Navigating practical challenges in application of Ind AS 118

The National Financial Reporting Authority (NFRA) has recommended Ind AS 118 Presentation and Disclosure in Financial Statements, along with consequential amendments to certain other Ind AS including Ind AS 7, Statement of Cash Flows, Ind AS 33, Earnings per share and Ind AS 34, Interim financial reporting, to the Central Government, for notification. Ind AS 118 corresponds to IFRS 18 issued by the International Accounting Standards Board (IASB) and the NFRA recommendation indicates that there may be no material change between IFRS 18 and Ind AS 118. In accordance with the NFRA recommendation, Ind AS 118, once notified, will apply for the financial year beginning 1 April 2027, and entities preparing financial statements on a calendar year basis may have an option to early adopt the same from 1 January 2027 onward.

We understand that the regulators are also working on revision of Division II and Division III to Schedule III to the Companies Act, 2013 (as amended) as well as the revision of the quarterly results format prescribed under the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015 (as amended). We expect the final Ind AS 118 and related amendments to be notified soon.

Overview of key Ind AS 118 impacts

Ind AS 118 sets out general and specific requirements for the presentation of financial statements and for disclosures in the notes. Given below is an overview of the key requirements of Ind AS 118:

• An entity should classify all income and expenses within its statement of profit and loss (P&L) into one of the five categories: operating, investing, financing, income taxes and discontinued operations. The first three categories are new from P&L perspective.
• An entity should present an analysis of expenses under the operating category using either nature-wise or function-wise or mixed classification of expenses. The entity should choose the presentation method which provides the most useful, structured summary of the expense, after considering criteria prescribed in the standard. It may be noted that Ind AS 1 Presentation of Financial Statements as well as Schedule III currently mandate nature-wise classification of expenses.
• Three new categories in P&L are complemented by the requirement to present three mandatory subtotals and totals, viz., ‘operating profit or loss’, ‘profit or loss before financing and income taxes’ and ‘profit or loss’.
• To apply the classification requirements into three new categories, Ind AS 118 requires an entity to assess whether it has a specified main business activity (MBA) of investing in the particular type of assets and/or providing financing to customers. If this is the case, the entity is required to classify certain specific income and expenses in the operating category, which would otherwise have been classified in the investing or financing categories. MBA assessment is made at the reporting entity level, and MBA of the group may differ from those of individual entities in the group. The consequence is that the classification of income and expense at the group consolidated financial statements (CFS) may change vis-à-vis the classification at individual entity financial statements level.
• Each entity should make specific disclosures about each Management-defined Performance Measure (MPM), including reconciliations to specified Ind AS subtotals, in a single note to the financial statements. MPMs are subtotals of income and expenses used in public communications outside the financial statements to communicate management's view of an aspect of financial performance of the entity as a whole.
• An enhanced guidance is provided on aggregation and disaggregation of information to be presented/disclosed in the financial statements. Entities may need to re-look at their financial statements to ensure compliance with the enhanced guidance.

For a detailed understanding of Ind AS 118 requirements, reference can be made to our publication Applying Ind AS: A closer look at Ind AS 118 and our webcast Ind AS 118: What CFOs and Finance Leaders Need to Know.

Overview of practical application issues

As entities prepare for practical application of Ind AS 118 once it is notified and becomes applicable, they are facing certain practical issues. In this article, we provide an overview of three such issues for entities not having an MBA of investing in a particular type of assets and/or providing finance to the customer.

Classification of foreign exchange differences on Type 2 liabilities (i.e., liabilities not purely related to raising of finance)

The basic principle for classifying foreign exchange differences is that they follow the category in which the related income and expenses from the item giving rise to the foreign exchange difference have been classified, unless doing so would involve undue cost or effort. If the latter is the case, all such differences are classified in the operating category. For example, foreign exchange differences on a trade receivable denominated in a foreign currency are classified in the operating category. Foreign exchange differences arising from a Type 1 liability, i.e., liabilities purely related to raising of finance (e.g., a debt instrument denominated in foreign currency) are classified in the financing category.

Type 2 liabilities, by definition, relate to more than one activity. For example, a lease liability relates to the acquisition of a right to use a leased asset as well as to the receipt of financing. A trade payable with a three-month credit term relates to the acquisition of goods or services and contains a financing component, even if no interest is accounted for due to the short-term nature of the liability.

When applying Ind AS 118 requirements to such liabilities, an entity could consider both activities that gave rise to the liability in order to assess the appropriate category in which the foreign exchange difference must be classified. Since Ind AS 118 is clear that an entity is not permitted to allocate the foreign exchange differences arising on an asset or a liability between categories, judgment is needed to decide which of these activities takes precedence and, therefore, in which single category to classify the difference.

In a practical scenario, applying the judgment, an entity may conclude:

• Foreign exchange differences on a lease liability relate to the interest expense included in the financing category, because Ind AS 116 Leases treats lease arrangements as a form of financing and the choice between buying or leasing an asset is a financing decision.
• Foreign exchange differences on a short-term trade payable, on which no interest expense is recognized, related to the acquisition of inventory relate to amounts included in the operating category. This judgment can be supported with the argument that the decision to purchase inventory in a foreign currency is an operating decision, or with the argument that trade payable do not result in any income or expense being recognized in the financing category.

How we see it

The classification of foreign exchange differences on a Type 2 liabilities requires the use of judgment, based on the particular facts and circumstances of the entity.

Therefore, differing conclusions on similar liabilities could occur between entities. However, each entity is required to classify the foreign exchange differences on similar Type 2 liabilities in the same category.

Classification of foreign exchange differences on intercompany loans eliminated on consolidation

As explained above, the basic principle in Ind AS 118 is that foreign exchange differences are classified in the same category in which the related income and expenses from the item giving rise to the foreign exchange difference have been classified, unless doing so would involve undue cost or effort.

The application of this principle can be challenging for intercompany loans within a group. Consider a multinational group where the parent commonly has a different functional currency from its subsidiaries. The parent company has provided a loan to its overseas subsidiary. The loan is denominated in the parent's functional currency and does not form part of the parent’s net investment in the subsidiary.

Any intercompany balances between the parent and its subsidiaries, which do not form part of the net investment in a foreign operation, are eliminated on consolidation applying Ind AS 110 Consolidated Financial Statements. However, the foreign exchange differences recognized in the consolidated statement of profit and loss, by applying paragraph 45 of Ind AS 21 The Effects of Changes in Foreign Exchange Rates, are not eliminated. Hence, from the consolidated group’s perspective, the underlying intercompany balances that gave rise to the foreign exchange differences do not exist. Therefore, there does not appear to be ‘related income and expenses’ that the foreign exchange differences can ‘follow.’ In the context of IFRS 18, this issue was considered by the IFRS Interpretation Committee (IFRS IC) in March 2026. The IFRS IC concluded there are two reasonable readings of the Standard in such cases:

1. Classify the foreign exchange difference in the operating category as the default category. This reading is on the basis that the related income and expenses arising from the item that gave rise to the foreign exchange differences are not included in the consolidated statement of profit and loss and, therefore, there is no ‘same’ category to follow.
2. Classify the foreign exchange difference in the same category in which the related income and expenses would have been classified before their elimination on consolidation, or, if doing so would involve undue cost and effort, in the operating category. This reading is based on the interpretation that the standard does not require the related income and expenses from the intragroup loan to be included in the consolidated statement of profit and loss in order for the foreign exchange differences to follow their classification before elimination.

This reading is applied from the perspective of the consolidated entity and, therefore, could differ from the category in which the subsidiary classifies the exchange difference in its individual financial statements (e.g., where the group and the subsidiary have different main business activities, for example, a subsidiary whose main business activity is providing financing to customers may classify exchange differences on related borrowings within the operating category in its standalone financial statements. However, the parent may classify those exchange differences within the financing category in the consolidated financial statements if providing financing is not a main business activity of the group).

Considering the example above, involving a loan from a parent to its subsidiary with a different functional currency (intragroup loan), which is:

• Denominated in the functional currency of the parent.
• Not part of the parent’s net investment in the subsidiary.

The subsidiary, therefore, has a foreign currency monetary item (Type 1 liability) and applies Ind AS 21 to translate the loan into its functional currency at the reporting date, recognizing foreign exchange differences in the financing category in its individual statement of profit or loss. In accordance with Ind AS 21.45, these foreign exchange differences are recognized in the consolidated statement of profit and loss. In this example, it is appropriate to recognize the foreign exchange difference either in the operating category, applying the first reading or in the financing category, applying the second reading.

An entity must develop an accounting policy in accordance with Ind AS 8 Accounting Policies, Changes in Accounting Estimates and Errors for its reading of Ind AS 118 in such circumstances (i.e., choosing either the reading (1) or (2) above) and apply that reading consistently. This means that it is not possible to apply different readings to different types of intragroup balances (for example, to long-term versus short-term balances).

Classification of interest arising on settlement of indirect tax litigation

Ind AS 118 requires an entity to classify interest income/expense as well as impact of changes in interest rate on Type 2 liability (i.e., liability not purely related to raising of finance) to be classified in the financing category, if they arise from application of other requirements in Ind AS. Any provision recognized for ongoing indirect tax litigation is a Type 2 liability accounted for in accordance with Ind AS 37 Provisions, Contingent Liabilities and Contingent Assets. Ind AS 37 requires that where the effect of the time value of money is material, the amount of a provision should be the present value of the expenditure expected to be required to settle the obligation. Any unwinding of discount is treated as borrowing/interest cost.

Consider a scenario where the entity is involved in the ongoing litigation related to an indirect tax matter. The applicable indirect tax law will require the entity to make payment with interest calculated from the date when the obligating event took place if the matter gets decided against the entity. The management, along with its legal professionals, has assessed that there are good chances of success and exposure under the litigation, both for principal amount as well as interest, was possible and not probable. Considering the expected favorable outcome, the entity has not made any upfront payment towards potential obligation, which may arise if the matter gets decided against the entity. The entity discloses both the principal amount of the obligation as well as the interest accrued till the reporting date as contingent liability in notes to the financial statements.

During the current year, the apex court has decided the matter against the entity, requiring it to pay both principal amount of obligation as well the interest relating to past periods. In this case, it seems clear that principal portion of the indirect tax liability is classified in the operating category, as it relates to the entity's ongoing operations and does not meet criteria for classification under investing of financing categories. However, an issue arises with regard to classification of past interest and, apparently, the following two views seem possible:

1. Interest presented in the operating category: To support this view, it may be mentioned that Ind AS 118 requires interest income and expense on Type 2 liabilities to be classified in the financing category only when such interest is identified and recognized by applying another Ind AS. In this fact pattern, the entity has not previously recognized a provision for the disputed amount and, therefore, has not recognized any interest expense under Ind AS 37. As a result, interest component does not meet the requirements for classification in the financing category and is instead classified in the operating category, which is a residual category under Ind AS 118.
2. Interest presented in the financing category: To support this view, it may be argued that though the entity has previously not recognized Type 2 liability and interest component separately, it was disclosing the obligation requiring possible cash outflows as such in notes to the financial statements. The legal position is clear that the entity is paying tax and interest thereon, for delay in making payment. Hence, interest component is in the nature of finance cost and classified in the financing category.

Ind AS 118 does not specifically address the classification of interest arising in such cases. As a result, more than one interpretation may be supportable depending on how an entity views the nature of the interest charge and its relationship with the underlying tax obligation. We recommend that it may be appropriate for the Institute of Chartered Accountants of India (ICAI) to provide guidance on the matter.

Concluding remarks

Ind AS 118 represents a fundamental evolution in financial statement presentation rather than a mere re-labeling exercise. The standard is expected to significantly enhance comparability, transparency and discipline in the presentation of financial performance. Its implementation will require entities to look beyond statutory formats and reassess how performance is defined, measured and communicated. The standard is also likely to drive changes in transaction systems, reporting processes and internal controls to ensure consistent classification and robust disclosures. This, among other matters, will require entities to evaluate and conclude technical/practical issues which are expected to arise. The experience indicates that such evaluation may be challenging and time-consuming exercise. For listed entities and IPO-bound companies in particular, early preparedness will be critical to ensure smooth transition, manage regulatory expectations and investor scrutiny.