IFRS 18: Financial services considerations

The International Accounting Standard Board recently published IFRS 18, Presentation and Disclosure in Financial Statements. While much of the material is carried across from IAS 1, there are some new requirements, notably affecting the profit and loss disclosures.

The published IFRS 18 is now available. A high-level summary of the new requirements was recent covered in the daily insights news.

In this article we set out some initial considerations for financial services entities.

Categories and sub-totals in the Statement of profit or loss account (SoPL)

The standard introduces new categories by which the income and expenditure information in the SoPL should be arranged, and new sub-headings. The five categories are, operating, investing, financing, income taxes and discontinued operations; while the new sub-headings are operating profit and profit before financing and income taxes.

The operating category can be thought of as an entity’s raison d’etre and provides a picture of how the entity is performing, whereas the investing and financing categories reflect an entity’s standalone investment activity (eg, use of surplus cash) and how it funds itself.

The standard recognises the particular features of financial services entities and that the income and expenses arising on their operations or main businesses are what non-financial entities might incur by way of investing or financing. A bank would therefore record interest receipts on loans to a company within the operating category, whereas that same company might record the interest payable within the financing category.

The standard achieves this in two ways. Firstly, it defines the operating category as including the income and expenses not reported in one of the other four categories. In other words, the operating category is a residual catch-all. For example, fees and commissions from asset management or advisory services are not derived from assets or liabilities arising from investing or financing, or from income tax or from discontinued operations, and as such would be included in the operating category. The definition also means that the operating category captures income and expenses that derive from businesses that would not be considered as the main business of an entity. Secondly, it sets out what should normally be reported in the investing and finance categories but then creates exemptions.

The investing category includes income and expenses from investing in (a) subsidiaries, associate, and joint ventures; (b) cash or cash equivalents, and (c) other assets that generate a return largely independently of the entity’s other resources. Assets under (c) could include mortgages, leases, bonds, equities. However, if an entity’s main business activity is to invest in assets within (a) or (c), the entity can include the associated income and expenses in the operating category. Likewise, in relation to (b) - cash or cash equivalents - if the main business activity is to invest in assets caught under (c) and/or it is to provide customer finance.

Similarly, exemptions apply to the financing category. For example, interest expenses are excluded where they relate to liabilities that arise from solely financing transactions and are related to a main business activity that is financing customers – as may be the case with the customer deposits which are used to fund lending. Premium income and expenses relating to insurance contracts are specifically excluded from the financing category by paragraph 64.

Paragraphs B30 to B41 provide application guidance how to assess a main business activity. Part of the consideration is to assess whether individual or groups of assets share common characteristics. This might give rise to the possibility that certain activities of a financial services entity might not be considered a main activity, and the income relating to the resultant assets would be reported in the investing category.

Many financial services groups might be said to be an aggregation of different business activities. Taking the case of a bank, ‘the’ the overarching activity might be said to be financial intermediation, whereas separately, its activities could be taking deposits, making loans, and providing payment services. In this regard, the standard recognises that that there may not be a single main business activity (see paragraph B30).

There is also some scope for entities to make an accounting policy choice to categorise income and expenses as part of the operating category. For example, the income flows on a bank’s reserve balances at the central bank might be treated as investing if held for structural reasons rather than as part of the provision of finance to customers.

The IASB has helpfully produce guidance material. Banks and insurers are discussed on page 8 of the IFRS 18 project summary, and both a bank and insurer are included in the illustrative examples.

Management defined performance measures

The standard introduces new requirements to disclose Management defined performance measures (MDPM). These are a subtotal of income and expenses that an entity uses in public communications to explain management’s view of the financial performance of the entity as a whole and are not a requirement of the accounting standards. An adjusted operating figure for the entity would be a MDPM.

The definition is in many ways restrictive, and many common measures used to report performance in financial services may not meet the definition. One reason is because it is the performance of, or the quality of an entity’s assets or liabilities that are of importance to financial service investors – ie, what returns or profits are generated by those assets and liabilities – and the commonly used measures are not a ‘sub-total of income and expenses’. For example, ‘net interest margin’ is not an MDPM (see the application guidance at B116).
Other key measures that would not seem to meet the definition are, asset coverage ratios or that report asset quality (eg, adequacy of an entity’s credit provisioning for its loan assets); Basel and Solvency II based capital and liquidity ratios; or insurance claims coverage ratios.

While these performance ratios might not be an MDPM, the denominator or numerator could be - but not always. For example, within the net interest margin calculation, the numerator is net interest income (ie, the net of interest income and interest expense). If this numerator’s value is as per the financial statements, it would not be an MDPM – applying paragraph 118 and the accompanying application guidance in B123, which exclude certain typically used measures from the MDPM definition. On the other hand, if the numerator’s value were an adjusted financial statement’s value that might be a MDPM.

Similarly, a combined operating ratio (claims as a percentage of insurance service result) would not be an MDPM, and neither would be the numerator and denominator, unless the denominator (insurance service result) were to be an ‘adjusted’ financial statement’s value.

Next steps

The Financial Services Faculty will be discussing the standard over the next few months and considering what further useful information could be developed for banks and insurance entities. The Corporate Reporting Faculty of ICAEW will also be looking to produce more general guidance to support members’ implementation of the standard.