounts are generally investing for an ordinary manufacturing entity.

Adding the KD 0.25 million investing result to operating profit gives profit before financing and income taxes of KD 2.00 million.

Investing in this context is narrower than the everyday meaning of investment.

A factory, inventory and trade receivables work together with other resources to produce and sell goods, so their related income and expenses are generally operating.

By contrast, a passive share portfolio, surplus deposits or a stand-alone investment property can produce returns largely on their own.

Understanding the Financing Category

The financing category shows the income and expenses arising from how the entity is funded.

If the manufacturer incurs:

• KD 0.18 million of interest on bank borrowings
• KD 0.02 million of interest on lease liabilities

those amounts are generally financing.

Deducting them from profit before financing and income taxes results in profit before tax of KD 1.80 million.

A lease also illustrates the boundary between categories.

The depreciation of the right-of-use asset is normally operating because the asset is used in the business, while interest on the lease liability is financing.

The principal repayment of a loan is not an expense at all and therefore does not appear in any profit-or-loss category.

When the Main Business Activity Changes the Analysis

The analysis changes when investing in assets or providing financing to customers is a main business activity.

This point is especially relevant in Kuwait for:

• Investment companies
• Asset managers
• Finance providers
• Insurers
• Some real-estate groups

Returns that would be investing for a manufacturer may be operating for an entity whose business is to earn those returns.

Similarly, interest income from customer financing and certain related funding costs may be operating for a finance company.

The conclusion is based on the facts of the reporting entity, including how performance is managed, described publicly and reported through its segments; it is not an accounting policy election or a label chosen for a particular year.

Results from associates and joint ventures accounted for using the equity method remain in investing.

Don't Confuse IFRS 18 Categories with the Cash Flow Statement

A common implementation error is to assume that these categories must match the operating, investing and financing classifications in the statement of cash flows under IAS 7.

They do not.

The objectives and detailed requirements are different.

In the example above, the gain on selling the production machine is operating in the statement of profit or loss, while the cash proceeds from the sale are normally an investing cash flow.

Borrowing proceeds are a financing cash flow, but they are not income and therefore never enter the statement of profit or loss.

Companies will need separate, reconciled mappings for the two statements.

Preparing for IFRS 18

The practical task is therefore more than renaming existing lines.

Management must trace material income and expense streams to the assets, liabilities and business activities that generate them, document whether a specified main business activity exists and configure the chart of accounts and reporting system to apply the conclusions consistently.

Comparative information will also need to be prepared on the new basis.

If that work begins with the economics of each transaction, IFRS 18 can produce the result the IASB intended: an operating profit that gives investors a clearer view of business performance, while keeping stand-alone investment returns and financing effects visible in their proper place.