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STAFF PAPER
September 2017
IASB Meeting
[March 2017]
Project
Primary Financial Statements
Paper topic
Analysis of expenses by function and by nature
CONTACT(S)
Denise Durant
ddurant@ifrs.org
+44 (0) 20 7246 6469
This paper has been prepared for discussion at a public meeting of the International Accounting Standards
Board (the Board) and does not represent the views of the Board or any individual member of the Board.
Comments on the application of IFRS
®
Standards do not purport to set out acceptable or unacceptable
application of IFRS Standards. Technical decisions are made in public and reported in IASB
®
Update.
Purpose of paper
1. In this paper, the staff:
(a) describe the main problems identified with the current requirements in
IAS 1 Presentation of Financial Statements for the presentation of an
analysis of expenses using the ‘function of expense’ method or the ‘nature
of expense’ method and discuss if those requirements are fit for purpose;
(b) summarise the results of the staff research on the use of a ‘function of
expense’ method and of a ‘nature of expense’ method; and
(c) provide some recommendations to the Board to improve the requirements
in IAS 1 for presenting an analysis of expenses.
2. We seek the Board’s views on the proposals included in this paper.
Staff recommendations
3. We recommend that the Board:
(a) (Issue 1) describes the ‘nature of expense’ method and the ‘function of
expense’ method for the analysis of expenses required by paragraph 99 of
IAS 1. The staff proposes the following descriptions:
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The nature of expense method provides information about
expenses arising from the main inputs that are consumed in
order to accomplish an entity’s business activities—such as
expenses related to materials (raw material purchases),
employees (labour and other employee benefits), equipment
(depreciation) or intangibles (amortisation)—without reference
to how these are allocated to functions within the business.
and
The function of expense method allocates and combines
expense items according to the activity from which the item
arises.
For example, cost of sales is a functional line item that may
combine the following natural line items: raw material costs,
labour and other employee benefit costs, depreciation or
amortisation. These expenses all arise from the entity’s
production activities.
(b) (Issue 2) retains the choice of classification for the analysis of expenses in
IAS 1 (either the by-nature or by-function method) but adds more discipline
to how an entity makes its choice of classification and how that choice is
applied. In this respect, we think that the Board should:
(i) require an entity to disclose the reasons why the entity has
chosen a particular method for providing an analysis of
expenses, including why the chosen method provides the most
useful information for that entity; and
(ii) require entities to use a single method for the analysis of
expenses to avoid a mixed approach in the statement(s) of
financial performance. This requirement would apply unless
specific natural or functional line items are mandated by IAS 1
or by other IFRS Standards.
(c) (Issue 3) requires:
(i) the use of the ‘nature of expense’ method for providing an
analysis of expenses when an entity is unable to allocate
natural components to the functions identified by the entity on
a consistent and non-arbitrary basis; and
(ii) an entity that uses the ‘nature of expense’ method to provide
additional information on the function of expenses if this
information is used internally by management.
(d) (Issue 4) requires an entity to present:
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(i) its ‘primary’ analysis of expenses in the statement(s) of
financial performance; and
(ii) additional information (ie by nature or by function –refer to
Issue 3) with its primary analysis of expenses, or alternatively,
disclosed in a single note.
Background information
4. At the March 2017 Board meeting, the staff discussed with the Board some basic
principles that could guide the aggregation and disaggregation of information in the
primary financial statements. IAS 1 requires the aggregation of items into different
classes on the basis of their ‘nature’ or ‘function’. At the March meeting the Board
expressed the view that it would be helpful to provide more guidance on those bases.
5. We think the results of our research and outreach activities (as summarised in
Appendix A of this paper) support the fact that aggregation of income and expenses
on the basis of their nature or function provides useful
1
information to users (refer to
our discussion in paragraphs A10–A12). Hence, we continue supporting the use of
those bases in the statement(s) of financial performance.
6. However, as our analysis in this paper shows, preparers and users have different
preferences for the presentation of an analysis of expenses. Furthermore, in this paper
the staff identify issues both with IAS 1 itself and its application in practice.
7. In this paper, we consider potential improvements to the current requirements in
IAS 1 regarding by-nature or by-function presentation and we ask the Board for its
views.
Structure of paper
8. This paper is structured as follows:
(a) Identifying the problem (paragraphs 9–34);
(b) Staff analysis and staff recommendations (paragraphs 35–61);
1
‘Useful information’ means information that is both relevant and that faithfully represents what it purports to
represent (refer to paragraph QC4 in the Conceptual Framework for Financial Reporting).
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(c) Other issues to consider to promote more disaggregation of functional or
natural line items (paragraphs 62–63); and
(d) Appendix A: Detailed summary of our research and of the feedback
received during our outreach activities (paragraphs A1–A25).
Identifying the problem
9. This section:
(a) identifies the main problems with the current requirements in IAS 1
regarding by-nature or by-function presentation; and
(b) summarises our research/findings in relation to the main problems
identified. This information is based on our research and on the feedback
received during our outreach activities (refer to Appendix A of this paper
for more detail).
10. The factors that the staff identified as main contributors to the lack of comparability
between entities in the presentation of an analysis of expenses and the lack of
consistency in the application of the requirements in paragraph 99–105 of IAS 1 are as
follows:
(a) lack of descriptions of ‘function’ and of ‘nature’ (paragraphs 11–13);
(b) allowing a free choice between two methods for an analysis of expenses
and flexibility on the level of detail of this analysis (paragraphs 14–25);
(c) limited guidance on the level of detail required for the additional
information by nature required by IAS 1 when using a ‘function of expense’
method (paragraphs 26–31); and
(d) allowing full flexibility on the location of the analysis of expenses
(paragraphs 32–34).
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a) Lack of descriptions of ‘function’ and of ‘nature’
Current requirements in IAS 1
11. Paragraph 30 of IAS 1 refers to an aggregation process where items are aggregated
together to form a class of information if they have a similar function or nature.
Paragraph 99 of IAS 1 allows a choice in the presentation of an analysis of expenses
in the statement(s) of financial performance either by using a ‘function of expense’
method or a ‘nature of expense’ method.
12. Neither paragraph 30 nor paragraph 99 of IAS 1 describe the meaning of ‘function’ or
‘nature’, or describe any natural or functional categories or explain why aggregation
on those bases is useful.
Summary of our research/findings
13. Our research and results of our outreach activities indicated a lack of consistency
between companies in the analysis of expenses presented by preparers and poor
disaggregation. We think that this may be attributed to preparers having a lack of
understanding of what ‘function’ or ‘nature’ mean, leading to their different
interpretations of the terms. If these notions are not clarified, users may continue to
find it difficult to understand the criteria used by preparers for aggregating or for
disaggregating information by function and/or by nature.
b) Allowing a free choice between two methods for an analysis of expenses
and flexibility on the level of detail of this analysis
Current requirements in IAS 1
14. Paragraph 99 of IAS 1 allows a choice in the presentation of an analysis of expenses
depending on which method (ie ‘function of expense’ method or a ‘nature of expense’
method) provides information that is reliable and more relevant.
15. IAS 1 allows entities to use judgement on the level of detail for the by-nature and by-
function expense analysis and only some illustrative examples are provided below
paragraphs 102–103 of IAS 1 and in the Implementation Guidance to IAS 1.
16. If an entity chooses an analysis of expenses using a:
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(a) ‘function of expense’ method, the only functional line item that is
specifically required to be presented (or disclosed) is ‘cost of sales’
(paragraph 103 of IAS 1). This paragraph also mentions (but does not
require) the presentation of two other functional lines: costs of distribution
and costs of administrative activities.
(b) ‘nature of expense’ method, paragraph 102 of IAS 1 provides examples of a
few line items by nature that could be included (ie depreciation, purchases
of materials, transport costs, employee benefits and advertising costs).
17. Paragraphs 102–103 of IAS 1 show the following examples of each methodology:
Presentation by Function Presentation by Nature
Revenue
X
Revenue
X
Cost of sales
(X)
Other income
X
Gross profit
X
Changes in inventories of finished
goods and work in progress
(X)
Other income
X
Raw materials and consumables
used
(X)
Distribution costs
(X)
Employee benefits expense
(X)
Administrative
expenses
(X)
Depreciation and amortisation
expense
(X)
Other expenses
(X)
Other expenses
(X)
Profit before tax
X
Total expenses
(X)
Profit before tax
X
18. Paragraph 101 of IAS 1 also states that the notions of ‘frequency, potential for gain or
loss and predictability’ can be used to distinguish between expenses. However, the
Standard does not describe those notions or clarifies how those notions interact with
the analysis of expenses (by function or by nature) required in paragraph 99 of IAS 1.
19. Paragraph 82 of IAS 1 requires, in addition, the presentation of a list of thirteen
‘minimum line items’
2
. This paragraph does not label these line items specifically as
functional or natural line items. In fact, they are a mixture of both.
Summary of our research/findings
20. Our research and results of our outreach activities shows that entities tend to report
only the minimum information required by paragraphs 82 and 102–104 of IAS 1
2
Includes the items added by IFRS 9 Financial Instruments (July 2014) and by IFRS 17 Insurance Contracts
(May 2017).
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rather than providing a more robust disaggregation of the entity’s activities. We think
that this may be because of the presentation choices provided by IAS 1 and
insufficient guidance on how to exercise the judgements about presentation required
by IAS 1.
21. The level of detail provided when an entity uses a by-function or a by-nature analysis
tends to be influenced either by their local laws and regulations or local GAAP
requirements without necessarily considering what provides the best information for
users.
22. Some preparers interpret the choice of methodology allowed in paragraph 99 of IAS 1
as allowing them complete freedom to decide which natural lines or functional lines to
include in their expense analysis. Other preparers regard it as giving them freedom to
present a mixture of by function and by nature line items, thereby making it unclear
which method has been used for the analysis of expenses presented by an entity
3
.
23. Users think that allowing preparers a choice of method has led to considerable
variation in practice and to a lack of comparability across entities, although there is
some evidence of more consistent practices within certain industries
4
.
24. In terms of preference for either methodology, our research indicates that:
(a) preparers welcome the choice in IAS 1 for presenting an analysis of
expenses because this choice allows them to ‘tell their story’;
5
whereas,
(b) users generally favour an analysis of expenses using a ‘nature of expense’
method because it provides them with granular information that they can
more easily use to develop forecasts in their analysis, but also find the
‘function of expense’ method useful because it facilitates the calculation of
their metrics and margins
6
.
25. Our research on the use of function-of or nature-of expense methods also confirmed
that entities choose different methods depending on their industry
7
. Some industries
3
Refer for example to our review of research in paragraph A6.
4
Refer to paragraphs A18–A19.
5
Refer to paragraph A15.
6
Refer to paragraph A10.
7
We analyse the preferences by industry in paragraph A18.
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(eg manufacturing entities) find a ‘function of expense’ method more useful because
this method is generally more descriptive of the entity’s overall operations and
provides useful information about the allocation of resources to the various activities
(functions) of an entity. Other entities (eg banks) have only one main function (eg a
financing activity) and, hence, preparers find it more obvious to have a more detailed
analysis of expenses using a ‘nature of expense’ method because this reflects better
the nature of their business.
c) Limited guidance on the level of detail required for the additional
information by nature required by IAS 1 when using a ‘function of expense’
method
Current requirements in IAS 1
26. Paragraph 104 of IAS 1 requires an entity choosing a ‘function of expense’ method to
provide additional information on the nature of the expenses. Paragraph 105 of IAS 1
further states that information on the nature of the expenses is useful in predicting
future cash flows and as a consequence, additional disclosure is required when the
‘function of expense’ method is used. Only a few natural items are specifically
required in paragraph 104 of IAS 1 (ie depreciation, amortisation and employee
benefits expense).
27. Paragraph 103 of IAS 1 adds that ‘allocating costs to functions may require arbitrary
allocations and involve considerable judgement’.
28. An entity choosing a ‘nature of expense’ method is not required to provide additional
information by function. IAS 1 does not explain why this additional information is
not required. IAS 1 does, however, explain why additional by nature information is
required if an entity presents expenses by function (IAS 1 states that information on
the nature of expenses is useful for users in predicting future cash flows
8
). We think
that the reason that an entity choosing a ‘nature of expense’ method is not required to
provide additional information by function might be because many entities that
present expenses by nature do not allocate expenses on a by-function basis even for
internal management reporting purposes.
8
Refer to paragraph 105 of IAS 1.
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Summary of our research/findings
29. Our research showed that many entities using a ‘function of expense’ method fail to
disclose additional information on the nature of expenses as required by IAS 1
9
and if
such information is presented it may be scattered across several notes.
30. Our research also indicated that some preparers disagree with the requirement to
disclose additional information on the nature of expenses when classifying expenses
by function. This is because they say that they are unable to provide this information
with their current accounting systems; or may only be able to allocate natural
components to the entity’s functions in an arbitrary or inconsistent way
10
.
31. Users have raised concerns about the situation described above because they think
that inconsistent or arbitrary information reduces comparability between entities, as
well as reducing the information content of the functional line items reported. Users
favour having break-downs of particular ‘functional’ items (ie cost of sales) into their
different ‘natural’ components, as those break-downs allow them to apply their
assumptions to different components and enable them to make better predictions of
net future cash flows.
d) Allowing full flexibility on the location of the analysis of expenses
Current requirements in IAS 1
32. Paragraph 99 of IAS 1 allows entities to present the analysis of expenses either in the
statement(s) of financial performance or in the notes. Paragraph 100 of IAS 1
encourages entities to present it in the statement(s) of financial performance.
Outcome of our research/findings
33. Our research and results of our outreach activities show that there is a wide range of
practice in presentation, ie sometimes the analysis of expenses is presented in the
statement(s) of financial performance and sometimes in the notes. Some preparers
present very little or no analysis in the statement(s) of financial performance.
9
Refer to paragraph A2 and A7.
10
Refer to paragraph A17 and our illustration below this paragraph.
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34. Some users that we spoke to during our outreach activities think that the flexibility in
presentation granted by IAS 1 reduces the usefulness of the statement(s) of financial
performance. Users are concerned that they cannot always find a coherent and full
analysis of expenses easily and would rather have that analysis in a single place
(preferably in the statement(s) of financial performance rather than in the notes) for
easy access to this information and to enable easy comparisons between entities.
Staff analysis
35. We have split our analysis in this paper as follows:
(a) Issue 1: Should the Board describe the meaning of ‘function’ and of
‘nature’? (paragraphs 36–48)
(b) Issue 2: Should the Board eliminate the choice between methods for
presenting an analysis of expenses? (paragraphs 49–52)
(c) Issue 3: Should the Board retain the requirement to provide additional
information on the nature of expenses when choosing a ‘function of
expense’ method? (paragraphs 53–57); and
(d) Issue 4: Should the Board require the analysis of expenses in the
statement(s) of financial performance or in the notes? (paragraphs 58–61).
Issue 1: Should the Board describe the meaning of ‘function’ and of ‘nature’?
36. IAS 1 does not describe the meaning of ‘function’ or of ‘nature’ which our analysis
suggests may lead to confusion and different interpretations of the meaning of those
notions. We think IAS 1 should describe the meaning of ‘function’ and of ‘nature’ in
the context of the analysis of expenses required by paragraph 99 of IAS 1. We think
that describing those terms could:
(a) serve as a guide for preparers in the aggregation and disaggregation of line
items in the statement(s) of financial performance which may lead to
greater consistency in how these terms are interpreted and applied by
entities, leading to greater comparability;
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(b) allow entities to take a more structured approach to allocating the natural
components they have identified to the entity’s functional activities; and
(c) help users to have a better understanding as to the reasons why some items
have been grouped/separated.
37. In subsequent paragraphs the staff provide some initial views about the meaning of
‘nature’ and ‘function’ and provide some recommendations on how a ‘nature of
expense’ method and a ‘function of expense’ method could be described.
What is ‘nature’?
38. The Oxford Dictionary defines ‘nature’ as follows
11
The basic or inherent features, character, or qualities of
something
39. The staff observe that attempting to identify the ‘basic or inherent features’ of
expenses has the risk of over-conceptualising what the ‘nature’ of expenses really
means in the context of the statement(s) of financial performance. This is because it
would require us to identify features that might distinguish the nature of one item
from another and defining these additional features might be challenging. For
example, a potential feature may be whether or not an item occurs frequently.
However, describing this feature may be subjective as stakeholders may have different
views on the meaning of frequency.
40. We are of the view that the Board could take, instead, a more pragmatic and simpler
approach to clarify the meaning of ‘nature’. In this respect, we think that the notion
of ‘nature’ could be linked to the ‘inputs’ that an entity uses to operate its business.
We think that ‘inputs’ is a notion that preparers can easily understand.
41. The Oxford Dictionary defines ‘inputs’ as follows
12
:
What is put in, taken in, or operated on by any process or
system.
42. For the statement(s) of financial performance, the definition of ‘inputs’ (above) could
be translated as the main categories of resources (ie employees, raw materials) that are
11
We consulted the online definition of ‘nature’ in the Oxford Dictionary.
12
We consulted the online definition of ‘inputs’ in the Oxford Dictionary.
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used within an entity’s operations (such as a manufacturing process) to obtain a
desired output in terms of profits and cash flows. Consequently, we are of the view
that ‘nature’ could be described as the ‘major categories of inputs, consumed as
expenses, required to accomplish an entity’s business activities’.
What is ‘function’?
43. The Oxford Dictionary defines ‘function’ as
13
:
An activity that is natural to or the purpose of a person or thing.
44. On the basis of the definition of ‘function’ above the staff think that an entity’s
functions would result from the aggregation of different natural items of income and
expense on the basis of a common activity (eg selling function or research function).
Other activities could include discontinued operations, which IFRS 5 Non-current
Assets Held for Sale and Discontinued Operations requires to be reported separately;
or a restructuring event (this information is required by paragraph 98 of IAS 1).
Should the Board develop a list of ‘natural’ items and a list of ‘functional’
activities that an entity may be involved in?
45. We do not think that the Board should prescribe a list of ‘natural’ items because we
think the appropriate natural items will depend on an entity’s business activities.
Likewise, we do not think that the Board should prescribe a list of activities that an
entity could be involved in because these activities would vary depending on the type
of industry and the way management runs its business. The staff is of the view that
management should be given flexibility to identify its primary activities or functions
as well as its natural line items.
46. Nevertheless, the definitions of a ‘nature of expense’ method and of a ‘function of
expense’ method could mention some of the natural or functional line items mandated
by IAS 1 (items such as depreciation and amortisation expense and employee benefits
expense, as required by paragraph 104 of IAS 1; or cost of sales, as required by
paragraph 103 of IAS 1). We further observe that illustrative examples of natural or
13
We consulted the online definition of ‘function’ in the Oxford Dictionary
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functional line items could be developed when the staff focuses on the development of
templates for specific industries
14
.
Staff proposal for defining the ‘nature of expense’ method and the ‘function of
expense’ method
47. On the basis of our discussion above the staff proposes that the ‘nature of expense’
method be described as follows:
The nature of expense method provides information about
expenses arising from the main inputs that are consumed in
order to accomplish an entity’s business activities—such as
expenses related to materials (raw material purchases),
employees (labour and other employee benefits), equipment
(depreciation) or intangibles (amortisation)—without reference
to how these are allocated to functions within the business.
48. On the basis of our discussion above the staff proposes that the ‘function of expense’
method could be described as follows:
The function of expense method allocates and combines
expense items according to the activity from which the item
arises.
For example, cost of sales is a functional line item that may
combine the following natural line items: raw material costs,
labour and other employee benefit costs, depreciation or
amortisation. These expenses all arise from the entity’s
production activities.
Issue 1—Question to the Board
1. Does the Board agree with our proposed descriptions in paragraphs 47 and 48 of
this paper of a ‘nature of expense’ method and of a ‘function of expense’ method?
Issue 2: Should the Board eliminate the choice between methods?
49. IAS 1 allows entities to choose whether to present information on the basis of
‘function’ or ‘nature’. Paragraph 105 of IAS 1 states that each method of presentation
has merit for different types of entities. The choice of presentation might depend on
the nature of the entity and might be influenced by different historical and industry
14
We are planning to bring a paper analysing this topic at a future meeting.
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factors. Our research revealed that the choice in the presentation of an analysis of
expenses has been in IAS 1 for many years. There is not much in IAS 1 about the
history of why we have the by function/by nature choice but we think it was likely
‘inspired’ by the requirements in other local GAAP. For example, in some informal
conversations with some stakeholders we became aware that by-nature information
was required in Germany before the 4th Directive was implemented there (1985 Act)
whereas the UK company law allowed a choice of formats. We also think that a by-
nature analysis may have arisen from cost accounting and financial management
drivers.
50. In spite of its historical origins, our research indicates that both methods are still
considered useful: preparers want flexibility to ‘tell their story’; whereas users find
information both by function and by nature useful for their analysis. We are of the
view that the Board should therefore retain the choice for presenting an analysis of
expenses because preparers and users find both methodologies useful.
51. However, we are of the view that the Board should add more discipline to how an
entity makes its choice of methodology and how that choice is applied. In this respect,
we think that the Board should:
(a) require an entity to disclose the reasons why the entity has chosen a
particular method for providing an analysis of expenses, including why the
chosen method provides the most useful information for that entity. We
think that adding such a disclosure would add more discipline to how an
entity makes the choice between the two methods and avoid it being a
decision based on other factors – such as systems configurations and
historical practice – rather than providing the best information for users of
the financial statements. The staff is of the view that such a disclosure
would make preparers think about the choice made and would give users
more confidence in the resulting figures as well as a better understanding of
an entity’s business activities.
(b) require entities to use a single method for the analysis of expenses to avoid
a mixed approach in the statement(s) of financial performance. This
requirement would apply except where specific natural or functional line
items are mandated by IAS 1 or by other IFRS Standards (or where the
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entity supplements its analysis of expenses by function with additional
information about the nature of expenses in the statement(s) of financial
performance– see Issue 3).
52. The staff could perhaps explore at a later stage whether it would be necessary to
develop criteria that entities could follow to determine whether by-function or by-
nature presentation provides the most useful information about their business.
Issue 2—Question to the Board
1. Does the Board agree with our recommendation in paragraph 50 of this paper
that the Board should retain the choice of classification for the analysis of
expenses in IAS 1 (either the by-nature or by-function method)?
2. Does the Board agree with our recommendations in paragraph 51 of this paper
to add more discipline to how an entity makes its choice of classification and how
that choice is applied?
Issue 3: Should the Board retain the requirement to provide additional
information on the nature of expenses when choosing a ‘function of expense’
method?
53. Our research revealed that some entities using the ‘function of expense’ method fail to
disclose additional information on the nature of expenses or only provide information
about the natural components allocated to the entity’s functions in an arbitrary or
inconsistent way.
54. Our research showed that additional information on the nature of expenses is useful
for users (refer to paragraph 31). However, we are aware that this may require some
preparers who currently only gather information by function, to reconfigure their
systems.
55. We think that the project’s first due process document (ie Discussion Paper or
Exposure Draft) could gather information about this to find out how feasible and
potentially costly it would be for some preparers to change their systems to provide
information by nature.
56. We think that it is unlikely that a by function analysis will provide the most useful
information to users of financial statements if that analysis cannot be done on a
consistent and non-arbitrary basis. Consequently, we think that the Board should
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require the use of the ‘nature of expense’ method for providing an analysis of
expenses when an entity is unable to allocate natural components to the functions
identified by the entity on a consistent and non-arbitrary basis. We think that users
would welcome this proposal as in their view the ‘nature of expense’ method is
generally considered more useful than a ‘function of expense’ method.
57. The staff observe that if an entity’s ‘primary’ analysis is an analysis by nature, IAS 1
currently does not require a further analysis by function. The staff is of the view that
the Board should require by function information if this is used internally by
management (our research and results of our outreach activities did not reflect much
appetite for forcing a by-function allocation if it is not actually used by the entity).
Issue 3—Questions to the Board
1. Does the Board agree with our recommendations in paragraphs 56–57 of this
paper that the Board requires:
(a) the use of the ‘nature of expense’ method for providing an analysis of
expenses when an entity is unable to allocate natural components to the functions
identified by the entity on a consistent and non-arbitrary basis; and
(b) an entity that uses the ‘nature of expense’ method to provide additional
information on the function of expenses if this information is used internally by
management?
Issue 4: Should the Board require the analysis of expenses in the statement(s)
of financial performance or in the notes?
58. IAS 1 allows entities to choose whether to present the analysis of expenses in the
statement(s) of financial performance or in the notes. Furthermore, IAS 1 does not
specifically require additional information on the nature of expenses to be presented
in a single location (eg it can be presented on the face of the statement(s) of financial
performance or across separate individual notes), which leads to diversity in practice.
59. Some users have commented that IAS 1 provides management with more flexibility
than they are comfortable with – as demonstrated by the request made by some users
for more comparable information between entities, but also for more disaggregation in
the statement(s) of financial performance itself. The staff is of the view that the Board
should prescribe the location of the primary analysis of expenses to add more
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discipline to the presentation of this analysis and address the concerns expressed by
users.
60. The Board discusses the role of the primary financial statements and the role and
content of the notes in Section 3 of the Discussion Paper Disclosure Initiative—
Principles of Disclosure), in particular, paragraphs 3.24(a) and (e) and paragraph
3.28. We think that the feedback we get on this discussion could help us to develop
guidance on the location of by-function or by-nature information.
61. However, the staff’s initial views are that:
(a) an entity should be required (and not just encouraged) to present its
‘primary’ analysis in the statement(s) of financial performance so that users
can more easily access this information and make comparisons between
entities.
(b) if an entity’s ‘primary’ analysis is an analysis by function, that entity should
have flexibility to provide the additional information on the nature of
expenses either in the statement(s) of financial performance, along with its
primary analysis of expenses; or in a single note so that users can find and
access this information more easily. The staff think that this proposed
presentation would enhance comparability between entities, and enable
users to find the relevant information more easily.
(c) if an entity’s ‘primary’ analysis is an analysis by nature, and the Board
agrees that an entity should further provide information by function if this
information is used internally by management, we think that such additional
information should be included either in the statement(s) of financial
performance or in the notes.
Issue 4—Questions to the Board
1. Does the Board agree with our recommendation in paragraph 59 to prescribe
the location of the primary analysis of expenses?
2. If the Board agrees with Question 1 above, does the Board agree with our
recommendations in paragraph 61 to present an entity’s:
(a) ‘primary’ analysis of expenses in the statement(s) of financial performance;
and
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(b) additional information (ie by nature or by function –refer to Issue 3) with its
primary analysis of expenses, or alternatively, disclosed in a single note?
Other issues to consider to promote more disaggregation of functional or
natural line items
62. If the Board wishes to promote more disaggregation of functional or natural line items
in the statement(s) of financial performance we think that the following areas could be
potentially explored:
(a) adding more minimum line items to the statement(s) of financial
performance (besides the ones already required by paragraph 82 of IAS 1).
We think that the identification of these additional minimum line items
could be based on line items that are commonly currently reported by
industry. We observe that a good starting point could be the line items
included in the IFRS Taxonomy. The staff could also look at the
requirements for minimum line items from other regulators or standard-
setters.
(b) incorporating thresholds to prevent the over-aggregation of line items (ie
the presentation of large ‘other expense’ or ‘other income’ line items). The
staff is aware that Regulation S-X issued by the U.S. Securities and
Exchange Commission includes some thresholds that we could consider as
a reference. For example, we understand that article 5 of this Regulation,
(Rule 5-03 -Income Statements) includes a requirement to separately
present revenue categories (ie operating revenues, income from rentals,
revenues from services or other revenues) that exceed 10 percent of total
revenues. Any revenue categories that are individually 10 percent or less of
total revenues may be combined into one line
15
.
(c) developing some high-level illustrative primary financial statements (ie
templates) for a small number of industries (for example, banks, non-
financial institutions, insurance companies and investment property
15
https://www.sec.gov/divisions/corpfin/ecfrlinks.shtml. Refer to Article 5, Rule 5-03 – Income Statements.
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companies)
16
. It might help to look at minimum line items alongside
templates to ensure the balance is right.
63. If the Board is of the view that the areas mentioned above should be explored, the
staff could bring a further analysis on those matters at a future meeting.
Issue 5—Questions to the Board
Does the Board think that the staff should explore:
(a) identifying additional minimum line items for the statement(s) of financial
performance by considering line items that are commonly-reported by entities?
Does the Board have any more suggestions about how we could identify
additional minimum line items?
(b) developing thresholds to prevent the over aggregation of line items? Does the
Board have any more suggestions about how we could develop those thresholds?
16
The Board agreed to explore the development of these templates at its December 2016 meeting. Refer to the
IASB Update
.
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Appendix A
A1. This Appendix presents the results of the staff research on the use of the ‘function of
expense’ method and of the ‘nature of expense’ method. This research includes:
(a) our review of a sample of financial statements (paragraphs A2–A4);
(b) our review of other academic and non-academic studies (paragraphs A5–
A8)
(c) the feedback received from users and preparers during our outreach
activities (paragraphs A9–A17);
(d) research on the method preferences by industry (paragraphs A18–A19); and
(e) a brief description of the proposals made by the previous Financial
Statement Presentation project for disaggregating information by function
and by nature and a summary of some of the feedback on those proposals
(paragraphs A20–A25).
Sample review of financial statements
A2. In our review of a sample of 25 financial statements
17
we observed that most entities
favoured an analysis of expenses ‘by function’ (60%) over an analysis ‘by nature’
(20%)
18
. About half of the entities using the ‘function of expense’ method did not
provide additional information on the nature of expenses when presenting an
analysis of expenses by function despite the requirement in paragraph 104 of IAS 1
‘to disclose additional information on the nature of expenses, including depreciation
and amortisation expense and employee benefits expense’
19
.
A3. Our review of a sample of financial statements revealed that permitting flexibility in
the presentation of an analysis of expenses results in a wide range of presentation
17
This analysis was presented in Agenda Paper 21A of November 2016.
18
Refer to the table below paragraph 21 in Agenda Paper 21A from November 2016. The remaining 20% are
entities that did not present expenses by nature or by function (eg an entity presented operating expenses as a
single line item). Some entities presented an analysis of expenses in the statement(s) of financial performance
and some others in the notes.
19
Refer to the table below paragraph 23 of Agenda Paper 21A of November 2016.
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formats which some users that we spoke to during our outreach activities think
reduces comparability across entities
20
.
A4. We also observed that every entity in the pharmaceutical industry in our sample
presented expenses by function. However, we did not find that same level of
consistency in other industries.
Evidence in academic and non-academic studies
A5. The academic and non-academic research revealed how entities apply IAS 1 in
practice and that some entities apply the requirements in IAS 1 poorly as we explain
below.
A6. The EFRAG Secretariat
21
conducted a research study in 2016 of 34 listed companies
included in the S&P Europe 350 Index, to understand current practice on
presentation of a limited number of European entities. This study revealed that
entities tend to prefer an analysis of expenses using the ‘function of expense’
method more than the ‘nature of expense’ method. The study also revealed that some
entities interpret the requirements in IAS 1 as allowing a mixture of by-function and
by-nature information
22
. The study further noted that in some cases the number of
line items presented was limited and the level of disaggregation was low.
A7. The Staff of the Securities and Exchange Commission
23
conducted a study in 2011
about the use of IFRS Standards by 183 companies domiciled in 22 countries (the
sample analysed included SEC and non-SEC registrants). This study showed that
approximately half of the companies included in the study reported expenses by
nature and the other half reported them by function. It also showed that about one-
third of companies that presented expenses by function did not disclose additional
information on the nature of the amounts classified by function, as required by
paragraph 104 of IAS 1.
20
Refer to paragraph 7 of Agenda Paper 21A of November 2016
21
Refer to paragraphs 16-20 in Paper 10-03 by the EFRAG Secretariat discussed at the EFRAG TEG meeting in
January 26, 2017.
22
In 2004 the IFRIC acknowledged that there were different and conflicting interpretations regarding whether
IAS 1 allowed an analysis of expenses using a ‘mixed basis’. The IFRIC did not reach any conclusion in this
respect (refer to Agenda Paper 3 of October 2004).
23
Securities and Exchange Commission (SEC). 2011. Work plan for the consideration of incorporating IFRS
into the financial reporting system for US issuers: An Analysis of IFRS in Practice, page 13. Washington D.C.
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A8. An academic study by Libby et al (2013)
24
analysed the presentation of the
functional line of selling, general and administrative expenses and found that
entities do not always provide a break-down of the natural expenses allocated to that
functional line.
Views from users and preparers
A9. At our meetings with the Capital Markets Advisory Committee (CMAC) and the
Global Preparers Forum (GPF)
25
users and preparers told us that ‘function’ and
‘nature’ are still considered appropriate attributes to be used for the aggregation and
disaggregation of items of income and expense in the statement(s) of financial
performance. However, users and preparers have different preferences for providing
an analysis of expenses. We explain these preferences below.
Which method is preferred by users?
A10. Our outreach activities show that in general users favour an analysis of expenses
using the ‘nature of expense’ method because it provides them with more granular
information that they could use in their analysis. However, some users also like the
‘function of expense’ method because this information facilitates the calculation of
some relevant performance metrics and margins.
A11. For example, in calculating a ‘core EBITDA’ metric users would normally exclude
non-core, financing and tax amounts that may include functional or natural items.
Users also need to know other natural components such as depreciation or
amortisation to exclude them from the calculation of their ‘core EBITDA’ metric.
A12. Users also favour having break-downs of particular ‘functional’ items (ie cost of
sales) into their different ‘natural’ components, because these break-downs allow
them to apply their assumptions to different components and enable them to make
better predictions of net future cash flows. For example, in the case of ‘cost of sales’
this functional line item has value for users in determining if the revenue generated
from the sale of the items covers the cost. It also helps users make predictions about
24
Libby, Robert and Emett Scott A, Earnings Presentation Effects on Manager and User Behaviour. November
13, 2013. S.C. Johnson Graduate School of Management. Cornell University, page 4.
25
The minutes from the joint meeting with the GPF-CMAC in June 2016 can be found in: http://www.ifrs.org/-
/media/feature/meetings/2017/june/cmac-gpf/cmac-gpf-meeting-summary-june-2017.pdf
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future margins. However, users are also interested in knowing the composition of
‘cost of sales’ because this functional line item groups natural items (eg raw material
costs, labour costs or transportation costs) that may change as the result of different
drivers and so it is helpful for users to have separate information about those costs.
For instance, labour costs may change as a result of increases in salaries; or
distribution costs may change at a different rate as a result of an increase in the cost
of fuel.
A13. Some users are of the view that the Board should consider mandating more
minimum line items in the statement(s) of financial performance to provide some
standardisation to the statement(s) of financial performance, as well as to promote
greater disaggregation. Some examples of items that they suggested could be
mandated and/or included as part of the list of minimum line items in paragraph 82
of IAS 1 are:
(a) cost of sales;
(b) selling, general and administrative expenses;
(c) research and development costs;
(d) restructuring costs;
(e) disposal gains and/losses; and
(f) share-based compensation expense.
A14. Some users also commented that information disaggregated by the nature of the
expense is often considered more useful than information by function. This is
because there is a perception that some natural components are allocated in an
arbitrary or inconsistent way to an entity’s different functions, which they think
reduces comparability between entities as well as reducing the information content
of the functional line items reported (we discuss this aspect in paragraphs A16–A17
below).
Which method is preferred by preparers?
A15. The preparers that we met during our outreach activities support the choice in
paragraph 99 of IAS 1 to present an analysis of expenses using the ‘function of
expense’ method or the ‘nature of expense’ method. This is because this choice
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allows them to ‘tell their story’. That is, to provide information consistent with their
industry type or organisational structure and to be able to show how their business is
managed.
A16. Some preparers disagree that entities classifying expenses by function should be
required to disclose additional information on the nature of expenses
26
. This is
because they say that they are unable to provide this information with their current
accounting systems; or may only be able to allocate natural components to the
entity’s functions in an arbitrary or inconsistent way. Those preparers are of the
view that they should be given the choice to provide additional information on the
nature of expenses rather than being required to provide this information.
A17. Feedback received from preparers on the 2010 Financial Statement Presentation
Staff Draft
27
highlighted some reasons why some preparers allocate natural
components in an arbitrary or inconsistent way to the entity’s functions. Some
entities told us that they are unable to track the original nature of the expenses
allocated into an entity’s functional activities (ie once the expenses have been
allocated into functions) because their systems are not designed for this purpose —
leading to information loss and/or an entity providing an arbitrary break-down of the
natural components allocated to an entity’s different functions. This is often the
case for large multinational companies that may internally allocate a number of
items of income and expense to various functions or cost centres. An illustration of
this case is provided below:
Illustration
An entity has an information technology (IT) department that serves various
functions throughout the organisation. The expenses of the IT department include
amongst others, natural expenses such as depreciation and labour expenses.
The IT department passes those expenses on as a single amount called ‘IT cost.’
Once those expenses are allocated to various functions and departments
throughout the organisation their original nature (ie depreciation and labour
expenses’) is not retained. To further complicate the process, the IT department
26
This requirement is in paragraph 104 of IAS 1.
27
Refer to Agenda Paper 1 (March 2011) Appendix A paragraphs 7-9.
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may be allocated costs from another cost centre (ie from the real estate cost
centre).
Method preferences by industry
A18. The staff observe that manufacturing companies more commonly use a classification
by function whereas service companies more commonly use a classification by
nature. This suggests that the entity’s business activities plays an important role in
choosing a classification. We found evidence in this respect in the following studies:
(a) in the SEC survey (2011), a majority of companies in the banking and
energy industries presented expenses by nature; while most companies in
the chemicals, motor vehicles, and mining and crude-oil production
industries presented expenses by function, resulting in comparability on an
industry basis, although not a global basis;
(b) The EFRAG Secretariat study (2016) reflected the following trend for the
following industries:
(i) preference for presentation by function: Consumer Staples,
Healthcare and Information Technology;
(ii) ‘mixed basis’ some information by nature and some by
function: Energy; and
(iii) preference for presentation by nature: Telecommunication
Services and Utilities.
(c) the Discussion Paper Preliminary Views on Financial Statement
Presentation acknowledged that some service industries, such as banks,
tend to disaggregate their expenses by nature only
28
as the majority of their
expenses are either compensation or interest related; and
28
Refer to paragraph 3.52 of the Preliminary Views Discussion Paper on Financial Statement Presentation.
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(d) a European Survey from INEUM Consulting (2008) noted that utilities,
travel and leisure companies tend to use a nature classification while the
automobile and parts companies tend to use a functional classification
29
.
A19. The staff observe that some studies suggest that the choice of methodology might
also be influenced by
30
:
(a) the laws and regulations issued by securities regulators. For example, the
U.S. Securities and Exchange Commission does not allow a choice for the
presentation of natural or functional lines. Regulation S-X specifically
requires a combination of natural and functional lines (ie a ‘mixed
approach’) for commercial and industrial companies. For the other
industries (ie banks, insurance entities and investment entities), Regulation
S-X requires the display of natural lines
31
.
(b) local GAAP requirements. For example, in France the Autorite Des Normes
Comptables (ANC) has issued recommendations for the presentation of the
statement(s) of financial performance when using a ‘function of expense’
method and the ‘nature of expense’ method. These are recommendations
for non-financial entities and for financial entities
32
.
(c) a need to provide more comparability with entities in other countries. For
example, there is evidence indicating that some European companies
switched from a by-nature method to a by-function method to provide more
comparability to some U.S. companies. Reporting by function also provides
the information necessary to compute some financial ratios
33
.
29
INEUM Consulting 2008 Evaluation of the Application of IFRS in the 2006 Financial Statements of EU
Companies in http://ec.europa.eu/internal_market/accounting/docs/studies/2009-report_en.pdf
, pages 70–71.
This survey was cited in Chapter 4 of the ‘Handbook to IFRS Transition and IFRS U.S. GAAP’, Wiley (2012).
30
Additionally, academic research, such as Kvaal and Nobes (2012) has found that companies’ accounting
policies under National GAAP before they adopted IFRS Standards influence their accounting policy choices
under IFRS Standards. (Kvaal, E. and Nobes, C.W. 2012, ‘IFRS Policy changes, and the Persistence of National
Patterns of IFRS Practice’, European Accounting Review, 24 (2): 343–71.)
31
https://www.sec.gov/divisions/corpfin/ecfrlinks.shtml. Refer to Article 5, Rule 5-03 – Income Statements.
32
We reviewed the recommendations issued by the ANC: Recommandation n° 2013-03 du 7 novembre 2013
(non-financial entities), Recommandation n°2017-02 du 2 juin 2017 (banking sector) and Recommandation n°
2013-05 du 7 novembre 2013.
33
Minutes from the Financial Accounting Standards Advisory Council meeting in June 22, 2006, pages 13-14.
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Previous Financial Statement Presentation Project
A20. The previous Financial Statement Presentation project proposed the use of a
‘function of expense’ method for an analysis of expenses (as a primary sort),
followed by further disaggregation of the functions identified into its natural
components (ie a ‘nature of expense’ method) as a secondary sort. This approach
made sense at the time because this project required the presentation of some
functional categories in the statement(s) of financial performance (ie operating,
investing
34
and financing categories).
A21. The Discussion Paper Preliminary Views on Financial Statement Presentation
35
proposed that within each category that the project had identified (ie operating,
investing and financing categories) an entity should disaggregate its items of income
and expense by function and further by nature (for all the identified functional
categories)
in the statement(s) of financial performance. Entities were required to
apply judgement to discern the appropriate functions within each category and to
determine the level of natural information to be disaggregated within those
functions. Entities could choose not to provide information by function if they
judged that disaggregation was not useful for users, and instead provide information
just by nature.
A22. The staff observe that the reason why the Board favoured at the time a ‘function of
expense’ method in the Financial Statement Presentation Project was because it
thought that such method was important in understanding how items of income and
expense relate to the entity’s activities. However, some feedback on the due process
documents published at the time indicated that allocating natural components to
functions sometimes leads to arbitrary and inconsistent information (we discuss this
aspect in paragraphs A16–A17 above).
A23. Furthermore, some feedback on the Discussion Paper Preliminary Views on
Financial Statement Presentation
36
indicated that requiring information both by
function and by nature in the primary financial statements led to too much
34
‘Operating’ and ‘Investing’ formed the ‘Business’ category.
35
Refer to paragraphs 3.42 and 3.48–3.49.
36
Refer to Agenda Paper 17C of July 2009 (paragraph 44).
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information which some users thought diminished understandability of the
information presented in those statements. To prevent too many line items in the
primary financial statements, many respondents recommended including additional
disaggregation of income and expense items in the notes to financial statements.
A24. Some feedback also indicated
37
that presenting an analysis of expenses (by function
or by nature) in the consolidated statement(s) of financial performance of a
diversified entity is not particularly useful for users in predicting future cash flows.
This is because the consolidated statement(s) of financial performance of a
diversified entity commonly aggregates financial data of subsidiaries and other
entities, and these entities may have different financial structures, lines of business
or risk attributes.
A25. Some users suggested that in the case of diversified entities the analysis of expenses
(by function or by nature) could be presented, instead, as part of the segment
reporting note, where the categories of expenses are most likely to be more
homogeneous, and therefore more meaningful for assessing the profitability of
individual units. For example, in analysing cost of sales there was a view that users
would be able to better predict future cash flows if they are able to relate specific
raw material costs to the related labour or overheads corresponding to a particular
(‘manufacturing’) segment.
37
Refer to Agenda Paper 5C/7C of October 2009 (paragraphs 39-40).
