Because operating is the residual under IFRS 18, the classification work happens in the other two categories. Investing captures returns from assets that generate a return largely independently of the entity’s other resources. Financing captures liabilities that involve raising finance. Getting these two right determines everything that falls into operating.
The investing category and the independent return test
Investing covers income and expenses from assets that generate a return individually and largely independently of the entity’s other resources. That phrase is the whole test, and it is more discriminating than it first appears.
Typically in investing:
- Income from investments in associates and joint ventures
- Dividends and returns from equity investments held for a return
- Interest and returns on cash and cash equivalents
- Income from investment property held for capital appreciation or rental, where property is not a main business activity
Applying the test
Ask whether the asset produces its return on its own, or only in combination with your people, systems and other assets.
A bank deposit earns interest whether or not anyone turns up to work. That is an independent return, and it is investing. A delivery van earns nothing on its own — it produces value only combined with drivers, customers and a business around it. Not independent, so its depreciation and disposal results sit in operating.
The awkward cases are assets that sit in between. A property let to a third party generates rent fairly independently. But if managing property is what your business does, it is a main business activity and the income is operating. Same asset, different answer, driven by what the entity is.
The financing category
Financing splits into two groups, and the distinction matters:
- Liabilities arising from transactions that involve only the raising of finance — bank loans, bonds, overdrafts. Interest on these is financing.
- Liabilities not arising solely from raising finance — lease liabilities, pension and end of service obligations, deferred consideration. For these, only the interest expense component is financing.
Why a lease, a loan and a gratuity liability differ
| Liability | Nature | Where the cost goes |
|---|---|---|
| Bank loan | Purely raising finance | All interest to financing |
| Lease liability | Obtaining an asset, financed over time | Interest to financing; right-of-use depreciation to operating |
| End of service obligation | Employee benefit, not finance-raising | Service cost to operating; unwinding of discount to financing |
| Deferred consideration | Purchase terms, not finance-raising | Interest element to financing |
For a UAE company, the end of service gratuity line is the one to look at. Under IFRS 18 it splits: the cost of employees earning further entitlement is operating, while the unwinding of the discount on the obligation is financing. Businesses currently reporting one gratuity charge will report two components in two categories.
Why the split has consequences
Moving interest out of operating is not cosmetic. It raises reported operating profit for leveraged businesses, because financing costs no longer sit above the subtotal.
Two companies with identical trading performance but different capital structures will now show more similar operating profits and different financing costs — which is the intended improvement in comparability. But if a covenant, bonus or valuation multiple references operating profit, the number moves without the business changing. Identify that now, not in the year it applies.
UAE-specific situations to look at
- Property-owning groups. Whether rental and fair value movements are operating or investing depends on main business activities — and the answer can differ between entities in the same group.
- Free zone holding companies. Dividends and investment returns will largely be investing, which changes the shape of the income statement for entities whose qualifying income analysis depends on income type.
- Groups with intercompany loans. Interest classification interacts with transfer pricing on those balances.
- Businesses with significant lease portfolios. Retail and logistics operations will see the operating/financing split most visibly.
Frequently asked questions
What is the investing category under IFRS 18?
Income and expenses from assets that generate a return individually and largely independently of the entity’s other resources — investments in associates, equity investments, cash returns and, in some cases, investment property.
What is the independent return test?
Whether the asset produces its return on its own or only in combination with the entity’s other resources. Independent returns go to investing.
Is all interest expense financing?
For liabilities that involve only raising finance, yes. For lease and employee benefit liabilities, only the interest component is financing; the rest is operating.
Where does end of service gratuity go?
The service cost is operating; the unwinding of the discount on the obligation is financing. One charge becomes two components.
Where does rental income go?
Investing where property is held for a return and property is not a main business activity. Operating where investing in property is what the business does.
Does this increase reported operating profit?
For leveraged businesses, generally yes, because interest moves below the operating subtotal.
Can the same item be classified differently across a group?
Yes, because classification depends on each entity’s main business activities. That has to be resolved consistently on consolidation.