In the first blog of this series, we introduced the five categories that IFRS 18 uses to reshape the statement of profit or loss: operating, investing, financing, income taxes, and discontinued operations. Of the five, the operating category is the one that will, for most companies, contain the bulk of their income and expenses, and it is also, structurally, the odd one out. Unlike investing and financing, which are defined by specific inclusion criteria, the operating category is deliberately built as a residual bucket. Understanding what that means, in practice, is the subject of this blog.
The Residual Principle: Everything Lands Here by Default
IFRS 18.B42 sets out the governing idea plainly: unless an item of income or expense meets the specific criteria to be classified in the investing, financing, income taxes or discontinued operations categories, it must be classified in the operating category. There is no separate checklist of what qualifies as ‘operating’ income or expense, the standard does not need one, because operating simply absorbs whatever the other four categories do not claim.
This is a genuinely important conceptual shift from how many finance teams have historically thought about operating profit. In the pre-IFRS 18 world, it was common for management to view ‘operating’ as a curated, judgement-based subset of results, often stripped of items considered unusual, one-off or non-core. IFRS 18 closes that door decisively.
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Key rule to remember IFRS 18.B42 explicitly states that income and expenses cannot be excluded from the operating category on the grounds that they are volatile, unusual or non-recurring. Being ‘messy’ is not a valid reason to reclassify an item out of operating. |
What Typically Lands in the Operating Category
Although the operating category is defined residually, IFRS 18's application guidance does describe, non-exhaustively, the types of income and expense that will typically end up there for an entity without specified main business activities. Broadly, these fall into three groups.
1. Income and expenses from assets that don't generate a standalone return
Most of a typical trading or manufacturing business's core assets, inventory, property, plant and equipment, trade receivables, do not generate a return ‘individually and largely independently’ of the rest of the business (a phrase that becomes central when we discuss the investing category in the next blog). As a result, income and expenses connected to these assets sit in operating.
- Revenue from contracts with customers (IFRS 15) and insurance revenue (IFRS 17).
- Depreciation, impairment, and gains or losses on disposal of property, plant and equipment.
- Cost of sales and inventory write-downs to net realisable value.
- Expected credit losses on trade receivables and contract assets (IFRS 9).
2. Liability-related income and expenses that are not purely financing
The financing category (covered in blog four of this series) is reserved for liabilities that arise from transactions involving only the raising of finance. Many liabilities do not meet that description, and the related income and expenses default to operating.
- Expenses linked to executory contracts, cleaning, catering, maintenance and similar services where a liability is recognised but no finance is being raised.
- Remeasurement of cash-settled share-based payment liabilities (IFRS 2).
- Contract modification gains and losses (IFRS 15) and lease liability modification gains and losses (IFRS 16).
- Changes in the best estimate required to settle a provision (IAS 37).
3. Items IFRS 18 specifically directs to operating
A handful of items are explicitly routed to the operating category by the standard, regardless of how they might ‘feel’ intuitively:
- Income and expenses from issued investment contracts with participation features (IFRS 9).
- Insurance finance income and expenses recognised in profit or loss under IFRS 17, notably, this applies even to a corporate entity that is not an ‘insurance company’ in the traditional sense but happens to issue contracts within the scope of IFRS 17.
- Income and expenses relating to business combinations, such as bargain purchase gains and remeasurement of contingent consideration.
A Worked Example: The Farewell to ‘Extraordinary Items’
IAS 1 explicitly banned entities from labelling anything as an ‘extraordinary item’ on the face of the statement of profit or loss, and IFRS 18 does not reintroduce that concept either, but it does clarify, through example, how even genuinely extraordinary events are classified.
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Practical case, the hurricane Entity K's manufacturing facility is destroyed by a hurricane, resulting in the derecognition of significant property, plant and equipment and inventory. Applying IFRS 18, these assets do not generate a return individually and largely independently of the entity's other resources, so the resulting losses are classified in the operating category, in full, with no carve-out for the fact the event was catastrophic and non-recurring. The entity's only lever here is aggregation and disaggregation (see blog six of this series): it may present the tornado-related losses as a separate, clearly labelled line item within operating to preserve transparency, but it cannot move the loss out of operating. |
Practical Implications for Preparers
For finance teams, the shift to a residual, catch-all operating category has several tangible consequences worth planning for now.
| Practical implication | What it means for your reporting |
|---|---|
| Operating profit will likely become more volatile | Because unusual, one-off items can no longer be pushed below operating profit, the subtotal will more faithfully reflect the full economic reality of the period, including the bad quarters. |
| Less room for ‘adjusted’ optics at the IFRS level | Entities that want to show a cleaner, adjusted view of performance will need to do so through a properly disclosed management-defined performance measure (MPM), not through selective reclassification within the statement. |
| Aggregation and disaggregation become the real design lever | Since items can't be excluded from operating, how they are presented, as a separate line, in a note, or aggregated with similar items, becomes the primary tool for telling a clear story. |
| Systems need to capture nature and function consistently | Because operating expenses can be presented by nature, function, or a mix of both (subject to conditions), general ledger structures need to support whichever presentation best reflects the business. |
The Interaction with Specified Main Business Activities
The operating category also absorbs items that would, for a typical company, sit in investing or financing, if the reporting entity has specified main business activities (SMBAs). A real estate company that invests in investment property as its core business, for example, classifies fair value gains and losses on that property in the operating category, not investing, because the standard requires income and expenses from an entity's main business activities to reflect that reality. We unpack SMBAs fully, including multi-activity groups, in blog five of this series, but it is worth flagging here because it directly determines what does, and does not, count as ‘operating’ for a given entity.
The Comprehensive Operating Category Checklist
Because the operating category is residual, there is no official closed list, but in practice, preparers benefit enormously from a working checklist covering most items they'll actually encounter. The table below consolidates the operating category items referenced throughout IFRS 18's application guidance into a single practical reference, organised by the type of income statement driver.
| Area | Typical operating category items |
|---|---|
| Revenue and customer contracts | Revenue from contracts with customers (IFRS 15); insurance revenue (IFRS 17); contract modification gains and losses; variable consideration remeasurements. |
| Cost of sales / inventory | Cost of sales and similar cost-of-goods-sold items; inventory write-downs to net realisable value and subsequent reversals; scrapping and obsolescence losses. |
| Property, plant and equipment (owner-occupied) | Depreciation; impairment losses and reversals (IAS 36); gains and losses on disposal or derecognition. |
| Receivables and contract assets | Expected credit losses and reversals on trade receivables and contract assets (IFRS 9); interest income on contract assets. |
| Employee costs | Salaries, wages and short-term employee benefits (IAS 19); remeasurement of cash-settled share-based payment liabilities (IFRS 2); equity-settled share-based payment expense. |
| Leases (lessee) | Depreciation of right-of-use assets; short-term and low-value lease expenses; lease modification gains and losses (the interest component of the lease liability itself is financing, not operating). |
| Provisions and contingencies | Changes in the best estimate required to settle a provision (IAS 37), other than the discount-unwinding component; litigation costs and settlements; warranty expense. |
| Executory and service contracts | Expenses for cleaning, catering, maintenance, repairs and similar consumed services where a liability is recognised but no finance is being raised. |
| Business combinations | Bargain purchase gains; acquisition-related transaction costs; remeasurement of contingent consideration; integration and restructuring costs. |
| Restructuring and impairment events | Restructuring provisions and related costs; impairment of goodwill and intangible assets; losses from catastrophic events (e.g. natural disasters) affecting operating assets, cannot be excluded from operating merely for being unusual. |
| Insurance-specific (always operating) | Insurance finance income and expenses recognised under IFRS 17; income and expenses from issued investment contracts with participation features (IFRS 9) , applies even to non-insurers that happen to issue in-scope contracts. |
| Foreign exchange and derivatives | FX differences on operating monetary items (trade receivables/payables); gains and losses on derivatives economically hedging an operating exposure. |
| SMBA-specific inclusions | For entities with specified main business activities: interest income/expense on customer financing; fair value gains/losses, rental income and depreciation on investment property held as a main business activity; fair value movements on financial assets held as a main business activity. |
How This Populates a Real Statement of Profit or Loss
To make the checklist concrete, here is how a representative set of operating category items, for a manufacturing entity without specified main business activities, might appear in the operating section of the statement of profit or loss, presented on a mixed nature/function basis (illustrative figures, AED 000s):
| Line item | 20X7 | Category detail |
|---|---|---|
| Revenue | 12,400 | Revenue from contracts with customers |
| Cost of sales | (7,200) | Includes inventory expensed and directly attributable production costs |
| Gross profit | 5,200 | Additional subtotal |
| Distribution expenses | (680) | Function-based operating expense |
| Administrative expenses | (1,150) | Function-based operating expense |
| Expected credit losses on trade receivables | (55) | IFRS 9 impairment, operating |
| Restructuring costs | (90) | Cannot be excluded from operating for being unusual |
| Interest income on contract assets | 45 | Operating, asset lacks independent return |
| Operating profit | 3,270 | Mandatory subtotal: total of all operating category items |
Presentation Choices Within the Operating Category
Because the operating category tends to be the largest and most heterogeneous of the five, IFRS 18 pays particular attention to how items within it are presented. As covered in more depth in our aggregation and disaggregation blog later in this series, entities must analyse operating expenses using nature, function, or a mixed approach, and, critically, this analysis must now appear on the face of the statement of profit or loss rather than being relegated to the notes, which was permitted under IAS 1. For a business with a genuinely diverse cost base, raw materials, direct labour, distribution, marketing, corporate overheads, this decision materially affects how readable the operating section of the income statement will be.
How the Operating Category Differs From ‘Underlying’ or ‘Adjusted’ Operating Profit
It's worth being explicit about a distinction that will matter enormously to investor relations teams: IFRS 18's operating profit is not the same thing as the ‘underlying’, ‘adjusted’ or ‘core’ operating profit many listed companies have historically reported in earnings releases. Those adjusted measures typically strip out items management considers non-representative of ongoing performance, restructuring charges, impairments, acquisition costs, and so on. IFRS 18's operating profit cannot do this, because, as discussed above, volatility and unusual nature are explicitly not valid grounds for exclusion from the category.
Companies that still want to communicate an adjusted view of performance are not prevented from doing so, but they must do it through a formally disclosed management-defined performance measure (MPM), complete with a reconciliation back to the nearest IFRS-defined subtotal and an explanation of why the adjustment is useful. This is a meaningful governance change: adjusted operating profit figures move from being a matter of investor relations style to a matter of mandatory, audited disclosure with specific reconciliation requirements.
Conclusion
The operating category is, in many respects, the quiet workhorse of IFRS 18. It doesn't have the sharply defined boundaries of investing or financing, and it doesn't attract the same attention as the new specified main business activities requirements. But because it is residual and mandatory, it will end up carrying the majority of most entities' income and expenses, and, critically, it can no longer be curated to exclude the uncomfortable, volatile, or one-off items that used to slip below a self-defined operating profit line. For preparers, the practical takeaway is this: get comfortable with the idea that operating profit under IFRS 18 will, for many businesses, look noisier and more complete than it used to , and start thinking now about how aggregation, disaggregation and clearly disclosed MPMs can be used to tell a coherent performance story around it.
If your finance team is still mapping out what IFRS 18 means for how operating profit will look and read, CLA Emirates can help you get there with confidence. As specialists in IFRS advisory in the UAE, our team works alongside preparers to reclassify income statement items, design MPM frameworks, and build lasting IFRS compliance in the UAE well before the 2027 effective date.
Next in this series, we turn to the investing category, the first of the two ‘defined by exception’ categories, and the one that introduces one of IFRS 18's more technical tests: whether an asset generates a return individually and largely independently of an entity's other resources.
