How to classify profit or loss statement elements under IFRS

Classification of expenses in profit or loss

When it comes to the classification of expenses in profit or loss statement, The standard IAS 1 Presentation of Financial Statement is silent. Means there is No mandatory format.

The fact that every single entity is different in its functional activities and shows different types of expenses necessary to achieve revenues.

Therefore, the standard requires the presentation of expenses in profit or loss in a way that provides more reliable and relevant information about your own activities.

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However, it is true that the standard IAS 1 suggests 2 different formats:

1. Expenses by nature and
2. Expenses by function.

OK! Let me explain in more details here. Keep reading!

1- Expenses by nature

When you present by nature, then you simply group the expenses by their nature regardless the role that they play in your company.

You do NOT really need to reallocate them among various function in your entity.

Fore instance, the salary of admin employees and the salary of warehouse employees will be shown as personnel expenses in your Profit or loss statement.

On the other hand, depreciation of admin building and depreciation of warehouse will be presented as depreciation expenses. 

The good thing of this approach is that it is very simple because you don't have to worry with allocations.

2- Expenses by function

Here, you should group your expenses by the functions in your company.

Take an example, salary of admin employees and depreciation of admin building are presented as administrative expenses. 

Mean while, salary of warehouse employees and depreciation of warehouse are classified as cost of sales and so on.

This method is more common because it requires certain work and professional judgment when grouping your profit or loss statement items. but still relevant for some types of companies.

What method to us?

The fact is that IAS 1 DOES NOT require breakdown of expense by function or by nature on the face of profit or loss statement - it is a suggestion.

In fact, you are permitted to disclose the classification on the face of the profit or loss statement on some mixed basis.

For example, you present cost of sales as a function, then you present gross profit and then you present depreciation expenses – this is an element from by nature method. That’s the illustration of the mixed basis.

How to deal with change in presentation?

Let’s get back to above examples:

It is permissible to show salaries of warehouse employees as cost of sales to categories they relate to their warehouse work. And, it is also OK to present these salaries as part of personnel expenses, if and and only if this is more relevant for the entity's activities'.

But here, you should not forget to consider one more important element: change in presentation.

I mean, one year the expenses were presented as cost of sales and another year, they were presented as personnel expenses.

Well, This is not allowed because it violates the Conceptual Framework of IFRS.

Instead, you should take in account further 2 requirements of IAS 1:

1. Consistency of presentation.
2. You need to retain the presentation and classification of items in the financial statements from one period to the next.You can change the presentation, but only when there is a change in entity’s operations and the new way of presenting would be more relevant.Or, when IFRS standards change.
3. Comparative informationIf you make the change in presentation, you need to reclassify your comparative information, too.It means that if you presented salaries of warehouse employees as cost of sales in the previous period, and now you want to present them as personnel expenses – you can do it, but you need to reclassify these salaries in the previous reporting period to personnel expenses too in order to make previous and current numbers comparable.So, the company from today’s question needs to present the profit or loss from the previous period in a new format and thus the cost of sales won’t dramatically decrease and the two statements will be fully comparable.

Any comments or questions? Please let me know below – thank you!