Insights on Ind As 118 Understanding the Five Categories for Classification of Income and Expenses
CA Prajwal Jha Associate Research and Advisory, Taxmann
CA Bhawna Grover Manager Research and Advisory, Taxmann
Insights on Ind As 118 Understanding the Five Categories for Classification of Income and Expenses
CA Prajwal Jha Associate Research and Advisory, Taxmann
CA Bhawna Grover Manager Research and Advisory, Taxmann
Contents 1.
Introduction
5
2.
The Critical Question: What is the entity’s main Business Activity?
5
3.
Operating Category
6
4.
Investing Category
6
5.
Financing Category
7
6.
Income Taxes and Discontinued Operations
8
7.
Conclusion
9
1. Introduction The statement of profit or loss is one of the most closely watched components of financial statements. While users have traditionally focused on revenue, operating profit, finance costs and profit after tax, Ind AS 118, Presentation and Disclosure in Financial Statements, introduces a more structured framework for classifying income and expenses within the statement of profit or loss. Under Ind AS 118, income and expenses included in profit or loss are classified into five categories, operating, and investing, financing, income taxes and discontinued operations. In particular, the determination of whether an entity has a specified main business activity of investing in assets or providing financing to customers can change the category in which certain income and expenses are presented. Ind AS 118 also establishes principles for aggregation and disaggregation, addresses offsetting, prescribes certain subtotals and specifies line items that are required to be presented separately. Consequently, the standard seeks to make the statement of profit or loss a more useful and structured summary of an entity’s financial performance. This article examines these requirements, with particular emphasis on the classification of income and expenses among the different categories and the resulting presentation of key subtotals.
2. The Critical Question: What is the entity’s main Business Activity? One of the important features of the classification model is that classification cannot always be determined merely by looking at the nature of an individual transaction. An entity is required to assess whether it has a specified main business activity involving investing in particular types of assets or providing financing to customers. This assessment is important because an entity having such a specified main business activity may classify certain income and expenses in the operating category, even though those amounts would otherwise have been classified as investing or financing income or expenses. Illustration 1 – Why the business activity matters Consider two entities: Entity A is a manufacturing company that holds surplus investments in financial assets. Entity B is an investment entity whose main business activity is investing in financial assets. Income generated from particular financial assets may therefore have a different classification for Entity A and Entity B because the assessment of the entity’s specified main business activity affects the application of the investing category requirements. Thus, the classification framework under Ind AS 118 is entity-specific in certain circumstances, rather than being determined solely by the underlying asset or liability. Further, the entity must disclose if investing in assets or providing financing to customers is a main business activity. Also, where the
Insights on Ind AS 118 Understanding the Five Categories for Classification of Income and Expenses
5
outcome of this assessment changes, specified information regarding the change, its date and the resulting changes in classification is required, subject to impracticability.
3. Operating Category The operating category is defined through a residual approach. An entity classifies in the operating category all income and expenses included in profit or loss that are not classified in the investing, financing, income taxes or discontinued operations categories. This means that operating profit is not necessarily limited to income and expenses directly arising from the entity’s primary revenue-generating activities. This is an important conceptual point. The operating category should not simply be equated with “core business revenue and expenses”. Instead, it represents the income and expenses remaining after applying the specific classification requirements for the other categories.
4. Investing Category Subject to the special rules applicable to entities having a specified main business activity, paragraph 53 requires income and expenses from the following assets to be classified in the investing category: a)
investments in associates, joint ventures and unconsolidated subsidiaries;
b)
cash and cash equivalents; and
c) other assets that generate a return individually and largely independently of the entity’s other resources. The income and expenses from the assets identified in paragraph 53 that an entity shall classify in the investing category comprise the amounts included in the profit or loss for the following: a)
income generated by the assets;
b) income and expenses arising from their initial and subsequent measurement, including derecognition; and c) incremental expenses directly attributable to their acquisition and disposal, such as transaction costs and costs to sell. Illustration 2 – Investment in an asset Suppose an entity holds an investment asset that generates dividend income of ₹10 lakh and records a fair value gain of ₹15 lakh during the year. It also incurs ₹1 lakh of directly attributable transaction costs on disposal. Where the asset falls within paragraph 53 and no specified-main-business exception applies, the relevant income and expenses arising from the asset would be considered for classification in the investing category.
6
Insights on Ind AS 118 Understanding the Five Categories for Classification of Income and Expenses
Thus, the classification analysis encompasses the complete range of income and expenses arising from the relevant asset, rather than merely the periodic return. 4.1. Special Rule for Investments in Associates and Joint Ventures A further distinction applies where investing in associates, joint ventures and unconsolidated subsidiaries is itself a main business activity. For such assets, if the investment is accounted for using the equity method, the relevant income and expenses remain in the investing category. However, if such investments are not accounted for using the equity method, the relevant income and expenses are classified in the operating category. This demonstrates how the specified main business activity assessment interacts with the accounting method applied to the investment. 4.2. Cash and Cash Equivalents – A More Nuanced Classification Cash and cash equivalents ordinarily fall within the investing category under paragraph 56. However, exceptions apply where the entity has specified main business activities. If an entity’s main business activity is investing in financial assets within paragraph 53(c), income and expenses from cash and cash equivalents are classified in the operating category. Similarly, where an entity’s main business activity is providing financing to customers, income and expenses from cash and cash equivalents that relate to providing such financing are classified in the operating category. For cash and cash equivalents not related to providing financing to customers, the entity has an accounting policy choice to classify the relevant income and expenses either in operating or investing. This policy choice must be consistent. Where the entity cannot distinguish between the two types of cash and cash equivalents, all such income and expenses are classified in “operating” using the specified policy choice.
5. Financing Category The financing category requires an entity to distinguish between two types of liabilities: First, liabilities arising from transactions that involve only the raising of finance. Second, liabilities arising from transactions that do not involve only the raising of finance. For liabilities that arise from transactions involving only the raising of finance, the financing category includes income and expenses arising from: a)
initial and subsequent measurement, including derecognition; and
b) incremental expenses directly attributable to issuing or extinguishing the liability, such as transaction costs. For other liabilities, the approach is narrower. Interest income and expenses, and income and expenses arising from changes in interest rates, are classified in financing only when the entity identifies those amounts for the purpose of applying other requirements in Ind ASs.
Insights on Ind AS 118 Understanding the Five Categories for Classification of Income and Expenses
7
Illustration 3 – Two types of liabilities Assume a company issues debt solely to raise finance. Interest expense and relevant measurementrelated amounts would generally fall within the financing category. Contrast this with a liability arising from an operating transaction. The mere existence of an interest component does not automatically mean that every related amount should be classified as financing. The requirements of paragraph 61 must first be considered. This distinction prevents the financing category from becoming a catch-all category for every expense involving an interest component. 5.1. Certain Items are specifically excluded from the Financing Category The financing classification requirements do not apply to gains and losses on derivatives and designated hedging instruments. Further, certain items are specifically excluded from financing and classified in operating. These include: a) income and expenses from issued investment contracts with participation features recognised under Ind AS 109; and b)
insurance finance income and expenses included in profit or loss under Ind AS 117.
5.2. Special Rules where Financing Customers is a main Business Activity The classification becomes particularly significant for entities whose main business activity is providing financing to customers. For liabilities arising from transactions involving only the raising of finance: a)
amounts relating to providing financing to customers are classified in operating; and
b) amounts not relating to providing financing to customers may be classified in operating or financing based on an accounting policy choice. However, the accounting policy choice is required to be consistent with the corresponding policy for cash and cash equivalents. Where the entity cannot distinguish between liabilities relating and not relating to customer financing, the policy choice is applied to all such liabilities, resulting in classification of the relevant income and expenses in operating.
6. Income Taxes and Discontinued Operations The income taxes category comprises tax expense or tax income included in profit or loss under Ind AS 12, together with related foreign exchange differences. The discontinued operations category comprises income and expenses from discontinued operations as required by Ind AS 105. These categories are relatively straightforward because their classification is linked directly to the requirements of the respective standards.
8
Insights on Ind AS 118 Understanding the Five Categories for Classification of Income and Expenses
7. Conclusion Ind AS 118 introduces a structured and principle-based framework for classifying income and expenses in the statement of profit or loss. The classification into operating, investing, financing, income taxes and discontinued operations requires entities to look beyond the nature of individual transactions and, in specified circumstances, consider their main business activities. The assessment of whether investing in assets or providing financing to customers constitutes a specified main business activity can significantly influence the presentation of income and expenses. Similarly, the specific requirements for associates and joint ventures, cash and cash equivalents, and different types of liabilities demonstrate that classification under Ind AS 118 is not merely a mechanical exercise. Entities will need to apply judgement consistently and maintain appropriate documentation supporting their classification decisions. Accordingly, implementation of Ind AS 118 will require entities to reassess existing presentation practices, particularly where the classification of income and expenses depends on the entity’s business activities. A clear understanding of these principles will be essential to ensure that the statement of profit or loss provides a meaningful and comparable representation of an entity’s financial performance.
Insights on Ind AS 118 Understanding the Five Categories for Classification of Income and Expenses
9
About Us
Our Journey Founded
1972
Evolution
From a small family business to a leading technology-oriented Publishing/Product company
Expansion
Launch of Taxmann Advisory for personalized consulting solutions
Our Vision
Aim
Growth
Future
Achieve perfection, skill, and accuracy in all endeavour
Evolution into a company with strong independent divisions: Research & Editorial, Production, Sales & Marketing, and Technology
Continuously providing practical solutions through Taxmann Advisory
Our Strength Core Editorial and Research Division
Team Over 200 motivated legal professionals (Lawyers, Chartered Accountants, Company Secretaries)
Expertise Monitoring and processing developments in judicial, administrative, and legislative fields with unparalleled skill and accuracy
Impact Helping businesses navigate complex tax and regulatory requirements with ease
Taxmann Today Legacy
Innovation
Commitment
Over 60 years of domain knowledge and trust
Technology-driven solutions for modern challenges
Ensuring perfection, skill, and accuracy in every solution provided
Our Core Domain Areas Income Tax Corporate Tax Advisory Trusts & NGO Consultancy TDS Advisory Global Mobility Services Personal Taxation Training Due Diligence
Goods & Services Tax Transaction Advisory Business Restructuring Classification & Rate Advisory Due Diligence Training Trade Facilitation Measures
Foreign Exchange Management Laws
UAE Corporate Tax
Due Dilligence Advisory Services Assistance in compounding of offences Transactions Services Investment outside India
Corporate Tax Advisory Corporate Structuring VAT Advisory Residential Status
Your Partners for Frictionless Advice Tax Advisory High-quality advice for all your Income-tax, GST, FEMA, and UAE Corporate Tax queries From a distinguished panel of experts
Tax Research Support Get real-time research support
Tax Restructuring and Implementation Support
By a team of trained researchers
Structure your business and processes in a tax-efficient way
To upscale the quality of your advice
Implement the SOPs for tax compliances
And save your manpower cost
Automate your ERPs to handle tax compliances
A Glimpse of the People Behind Taxmann
Naveen Wadhwa
Vinod K. Singhania
V.S. Datey
Research and Advisory [Corporate and Personal Tax]
Expert on Panel | Research and Advisory (Direct Tax)
Expert on Panel | Research and Advisory [Indirect Tax]
Chartered Accountant (All India 24th Rank)
Over 35 years of experience in tax laws
Holds 30+ years of experience
14+ years of experience in Income tax and International Tax
PhD in Corporate Economics and Legislation
Engaged in consulting and training professionals on Indirect Taxation
Expertise across real estate, technology, publication, education, hospitality, and manufacturing sectors
Author and resource person in 800+ seminars
A regular speaker at various industry forums, associations and industry workshops Author of various books on Indirect Taxation used by professionals and Department officials
Contributor to renowned media outlets on tax issues
S.S. Gupta
Expert on Panel | Research and Advisory [Indirect Tax] Chartered Accountant and Cost & Works Accountant 34+ Years of Experience in Indirect Taxation Bestowed with numerous prestigious scholarships and prizes Author of the book GST – How to Meet Your Obligations', which is widely referred to by Trade and Industry
Manoj Fogla
Nirav Shah
Expert on Panel | Research and Advisory [Charitable Trusts and NGOs]
Expert on Panel | Research and Advisory [UAE Corporate Tax]
Over three decades of practising experience on tax, legal and regulatory aspects of NPOs and Charitable Institutions
25+ years of experience and practicing in the UAE
Law practitioner, a fellow member of the Institute of Chartered Accountants of India and also holds a Master's degree in Philosophy
Has previously worked with the KPMG
PhD from Utkal University, Doctoral Research on Social Accountability Standards for NPOs Author of several best-selling books for professionals, including the recent one titled 'Trust and NGO's Ready Reckoner' by Taxmann Drafted publications for The Institute of Chartered Accountants of India, New Delhi, such as FAQs on GST for NPOs & FAQs on FCRA for NPOs. Has been a faculty and resource person at various national and international forums
Chartered Accountant (All India 36th Rank)
Contact Us Taxmann Delhi 59/32, New Rohtak Road New Delhi – 110005 | India Phone | 011 45562222 Email | sales@taxmann.com Taxmann Mumbai 35, Bodke Building, Ground Floor, M.G. Road, Mulund (West), Opp. Mulund Railway Station Mumbai – 400080 | Maharashtra | India Phone | +91 93222 47686 Email | sales.mumbai@taxmann.com Taxmann Pune Office No. 14, First Floor, Prestige Point, 283 Shukrwar Peth, Bajirao Road, Opp. Chinchechi Talim, Pune – 411002 | Maharashtra | India Phone | +91 98224 11811 Email | sales.pune@taxmann.com Taxmann Ahmedabad 7, Abhinav Arcade, Ground Floor, Pritam Nagar Paldi Ahmedabad – 380007 | Gujarat | India Phone: +91 99099 84900 Email: sales.ahmedabad@taxmann.com Taxmann Hyderabad 4-1-369 Indralok Commercial Complex Shop No. 15/1 – Ground Floor, Reddy Hostel Lane Abids Hyderabad – 500001 | Telangana | India Phone | +91 93910 41461 Email | sales.hyderabad@taxmann.com Taxmann Chennai No. 26, 2, Rajan St, Rama Kamath Puram, T. Nagar Chennai – 600017 | Tamil Nadu | India Phone | +91 89390 09948 Email | sales.chennai@taxmann.com
www.taxmann.com
Taxmann Bengaluru 12/1, Nirmal Nivas, Ground Floor, 4th Cross, Gandhi Nagar Bengaluru – 560009 | Karnataka | India Phone | +91 99869 50066 Email | sales.bengaluru@taxmann.com Taxmann Kolkata Nigam Centre, 155-Lenin Sarani, Wellington, 2nd Floor, Room No. 213 Kolkata – 700013 | West Bengal | India Phone | +91 98300 71313 Email | sales.kolkata@taxmann.com Taxmann Lucknow House No. LIG – 4/40, Sector – H, Jankipuram Lucknow – 226021 | Uttar Pradesh | India Phone | +91 97924 23987 Email | sales.lucknow@taxmann.com Taxmann Bhubaneswar Plot No. 591, Nayapalli, Near Damayanti Apartments Bhubaneswar – 751012 | Odisha | India Phone | +91 99370 71353 Email | sales.bhubaneswar@taxmann.com Taxmann Guwahati House No. 2, Samnaay Path, Sawauchi Dakshin Gaon Road Guwahati – 781040 | Assam | India Phone | +91 70866 24504 Email | sales.guwahati@taxmann.com