# Three Financial Statements Concept Card: [Your course or company]

> A concept card for the core idea of financial accounting: the income statement, the balance sheet and the cash flow
> statement are three views of one set of transactions, and they must articulate (tie to each other) exactly. It is
> for MBA students in the first financial accounting course, career switchers preparing for finance or consulting
> interviews, and managers who read annual reports. It shows how the statements link, how IFRS and US GAAP name and
> place the main items, and how the income statement changes when IFRS 18 replaces IAS 1 for annual periods
> beginning on or after 1 January 2027 (operating, investing and financing categories, two new subtotals and
> management-defined performance measures). Source basis: the IASB Conceptual Framework (2018), IAS 1, IFRS 18, IAS 7,
> IFRS 15, IFRS 16, FASB ASC 606, 842 and 230, and Pacioli (1494) for double entry, written up in original words with
> a fictional company. Replace every [bracketed] value and every row marked *Example*. This is a learning aid, not
> accounting, audit or investment advice.

<!--
Guidance: How to use this template
- Read "The idea in plain language" and the articulation diagram first. Then rebuild Worked example A in a
  spreadsheet with the sheet layout given (sheets IS, BS and CF, FY2024 in column B, FY2025 in column C, FY2026 in
  column D) and check that every articulation test returns zero.
- Complete Worked example B (transaction walk) and Exercise C (IFRS 18 classification) before you open the answer key.
- The fictional company is Northfield Outdoor Co., a mid-size outdoor-gear retailer and brand with stores and an
  online shop. Amounts are USD millions. The same statements are used in mba/mba-ratio-analysis-card,
  mba/mba-cash-flow-statement-card and the mini-case in mba/mba-financial-accounting-guide, so you can move between
  the cards without re-learning the numbers. Every number was computed in Python and is re-runnable.
- Answer the self-test from memory, then check the answer key. Log every miss in mba/mba-error-log and turn the
  definitions into cards in mba/mba-concept-flashcards.
- Related templates: mba/mba-financial-accounting-guide, mba/mba-ratio-analysis-card,
  mba/mba-cash-flow-statement-card, mba/pre-mba-accounting-primer, mba/mba-formula-sheet, mba/mba-glossary,
  mba/mba-managerial-accounting-guide, mba/mba-dcf-valuation-card, finance/ifrs-18-transition-plan,
  finance/revenue-recognition-memo, finance/lease-accounting-memo, finance/financial-model-specification,
  finance/financial-statement-disclosure-checklist, academic/finance-case-analysis.
-->

## Document control

<!-- Guidance: Record which framework (IFRS or US GAAP) and which year of standards your course uses. Courses written before 2027 teach the IAS 1 layout; from 2027 IFRS reporters present under IFRS 18, so state which one your notes follow. -->

| Field | Value |
|---|---|
| Course or purpose | [Financial accounting core course / interview preparation / annual report reading] |
| Learner | [Your name] |
| Framework studied | [IFRS (IAS 1 until replaced, IFRS 18 from 2027) / US GAAP / both] |
| Company in the examples | Northfield Outdoor Co. (fictional), FY2025 and FY2026, USD m |
| Spreadsheet used | [Excel / Google Sheets / LibreOffice Calc] |
| Standards checked on | 2026-10-28 (ifrs.org, fasb.org); check again before you rely on a date |
| Reviewed by | [Study partner, tutor or mentor] |
| Version | [0.1] |
| Last updated | YYYY-MM-DD |

## Contents

1. [When to use it](#when-to-use-it)
2. [The idea in plain language](#the-idea-in-plain-language)
3. [Formulas and notation](#formulas-and-notation)
4. [IFRS and US GAAP: where the rules sit](#ifrs-and-us-gaap-where-the-rules-sit)
5. [Assumptions and limits](#assumptions-and-limits)
6. [How managers use it](#how-managers-use-it)
7. [Worked example A (fully solved)](#worked-example-a-fully-solved)
8. [Worked example B (half solved)](#worked-example-b-half-solved)
9. [Exercise C (unsolved)](#exercise-c-unsolved)
10. [Connections to other cards](#connections-to-other-cards)
11. [Common mistakes and misconceptions](#common-mistakes-and-misconceptions)
12. [Self-test questions](#self-test-questions)
13. [My notes and next steps](#my-notes-and-next-steps)
14. [Sources and further reading](#sources-and-further-reading)
15. [Answer key](#answer-key)

## When to use it

<!-- Guidance: Use the card whenever you need to trace one event through all three statements, build or audit a model, or explain why profit and cash differ. If your question is "how good is this performance", go on to the ratio card after this one. -->

Use this card when you need to:

- **Read an annual report** and know where to look: performance over a period (income statement), position at a date
  (balance sheet), and cash movements over the period (cash flow statement), plus the statement of changes in equity
  and the notes.
- **Build or check a three-statement model** in a case, a valuation or a lending decision. A model whose balance sheet
  does not balance, or whose closing cash differs from the cash flow statement, has an error somewhere.
- **Trace a transaction** (a sale on credit, a new store lease, a gift card sold, an inventory write-down) through the
  three statements in an interview or exam.
- **Prepare for the IFRS 18 change**: from 2027 IFRS reporters present a new income statement structure, and the
  2026 comparatives are restated. Analysts, lenders and boards will see "operating profit" change meaning for many
  companies.

Do not use it alone to judge performance: the ratio card (mba/mba-ratio-analysis-card) turns the statements into
comparable measures, and the cash flow card (mba/mba-cash-flow-statement-card) goes deeper into cash.

## The idea in plain language

<!-- Guidance: Be able to say these five sentences without notes. Interviewers and exam markers test exactly this. -->

1. **The balance sheet is a photograph.** At one date it lists what the business controls (assets), what it owes
   (liabilities) and the residual that belongs to owners (equity). Assets always equal liabilities plus equity because
   every transaction is recorded twice (double entry, first described in print by Pacioli in 1494).
2. **The income statement is a film of performance.** Over a period it shows income earned and expenses incurred on
   the accrual basis: revenue when control of goods or services passes to the customer (IFRS 15, ASC 606), expenses
   when the related benefit is used, not when cash moves.
3. **The cash flow statement is a film of cash.** Over the same period it shows cash in and out, sorted into
   operating, investing and financing activities (IAS 7, ASC 230).
4. **They articulate.** Profit for the year flows into retained earnings (equity) on the balance sheet. The net change
   in cash on the cash flow statement equals the change in the cash line on the balance sheet. Every other balance
   sheet line moves by a flow you can find in one of the statements or the notes.
5. **Profit and cash differ for known reasons**: non-cash expenses (depreciation, impairment), changes in working
   capital (receivables, inventory, payables, contract liabilities), investment spending that is capitalised rather
   than expensed, and financing flows that never touch profit (borrowing, repaying, dividends).

```mermaid
flowchart LR
  OB["Opening balance sheet (31 Dec 2025)"] --> IS["Income statement FY2026: profit for the year 19.5"]
  OB --> CF["Cash flow statement FY2026: net change in cash -28.5"]
  IS -->|"profit less dividends 11.0"| RE["Retained earnings: 103.6 to 112.1"]
  CF -->|"opening cash 50.5 plus change"| CASH["Cash: 22.0"]
  IS -->|"depreciation, impairment"| NCA["PP&E, right-of-use assets, software"]
  CF -->|"capex, lease principal, loan repayment"| NCA
  RE --> CB["Closing balance sheet (31 Dec 2026): assets 499.7 = liabilities 347.6 + equity 152.1"]
  CASH --> CB
  NCA --> CB
```

## Formulas and notation

<!-- Guidance: These identities are the tests you run on any model. Write them as spreadsheet checks that should return zero. -->

The accounting equation at any date $t$:

$$A_t = L_t + E_t$$

Clean-surplus relation (retained earnings roll-forward, ignoring other comprehensive income and share issues):

$$RE_t = RE_{t-1} + NI_t - Div_t$$

Cash articulation:

$$Cash_t = Cash_{t-1} + CFO_t + CFI_t + CFF_t$$

Any long-lived asset roll-forward (here PP&E):

$$PPE_t = PPE_{t-1} + Capex_t - Dep_t - Impairment_t - Disposals_t$$

Lease liability roll-forward under IFRS 16 (interest added and paid in the same year in this example):

$$LL_t = LL_{t-1} + NewLeases_t - Principal_t$$

IFRS 18 subtotals for a company without a specified main business activity:

$$OP = Revenue - \text{operating expenses (all categories default to operating)}$$

$$PBFIT = OP + \text{investing category income and expenses}$$

$$PBT = PBFIT - \text{financing category expenses}, \qquad NI = PBT - \text{income tax}$$

| Symbol | Meaning | Northfield FY2026 (USD m) |
|---|---|---|
| $A_t$, $L_t$, $E_t$ | Total assets, liabilities, equity at the year end | 499.7, 347.6, 152.1 |
| $RE_t$ | Retained earnings at the year end | 112.1 |
| $NI_t$ | Profit for the year | 19.5 |
| $Div_t$ | Dividends declared and paid | 11.0 |
| $CFO_t$, $CFI_t$, $CFF_t$ | Net cash from operating, investing, financing activities | 70.4, -35.0, -63.9 (IFRS 18 basis) |
| $Capex_t$, $Dep_t$ | Purchases of PP&E, depreciation of PP&E | 30.0, 19.5 |
| $LL_t$ | Lease liabilities (current plus non-current) | 185.0 |
| $OP$ | Operating profit (IFRS 18 defined subtotal) | 37.4 |
| $PBFIT$ | Profit before financing and income taxes | 40.2 |
| $PBT$ | Profit before income taxes | 25.3 |

## IFRS and US GAAP: where the rules sit

<!-- Guidance: Know the standard numbers and what each governs; you will not be asked to quote paragraphs in an MBA course, but you must know which rulebook applies and what changes when. Facts checked on 2026-10-28; check the official pages again before you rely on them. -->

| Topic | IFRS Accounting Standards | US GAAP (FASB Accounting Standards Codification) | What an MBA reader needs to know |
|---|---|---|---|
| Presentation of the statements | IAS 1 Presentation of Financial Statements, replaced by **IFRS 18 Presentation and Disclosure in Financial Statements** for annual periods beginning on or after 1 January 2027 (earlier application permitted) | No single equivalent; SEC Regulation S-X for registrants; ASU 2024-03 adds expense disaggregation disclosures (annual periods beginning after 15 December 2026 for public business entities, as clarified by ASU 2025-01) | IFRS 18 changes the income statement layout and adds MPM disclosure; it does not change recognition or measurement. US GAAP is not affected by IFRS 18 |
| Cash flows | IAS 7 Statement of Cash Flows (amended by IFRS 18) | ASC 230 Statement of Cash Flows | Under amended IAS 7 the indirect method starts from operating profit, and the interest and dividend classification choices are removed for most companies |
| Revenue | IFRS 15 Revenue from Contracts with Customers (effective 2018) | ASC 606, same name, issued jointly as ASU 2014-09 | Five steps, revenue when control passes; gift cards and loyalty points are contract liabilities until redeemed |
| Leases | IFRS 16 Leases (effective 2019) | ASC 842 Leases (ASU 2016-02) | Both put most leases on the balance sheet. IFRS 16 has one lessee model (depreciation plus interest); ASC 842 keeps an operating lease class with a single straight-line lease cost in operating expenses |
| Conceptual basis | Conceptual Framework for Financial Reporting (2018) | FASB Concepts Statements | Definitions of asset, liability, income and expense |

**IFRS 18 in five points (as of October 2026; check the standard on ifrs.org):**

1. **Five categories** in the statement of profit or loss: operating, investing, financing, income taxes and discontinued
   operations. Operating is the default category for anything that does not belong elsewhere, including unusual items.
2. **Investing** holds income and expenses from investments in associates, joint ventures and unconsolidated
   subsidiaries, cash and cash equivalents, and other assets that earn a return individually and largely independently
   of the company's other resources (for a company whose main business is not investing).
3. **Financing** holds income and expenses from liabilities that arise from raising finance (a bank loan) and the
   interest expense on other liabilities such as lease liabilities and the unwinding of discount on provisions.
4. **Two required subtotals:** operating profit, and profit before financing and income taxes. Banks, insurers and
   investment entities (companies with a "specified main business activity") classify some investing and financing
   items in operating; that judgement is outside this card.
5. **Management-defined performance measures (MPMs):** subtotals of income and expenses that a company uses in public
   communication outside the financial statements (an "adjusted operating profit" in a results presentation, for
   example) must be disclosed in one note with a description, the reason it is useful, how it is calculated and a
   reconciliation to the most directly comparable IFRS subtotal, showing the income tax effect and the effect on
   non-controlling interests for each reconciling item. IFRS 18 also lists some subtotals that are not MPMs, such as
   gross profit and operating profit before depreciation, amortisation and impairments within the scope of IAS 36;
   check the list in the standard. Companies that present expenses by function must also disclose in a note the
   amounts of depreciation, amortisation, employee benefits, impairment losses and inventory write-downs included in
   each line.

**Transition.** IFRS 18 applies retrospectively: a calendar-year company's first IFRS 18 annual report covers FY2027
and restates FY2026 as the comparative. That is why Worked example A shows FY2026 in both forms.

## Assumptions and limits

<!-- Guidance: These are the reasons two analysts can read the same statements differently. Name the one that matters most for your company. -->

- **Accrual accounting needs estimates.** Useful lives, inventory net realisable value (IAS 2), expected credit losses
  (IFRS 9), impairment (IAS 36), lease terms and discount rates (IFRS 16), and the stand-alone selling prices and
  breakage on gift cards (IFRS 15) all involve judgement. Profit is an estimate; cash is a fact.
- **Historical cost dominates.** Most operating assets are carried at cost less depreciation, not at market value. Brand
  value built internally (Northfield's brand) is not on the balance sheet at all.
- **Classification is a choice in places.** Under IAS 1 there was no defined operating profit, so companies chose their
  own subtotal. IFRS 18 removes much of that freedom but still leaves judgement (for example, whether an asset earns a
  return "largely independently").
- **IFRS and US GAAP differ** on leases (presentation of operating lease cost), on cash flow classification of interest
  and dividends, and on some measurement rules (LIFO is allowed under US GAAP, prohibited under IFRS; impairment
  reversals are allowed for most assets under IFRS, prohibited under US GAAP). Compare companies on one basis.
- **The statements are aggregated.** Segment notes (IFRS 8, ASC 280), the revenue disaggregation note and the
  by-nature expense note carry information the face of the statements does not.
- **The example is simplified.** No deferred tax, no other comprehensive income, no share issues, interest paid equals
  interest expense, and tax is 25% of profit before tax excluding the post-tax associate share.

## How managers use it

<!-- Guidance: The statements are a management tool, not only an external report. List the two or three uses that apply to your role. -->

- **Budgeting and planning.** A plan is credible only when the projected income statement, balance sheet and cash flow
  articulate. A sales plan that needs 20 more days of inventory shows up in the cash plan, not in the profit plan.
- **Lending and covenants.** Banks write covenants on balance sheet and income statement measures (net debt to EBITDA,
  minimum liquidity). Managers must know how a decision (a sale and leaseback, a dividend, an inventory build) moves
  each covenant before they make it.
- **Investor communication.** Under IFRS 18 an "adjusted operating profit" used in results presentations becomes an
  audited MPM note with a reconciliation. Finance teams need definitions they are willing to show in the financial
  statements (see finance/ifrs-18-transition-plan).
- **Decision analysis.** Capital budgeting (mba/mba-npv-irr-card) and valuation (mba/mba-dcf-valuation-card) start
  from the statements but use cash flows, so a manager must translate in both directions.

## Worked example A (fully solved)

<!-- Guidance: Rebuild the three exhibits in a spreadsheet with the row numbers shown, then run every check in the articulation table. A check that does not return zero points to the line you mistyped. -->

**Setting.** Northfield Outdoor Co. sells outdoor equipment and clothing through 48 stores and an online shop. It leases
all its stores (IFRS 16), owns its fixtures and distribution equipment, holds a 30% stake in a trail-tourism associate,
and has a USD 80m term loan maturing in 2029. In 2026 it closed three stores (restructuring and impairment 6.6) and made
a voluntary 10.0 prepayment of the loan. Tax rate 25%. All figures USD m, fictional, computed in Python.

**Spreadsheet layout.** Sheets `IS`, `BS` and `CF`; column B = FY2024 (balance sheet only), C = FY2025, D = FY2026.
On `IS` expenses are entered as positive numbers and subtotals subtract them. On `CF` outflows are negative and totals
are sums.

**Exhibit A1. Income statement in the IFRS 18 form (FY2026 is the restated comparative that will appear in the FY2027
report).**

| Row | Line (category) | FY2025 | FY2026 | Excel (column D) |
|---|---|---|---|---|
| 5 | Revenue (operating) | 468.0 | 512.0 | input |
| 6 | Cost of sales (operating) | 262.1 | 284.2 | input |
| 7 | Gross profit | 205.9 | 227.8 | `=D5-D6` |
| 8 | Selling and distribution expenses (operating) | 125.1 | 136.7 | input |
| 9 | Administrative expenses (operating) | 42.9 | 47.1 | input |
| 10 | Restructuring and impairment (operating) | 0.0 | 6.6 | input |
| 11 | **Operating profit** | 37.9 | 37.4 | `=D7-D8-D9-D10` |
| 12 | Share of profit of associate (investing) | 1.6 | 2.0 | input |
| 13 | Interest income on cash (investing) | 0.7 | 0.8 | input |
| 14 | **Profit before financing and income taxes** | 40.2 | 40.2 | `=D11+D12+D13` |
| 15 | Interest expense on bank loan (financing) | 5.6 | 5.6 | input |
| 16 | Interest expense on lease liabilities (financing) | 9.0 | 9.3 | input |
| 17 | **Profit before income taxes** | 25.6 | 25.3 | `=D14-D15-D16` |
| 18 | Income tax expense (income taxes) | 6.0 | 5.8 | `=ROUND(0.25*(D17-D12),1)` |
| 19 | **Profit for the year** | 19.6 | 19.5 | `=D17-D18` |
| 20 | Memo: depreciation and amortisation | 50.0 | 55.3 | from notes (PP&E 19.5, right-of-use 30.0, software 5.8) |
| 21 | Memo: EBITDA (operating profit + D&A + impairment) | 87.9 | 95.7 | `=D11+D20+3.0` (impairment 3.0 in FY2026) |
| 22 | Memo: adjusted operating profit (MPM) | 37.9 | 44.0 | `=D11+D10` |

**Exhibit A2. Balance sheet at 31 December.**

| Row | Line | FY2024 | FY2025 | FY2026 |
|---|---|---|---|---|
| 5 | Cash and cash equivalents | 45.0 | 50.5 | 22.0 |
| 6 | Trade receivables | 14.0 | 15.0 | 17.6 |
| 7 | Inventories | 96.0 | 101.0 | 121.0 |
| 8 | Prepayments | 6.0 | 6.4 | 7.0 |
| 9 | **Total current assets** `=SUM(D5:D8)` | 161.0 | 172.9 | 167.6 |
| 10 | Property, plant and equipment | 120.0 | 124.0 | 134.5 |
| 11 | Right-of-use assets | 150.0 | 153.0 | 164.0 |
| 12 | Software | 18.0 | 19.0 | 20.2 |
| 13 | Investment in associate | 12.0 | 12.6 | 13.4 |
| 14 | **Total assets** `=SUM(D9:D13)` | 461.0 | 481.5 | 499.7 |
| 15 | Trade payables | 52.0 | 55.0 | 56.5 |
| 16 | Accrued liabilities | 18.0 | 19.2 | 20.0 |
| 17 | Contract liabilities (gift cards, loyalty points) | 9.0 | 10.1 | 11.0 |
| 18 | Income tax payable | 4.0 | 4.6 | 3.9 |
| 19 | Restructuring provision | 0.0 | 0.0 | 1.2 |
| 20 | Lease liabilities, current | 25.0 | 28.0 | 30.0 |
| 21 | **Total current liabilities** `=SUM(D15:D20)` | 108.0 | 116.9 | 122.6 |
| 22 | Lease liabilities, non-current | 139.0 | 141.0 | 155.0 |
| 23 | Bank loan (non-current, matures 2029) | 80.0 | 80.0 | 70.0 |
| 24 | **Total liabilities** `=D21+D22+D23` | 327.0 | 337.9 | 347.6 |
| 25 | Share capital | 40.0 | 40.0 | 40.0 |
| 26 | Retained earnings | 94.0 | 103.6 | 112.1 |
| 27 | **Total equity** `=D25+D26` | 134.0 | 143.6 | 152.1 |
| 28 | **Total liabilities and equity** `=D24+D27` | 461.0 | 481.5 | 499.7 |

**Exhibit A3. Cash flow statement, IAS 7 as amended by IFRS 18 (indirect method from operating profit).**

| Row | Line | FY2025 | FY2026 |
|---|---|---|---|
| 5 | Operating profit | 37.9 | 37.4 |
| 6 | Depreciation and amortisation | 50.0 | 55.3 |
| 7 | Impairment of right-of-use assets | 0.0 | 3.0 |
| 8 | Increase in restructuring provision | 0.0 | 1.2 |
| 9 | Increase in trade receivables | -1.0 | -2.6 |
| 10 | Increase in inventories | -5.0 | -20.0 |
| 11 | Increase in prepayments | -0.4 | -0.6 |
| 12 | Increase in trade payables | 3.0 | 1.5 |
| 13 | Increase in accrued liabilities | 1.2 | 0.8 |
| 14 | Increase in contract liabilities | 1.1 | 0.9 |
| 15 | Income taxes paid | -5.4 | -6.5 |
| 16 | **Net cash from operating activities** `=SUM(D5:D15)` | 81.4 | 70.4 |
| 17 | Purchase of PP&E | -22.0 | -30.0 |
| 18 | Purchase of software | -6.0 | -7.0 |
| 19 | Interest received | 0.7 | 0.8 |
| 20 | Dividends received from associate | 1.0 | 1.2 |
| 21 | **Net cash used in investing activities** `=SUM(D17:D20)` | -26.3 | -35.0 |
| 22 | Lease principal paid | -25.0 | -28.0 |
| 23 | Interest paid on lease liabilities | -9.0 | -9.3 |
| 24 | Interest paid on bank loan | -5.6 | -5.6 |
| 25 | Repayment of bank loan | 0.0 | -10.0 |
| 26 | Dividends paid | -10.0 | -11.0 |
| 27 | **Net cash used in financing activities** `=SUM(D22:D26)` | -49.6 | -63.9 |
| 28 | **Net change in cash** `=D16+D21+D27` | 5.5 | -28.5 |
| 29 | Opening cash `=BS!C5` | 45.0 | 50.5 |
| 30 | **Closing cash** `=D28+D29` | 50.5 | 22.0 |

**Step 1. Articulation tests (FY2026).** Each check should return zero.

| Check | Arithmetic | Excel check (returns 0) |
|---|---|---|
| Balance sheet balances | 499.7 = 347.6 + 152.1 | `=BS!D14-BS!D28` |
| Retained earnings roll-forward | 103.6 + 19.5 - 11.0 = 112.1 | `=BS!C26+IS!D19+CF!D26-BS!D26` |
| Cash ties to the balance sheet | 50.5 - 28.5 = 22.0 | `=CF!D30-BS!D5` |
| PP&E roll-forward | 124.0 + 30.0 - 19.5 = 134.5 | `=BS!C10-CF!D17-19.5-BS!D10` |
| Right-of-use assets | 153.0 + 44.0 new leases - 30.0 depreciation - 3.0 impairment = 164.0 | `=BS!C11+44-30-3-BS!D11` |
| Lease liabilities | 169.0 + 44.0 new leases - 28.0 principal = 185.0 | `=BS!C20+BS!C22+44+CF!D22-(BS!D20+BS!D22)` |
| Software | 19.0 + 7.0 - 5.8 = 20.2 | `=BS!C12-CF!D18-5.8-BS!D12` |
| Associate (equity method) | 12.6 + 2.0 share - 1.2 dividend = 13.4 | `=BS!C13+IS!D12-CF!D20-BS!D13` |
| Income tax payable | 4.6 + 5.8 expense - 6.5 paid = 3.9 | `=BS!C18+IS!D18+CF!D15-BS!D18` |
| Bank loan | 80.0 - 10.0 = 70.0 | `=BS!C23+CF!D25-BS!D23` |

Two items are **non-cash** and appear in no cash flow line: the 44.0 of new store leases (an asset and a liability
recognised together, disclosed as a non-cash transaction) and the 3.0 impairment.

**Step 2. The same FY2026 income statement in the IAS 1 form Northfield actually published.** Under IAS 1 the company
chose its own "operating profit" and included the associate inside it, and it netted finance income and costs.

| Line (IAS 1 form, as published) | FY2026 | Line (IFRS 18 form, restated) | FY2026 |
|---|---|---|---|
| Revenue | 512.0 | Revenue | 512.0 |
| Cost of sales | (284.2) | Cost of sales | (284.2) |
| Gross profit | 227.8 | Gross profit | 227.8 |
| Selling and distribution | (136.7) | Selling and distribution | (136.7) |
| Administrative | (47.1) | Administrative | (47.1) |
| Restructuring and impairment | (6.6) | Restructuring and impairment | (6.6) |
| Share of profit of associate | 2.0 | **Operating profit** | **37.4** |
| **Operating profit (company-defined)** | **39.4** | Share of profit of associate (investing) | 2.0 |
| Finance income | 0.8 | Interest income on cash (investing) | 0.8 |
| Finance costs | (14.9) | **Profit before financing and income taxes** | **40.2** |
| | | Interest expense, loan and leases (financing) | (14.9) |
| **Profit before tax** | **25.3** | **Profit before income taxes** | **25.3** |
| Income tax | (5.8) | Income tax (income taxes category) | (5.8) |
| **Profit for the year** | **19.5** | **Profit for the year** | **19.5** |

Profit for the year is identical (IFRS 18 changes presentation, not measurement). "Operating profit" falls from 39.4 to
37.4 because the associate moves to the investing category, so any bonus target, covenant or analyst model built on the
old subtotal needs to be restated.

**Step 3. The MPM note.** Northfield's results presentation uses "adjusted operating profit". Under IFRS 18 it must
reconcile it to operating profit in a note:

| Reconciliation, FY2026 *(Example)* | Amount | Income tax effect | Effect on non-controlling interests |
|---|---|---|---|
| Operating profit (IFRS 18 subtotal) | 37.4 | | |
| Add back: severance for three store closures | 3.6 | -0.9 | none (wholly owned) |
| Add back: impairment of right-of-use assets, closed stores | 3.0 | -0.8 | none |
| **Adjusted operating profit (MPM)** | **44.0** | total -1.7 | |

Tax effects are 25% of each item, rounded (`=ROUND(0.25*3.6,1)` = 0.9 and `=ROUND(0.25*3.0,1)` = 0.8). Under IAS 1
the company's adjusted measure started from its own 39.4 and came to 46.0; the redefinition to 44.0 must itself be
explained, because IFRS 18 requires disclosure of changes to an MPM.

**Step 4. Which profit?** The chart shows how many "profits" a reader meets for one company and one year.

```vega-lite
{
  "$schema": "https://vega.github.io/schema/vega-lite/v5.json",
  "description": "Northfield Outdoor Co. FY2026 profit measures, USD m (fictional)",
  "width": 420,
  "height": 220,
  "data": {"values": [
    {"measure": "EBITDA", "value": 95.7, "basis": "Not defined by IFRS"},
    {"measure": "Adjusted operating profit (MPM)", "value": 44.0, "basis": "MPM, reconciled in a note"},
    {"measure": "Operating profit, IAS 1 company subtotal", "value": 39.4, "basis": "Company-defined (IAS 1)"},
    {"measure": "Profit before financing and income taxes", "value": 40.2, "basis": "IFRS 18 required subtotal"},
    {"measure": "Operating profit, IFRS 18", "value": 37.4, "basis": "IFRS 18 required subtotal"},
    {"measure": "Profit before income taxes", "value": 25.3, "basis": "IFRS 18 required subtotal"},
    {"measure": "Profit for the year", "value": 19.5, "basis": "IFRS 18 required subtotal"}
  ]},
  "mark": "bar",
  "encoding": {
    "y": {"field": "measure", "type": "nominal", "sort": "-x", "title": null},
    "x": {"field": "value", "type": "quantitative", "title": "USD m"},
    "color": {"field": "basis", "type": "nominal", "title": "Basis"}
  }
}
```

**Conclusion.** The statements articulate on every test. Profit was flat (19.6 to 19.5) while revenue grew 9.4%, cash
fell 28.5 and inventory rose 20.0: the next two cards explain why that pattern matters.

## Worked example B (half solved)

<!-- Guidance: Fill each [ ] before you look at the answer key. Ignore income tax in this walk (pre-tax effects only), as most interview questions do unless they say otherwise. -->

**Task.** Trace six January 2027 transactions through Northfield's three statements. Use + and - for increases and
decreases; "none" where a statement is not affected. Pre-tax, USD m.

| ID | Transaction | Income statement | Balance sheet (assets) | Balance sheet (liabilities and equity) | Cash flow statement |
|---|---|---|---|---|---|
| T1 *(Example)* | Sells goods costing 3.3 to a hiking club for 6.0 on 30-day credit | Revenue +6.0, cost of sales -3.3, operating profit +2.7 | Receivables +6.0, inventories -3.3 | Retained earnings +2.7 | None this month |
| T2 *(Example)* | Buys inventory of 8.0 on credit | None | Inventories +8.0 | Trade payables +8.0 | None |
| T3 | Pays suppliers 5.0 | [ ] | Cash -5.0 | [ ] | [ ] |
| T4 | Sells gift cards for 1.5 cash | [ ] | [ ] | [ ] | Operating +1.5 |
| T5 | Signs a 5-year store lease, present value of payments 4.2 | None | [ ] | [ ] | [ ] |
| T6 | Pays a lease instalment: interest 0.8, principal 2.3 | [ ] | Cash -3.1 | [ ] | Financing: [ ] (IFRS 18 amended IAS 7) |

Then answer: (a) under US GAAP with T5 classified as an operating lease, how would T6 appear in the income statement
and the cash flow statement? (b) Which transaction raises revenue in a later month without any new cash?

## Exercise C (unsolved)

<!-- Guidance: Classify first, compute second. The classification is the skill that IFRS 18 tests; the arithmetic is easy. -->

Corvane Robotics, a growth-stage warehouse-robotics company (fictional, no specified main business activity), reports
these FY2026 items (USD m):

| Item | Amount |
|---|---|
| Revenue | 84.0 |
| Cost of sales | 50.4 |
| Research and development | 18.0 |
| Sales and marketing | 14.2 |
| General and administrative | 7.6 |
| Foreign exchange gain on trade receivables | 0.2 |
| Fair value gain on a money-market fund held as surplus cash investment (not a cash equivalent) | 0.9 |
| Interest income on bank deposits (cash equivalents) | 1.1 |
| Interest expense on convertible notes | 0.6 |
| Interest expense on lease liabilities | 0.3 |
| Income tax expense | 0.4 |

Tasks:

1. Assign each item to an IFRS 18 category (operating, investing, financing, income taxes).
2. Compute gross profit, operating profit, profit before financing and income taxes, profit before income taxes and
   profit (loss) for the year.
3. Management presents "operating loss before share-based compensation" in its investor letter. Is it an MPM? What must
   the note contain?
4. Under IAS 1 the company presented an "operating loss" that included the fair value gain and the interest income,
   with only interest expense shown below it. What was that figure, how does the operating subtotal change on
   transition to IFRS 18, and why should a lender care?

## Connections to other cards

<!-- Guidance: Use this list to plan your next study block. Each card picks up exactly where this one stops. -->

| Next card | What it adds |
|---|---|
| mba/mba-ratio-analysis-card | Turns the three statements into margins, returns, liquidity, solvency and efficiency, with DuPont analysis |
| mba/mba-cash-flow-statement-card | Direct and indirect methods, the IFRS 18 changes to IAS 7, and free cash flow definitions |
| mba/mba-financial-accounting-guide | The course map, the full Northfield mini-case and the exam plan |
| mba/pre-mba-accounting-primer | Debits, credits and the journal if double entry is still new to you |
| mba/mba-managerial-accounting-guide | The internal view: costs, contribution and decisions |
| mba/mba-dcf-valuation-card | Uses the statements to forecast free cash flow and value a company |
| finance/ifrs-18-transition-plan | How a company plans its IFRS 18 transition in practice |
| finance/lease-accounting-memo and finance/revenue-recognition-memo | Technical memos on IFRS 16 and IFRS 15 judgements |

## Common mistakes and misconceptions

<!-- Guidance: Read this list before every exam. Copy any mistake you make into mba/mba-error-log with the correct rule. -->

- **"Profit is cash."** Northfield's FY2026 profit was 19.5 while cash fell by 28.5. Accruals, working capital,
  capital spending and financing flows separate the two.
- **Putting dividends on the income statement.** Dividends are a distribution of profit to owners: they reduce
  retained earnings and are a financing cash outflow. They are never an expense.
- **Forgetting the non-cash transactions.** A new lease creates an asset and a liability without any cash flow. Models
  that push new leases through capex double-count.
- **Treating the IAS 1 "operating profit" as defined.** Before IFRS 18, operating profit was a company choice; Northfield
  included its associate. Compare companies only after restating to one definition.
- **Thinking IFRS 18 changes profit.** It changes categories, subtotals and disclosure, not recognition or measurement.
  Profit for the year is the same in both forms.
- **Assuming US GAAP companies adopt IFRS 18.** They do not. A US GAAP company keeps its own presentation; ASU 2024-03
  adds expense disaggregation in the notes, and SEC rules govern non-GAAP measures.
- **Ignoring contract liabilities.** Gift cards and loyalty points are cash received before revenue is earned. They are
  a liability, and a growing balance helps cash before it helps profit.
- **Unbalanced models fixed with a plug.** Forcing cash or "other liabilities" to balance a model hides the error. Run
  the roll-forward checks line by line instead.
- **Classifying lease interest as operating expense under IFRS 16.** Under IFRS 16 the lease cost splits into
  depreciation (operating) and interest (financing category under IFRS 18); under ASC 842 operating leases show one
  straight-line cost in operating expenses.

## Self-test questions

<!-- Guidance: Answer in writing from memory, then check the key. Repeat after two days and after a week (spacing). -->

1. State the three articulation tests that link the statements and give Northfield's FY2026 numbers for each.
2. Northfield's profit was flat while revenue grew 9.4%. Name two lines on the income statement that explain it.
3. What two subtotals does IFRS 18 require, and what is the value of each for Northfield in FY2026?
4. Why does Northfield's operating profit fall from 39.4 to 37.4 on transition, although nothing in the business changed?
5. From which date does IFRS 18 apply, and which comparative year must a calendar-year company restate?
6. List four things an MPM note must contain.
7. A company declares a dividend of 5.0, paid next year. What happens to each statement this year?
8. A new 10-year store lease starts on 31 December. What appears on the balance sheet and the cash flow statement under
   IFRS 16 on that date?
9. Under IFRS 16 and under ASC 842 (operating lease), where does the lease cost appear in the income statement?
10. Gift card sales rise by 2.0 more than redemptions this year. Effect on revenue, liabilities and operating cash flow?
11. True or false: a company that changes from IAS 1 to IFRS 18 must re-estimate its inventory and depreciation.
12. Which category does IFRS 18 use as the default for an unusual item such as a store-closure cost?

## My notes and next steps

<!-- Guidance: Be honest about confidence. Plan the next card and a date to repeat the self-test. -->

| Item | My entry |
|---|---|
| Confidence linking the three statements (1 = lost, 5 = could teach it) | [ ] |
| Articulation checks I can now build without notes | [ ] |
| IFRS 18 points still unclear | [ ] |
| Mistakes logged in mba/mba-error-log | [Date and short description] |
| Next review date (+2 days, +1 week, +1 month) | YYYY-MM-DD |
| Next card | [mba/mba-ratio-analysis-card / mba/mba-cash-flow-statement-card] |

## Sources and further reading

<!-- Guidance: Standard numbers and effective dates were checked on the official pages on 2026-10-28. Textbooks are named for further reading only; nothing in this card is copied from them. -->

- Pacioli, L. (1494). *Summa de arithmetica, geometria, proportioni et proportionalita*. Venice. (Earliest printed
  description of double entry bookkeeping.)
- IFRS Foundation. *IFRS 18 Presentation and Disclosure in Financial Statements* (issued April 2024; annual periods
  beginning on or after 1 January 2027). https://www.ifrs.org/issued-standards/list-of-standards/ifrs-18-presentation-and-disclosure-in-financial-statements/
  (checked 2026-10-28).
- IFRS Foundation. *IAS 1 Presentation of Financial Statements*; *IAS 7 Statement of Cash Flows*; *IFRS 15 Revenue from
  Contracts with Customers* (effective 1 January 2018); *IFRS 16 Leases* (effective 1 January 2019);
  *Conceptual Framework for Financial Reporting* (2018). https://www.ifrs.org (checked 2026-10-28).
- FASB. ASU 2014-09 *Revenue from Contracts with Customers (Topic 606)*; ASU 2016-02 *Leases (Topic 842)*; ASC 230
  *Statement of Cash Flows*; ASU 2024-03 *Disaggregation of Income Statement Expenses* as clarified by ASU 2025-01.
  https://www.fasb.org (checked 2026-10-28).
- Textbooks (further reading by name only): Penman, S. H., *Financial Statement Analysis and Security Valuation*
  (McGraw Hill); Palepu, K. G., Healy, P. M. and Wright, S., *Business Analysis and Valuation: IFRS Edition* (Cengage);
  Libby, R., Libby, P. A. and Hodge, F., *Financial Accounting* (McGraw Hill).
- Open resource: OpenStax, *Principles of Accounting, Volume 1: Financial Accounting* (CC BY-NC-SA 4.0), openstax.org.

## Answer key

<!-- Guidance: Check only after you have written your own answers. For every miss, write down why your first answer was wrong. -->

**Worked example B.**

| ID | Income statement | Assets | Liabilities and equity | Cash flow statement |
|---|---|---|---|---|
| T3 | None | Cash -5.0 | Trade payables -5.0 | Operating -5.0 (payments to suppliers) |
| T4 | None (revenue only when the card is redeemed, less expected breakage under IFRS 15) | Cash +1.5 | Contract liabilities +1.5 | Operating +1.5 |
| T5 | None | Right-of-use assets +4.2 | Lease liabilities +4.2 | None (non-cash transaction, disclosed) |
| T6 | Interest expense +0.8 (financing category); profit -0.8 | Cash -3.1 | Lease liabilities -2.3, retained earnings -0.8 | Financing -3.1 (interest 0.8 and principal 2.3) |

(a) Under ASC 842 an operating lease shows a single straight-line lease cost in operating expenses (no separate
interest line), and the whole payment of 3.1 is an operating cash outflow. The right-of-use asset and lease liability
are still on the balance sheet. (b) T4: the gift cards become revenue when redeemed, after the cash was received.

**Exercise C.** (1) Operating: revenue, cost of sales, R&D, sales and marketing, G&A, and the FX gain on trade
receivables (it follows the operating item it relates to). Investing: fair value gain on the money-market fund and
interest income on cash equivalents. Financing: interest on the convertible notes and on lease liabilities. Income taxes:
tax expense. (2) Gross profit 84.0 - 50.4 = 33.6; operating profit 33.6 - 18.0 - 14.2 - 7.6 + 0.2 = -6.0; profit before
financing and income taxes -6.0 + 0.9 + 1.1 = -4.0; profit before income taxes -4.0 - 0.6 - 0.3 = -4.9; loss for the
year -4.9 - 0.4 = -5.3. (3) Yes, if it is a subtotal of income and expenses used in public communication to show
management's view of performance and it is not one of the subtotals IFRS 18 lists or requires. The note needs the
description and why it is useful, the calculation, a reconciliation to operating profit with the tax and
non-controlling-interest effect of each reconciling item, and an explanation of any change. (4) The IAS 1 operating loss was -6.0 + 0.9 + 1.1 = -4.0.
Under IFRS 18 the fair value gain and the interest income move to the investing category, so the operating loss worsens
to -6.0 (the -4.0 reappears as profit before financing and income taxes). Lenders
care because covenants and credit models often reference operating profit or EBITDA and may need a "frozen GAAP" clause
or a redefinition.

**Self-test.**

1. Assets = liabilities + equity (499.7 = 347.6 + 152.1); retained earnings 103.6 + 19.5 - 11.0 = 112.1; cash
   50.5 - 28.5 = 22.0.
2. Gross profit grew by 21.9, but selling and administrative expenses grew by 15.8 (up 9.3% and 9.8%, in line with
   revenue) and restructuring and impairment added 6.6, so operating profit slipped from 37.9 to 37.4; financing costs
   also rose from 14.6 to 14.9.
3. Operating profit 37.4 and profit before financing and income taxes 40.2.
4. The share of profit of the associate (2.0) moves from the company-defined operating profit to the investing category.
5. Annual periods beginning on or after 1 January 2027; FY2026 comparatives are restated (retrospective application).
6. Any four of: description and why it is useful; how it is calculated; reconciliation to the most directly comparable
   IFRS subtotal; income tax effect of each reconciling item; effect on non-controlling interests; explanation of changes.
7. Income statement: none. Balance sheet: retained earnings -5.0, dividend payable +5.0. Cash flow: none until paid,
   then a financing outflow.
8. Right-of-use asset and lease liability at the present value of the payments; no cash flow (non-cash transaction).
9. IFRS 16: depreciation of the right-of-use asset in operating expenses and interest in the financing category. ASC 842
   operating lease: one straight-line lease cost in operating expenses.
10. Revenue: no effect until redemption. Contract liabilities +2.0. Operating cash flow +2.0.
11. False. IFRS 18 changes presentation and disclosure only.
12. Operating, the default category.

## Revision history

<!-- Guidance: Add a row when you replace the example with your own company or move your notes to a new standard. -->

| Version | Date | Author | Change summary |
|---|---|---|---|
| 0.1 | YYYY-MM-DD | [Your name] | First pass through examples A and B |
| 0.2 | YYYY-MM-DD | [Your name] | *Example:* Rebuilt with a listed retailer's FY2026 report and its IFRS 18 restatement |

## Standard and licence note

Based on the IFRS Accounting Standards named above (IAS 1, IFRS 18, IAS 7, IFRS 15, IFRS 16) and the FASB Accounting
Standards Codification topics 230, 606 and 842, using standard numbers, concept names and effective dates only, checked
on ifrs.org and fasb.org on 2026-10-28. No text of the standards or of any textbook is reproduced; the explanations,
exhibits and questions are original and Northfield Outdoor Co. and Corvane Robotics are fictional. The template is
independent and not affiliated with or endorsed by the IFRS Foundation, the FASB or any business school. Check the
current official versions before you rely on any date or requirement.
Template licence: MIT.