Ind AS 118: presenting expenses by function, and the note that comes with it

Short answer: by nature and by function stop being a style choice. Choosing function buys a cleaner statement and costs you a note; choosing nature costs nothing extra and has to be the right answer rather than the default one.

The two ways to present an operating expense

By nature is what it is: employee benefits, depreciation, raw materials, power and fuel, freight.

By function is what it was for: cost of sales, distribution, administration.

An Indian group reading this is almost certainly presenting by nature, because that is how Schedule III lays the statement out. That has made the question feel settled for a long time. Ind AS 118 unsettles it — not by forcing a change, but by attaching a consequence to the choice.

What changes

Two things.

The choice has to be reasoned. The presentation you use is the one that most usefully describes your performance. That is a judgement, and like every judgement in this standard it is one you have to be able to explain rather than inherit.

Function comes with a note. If operating expenses are presented by function, the specified nature amounts — depreciation, amortisation, employee benefits, impairment losses on non-financial assets and reversals, inventory write-downs and reversals — go into a single note, where a reader can see them in one place. And not only as totals: the note also shows how much of each amount sits inside each function line, so depreciation is split between cost of sales, distribution and administration as the statement itself splits it. That second half is the one that needs the ledger tagged at posting, because it cannot be rebuilt from the totals afterwards.

The reasoning behind that is worth understanding, because it tells you what the standard is protecting. By-function presentation is easier to read and easier to hide inside. Depreciation spread across cost of sales, distribution and administration is invisible to anybody outside the company. The note puts it back.

The case that catches Indian groups

Not the pure-by-nature statement. The mixed one.

A group that presents mostly by nature but carries “cost of materials consumed” alongside a functional line, or that has one subsidiary reporting by function into a by-nature group, has a mixed presentation and usually does not know it. Mixed presentation is allowed, and it is the case that needs the clearest reasoning, because a reader has to be able to tell which lines are which. The mix is permitted between lines, not within one: each individual line has to be aggregated on a single basis. A line that is partly nature and partly function is not a mixed presentation. It is a line that needs splitting.

The practical test: take your operating expense lines and label each N or F. If the answer is not uniformly one letter, you have a mixed presentation and a decision to record. If any single line honestly needs both letters, that line is the first thing to fix.

What a group should do about it

1. Label every operating expense line N or F, at group level and at each company.
2. If the letters differ between companies, decide which the group presents in and fix the mapping.
3. Write down why the chosen presentation is the most useful one. A paragraph. It is the thing you will be asked for and the thing nobody has.
4. If any function presentation survives, check you can produce the nature amounts. Depreciation and employee benefits by function require the functional split to exist in the ledger, not to be estimated afterwards. That is a chart of accounts question, and it takes longer to fix than the note takes to write.

Point 4 is the one with a lead time. Everything else is a decision; that one is data you either have or do not.

Where FINAHQ fits

Nature and function are two groupings of the same ledgers, which is exactly the shape of problem the mapping is built for: one set of books, more than one view over it, applied the same way in every company and recorded rather than re-decided each period.

What the statements look like, and what this is worth for a group your shape.