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Plain‑English explainer of HKAS 1 / IAS 1 for students, junior accountants and non‑specialists who find official standards too dense to read.
This article is based on Hong Kong Accounting Standards (HKAS / HKFRS), which are fully aligned with IAS / IFRS except for minor local tweaks, so the same principles generally apply under IAS / IFRS unless noted otherwise. The goal is to unpack HKAS 1 Presentation of Financial Statements (equivalent to IAS 1) using plain English and practical, real‑life examples instead of technical jargon. It is written for students, junior accountants, audit juniors and finance professionals who want to understand not just “what the standard says” but how to actually read and prepare financial statements in line with it.
When you see “the company” or “the entity” below, you can think of any entity that prepares general purpose financial statements under HKFRS / IFRS.
When the Numbers Are Not Enough
Many people glance at a set of financial statements by checking only two figures: profit in the income statement and total assets in the statement of financial position. In real Hong Kong practice, analysts, banks, regulators and audit teams spend a lot more time on the breakdown of the statement of profit or loss and other comprehensive income, the statement of changes in equity, and the notes on accounting policies, judgements and capital management.
Take this simple example: a company shows stable profit, but has large revaluation losses in other comprehensive income (OCI), has paid out high dividends for several years, and discloses pressure from capital requirements in the notes. Put together, these signals can be more important for credit ratings and investment decisions than the single “profit” number itself. This article starts from how HKAS 1 / IAS 1 wants you to present profit and OCI, then connects that to the statement of changes in equity, the notes, key judgements and estimation uncertainty, and finally capital disclosures, so you can read the “story behind the numbers”.
What You Should Be Able to Do After Reading?
By the end, you should be able to:
- Distinguish the two presentation formats for the statement of profit or loss and other comprehensive income, understand how OCI is grouped, and remember that “extraordinary items” are not allowed labels.
- Explain the difference between analysing expenses by nature and by function, and know the extra disclosures required when the entity uses the function‑of‑expense method.
- Describe what must be shown in the statement of changes in equity, including total comprehensive income, retrospective application / restatement, and where dividend information should appear.
- Understand the structure of the notes and why cross‑referencing is so important, plus the newer focus on “material” accounting policy information instead of long boilerplate text.
- Grasp the key points for disclosing judgements, estimation uncertainty and capital management, and know how an entity should explain breaches of capital requirements to users of the financial statements.
1. Profit or Loss and OCI: One Statement or Two?
HKAS 1 / IAS 1 allows two formats for presenting the statement of profit or loss and other comprehensive income. Both are acceptable as long as they present equivalent information.
Two Presentation Formats
The entity can choose between:
- Single statement approach: One continuous statement that first shows profit or loss, then other comprehensive income, and finally total comprehensive income.
- Two‑statement approach:
- First, a separate statement of profit or loss;
- Immediately followed by a statement of profit or loss and other comprehensive income (or a separate statement of OCI) that starts with profit and then adds OCI to arrive at total comprehensive income.
Whichever format is used, HKAS 1 / IAS 1 requires the entity to:
- Clearly present: total profit or loss, total OCI and total comprehensive income.
- Split OCI into items that may be reclassified to profit or loss in the future and items that will not be reclassified.
- For groups, separately show amounts attributable to owners of the parent and to non‑controlling interests.
No “Extraordinary Items” Allowed
HKAS 1 / IAS 1 explicitly prohibits labelling any income or expense as “extraordinary items” or similar wording in the statement of profit or loss or in the statement showing profit or loss and OCI. The reason is that separating “recurring” and “non‑recurring” items is highly judgemental and can be abused to dress up performance. Instead of using a “one‑off” label, entities should use proper line‑item presentation and note disclosures to explain the nature and impact of unusual or significant transactions.
How OCI Is Grouped and Reclassified
OCI includes income and expenses that, under other standards, bypass current‑period profit or loss. Common examples are revaluation gains and losses, certain fair value movements on financial assets, and foreign currency translation differences.
HKAS 1 / IAS 1 requires OCI to be split into:
- Items that may or will be reclassified to profit or loss in future (for example, foreign currency translation reserves, some fair value reserves for debt instruments).
- Items that will not be reclassified to profit or loss (for example, revaluation surplus on owner‑occupied property, fair value changes for some equity investments designated at FVOCI).
For the reclassifiable items, when they are “realised” or meet the conditions for recycling, amounts are moved (“reclassified”) from OCI to profit or loss. HKAS 1 / IAS 1 requires disclosure of the amounts of these reclassification adjustments and their related income tax effects, either within the statement itself or grouped in the notes.
In practice, some people feel that the two‑statement approach is conceptually messy because splitting profit and OCI might make users think OCI is unimportant. Others like it because it highlights recurring operating performance more clearly. The standard stays neutral: both formats are fine as long as they present equally important information and link clearly to each other.
2. Analysing Expenses: By Nature vs By Function
Within profit or loss, HKAS 1 / IAS 1 allows entities to present an analysis of expenses either by their nature or by their function. This choice affects how users see the cost structure.
Method 1 – By Nature of Expense
Under the “by nature” method, expenses are grouped according to what they are, for example:
- Raw materials and consumables
- Employee benefits expense
- Depreciation and amortisation
- Rent and utilities and so on
This method is straightforward and is more common for entities with simpler cost structures or short production chains. It is also easier to prepare, because there is no need to allocate costs across functions or departments.
Method 2 – By Function of Expense
Under the “by function” method, expenses are grouped according to what they are used for inside the entity, for example:
- Cost of sales
- Selling and distribution expenses
- Administrative expenses
- Research and development costs
Many listed entities prefer the function‑of‑expense presentation because it is closer to how management monitors performance internally and it helps users calculate gross margin, operating margin and similar performance metrics.
However, when the entity uses the function‑of‑expense method, HKAS 1 / IAS 1 also requires disclosure of key expense items by nature, such as total depreciation and amortisation and total employee benefit expenses. This helps users understand the underlying cost structure even when the main presentation is by function.
In exams and in practice, you are often asked to compare these methods. Presenting by nature is simpler and more transparent at the line‑item level; presenting by function is more aligned with performance analysis. Whichever method is chosen should be applied consistently from period to period, unless there is a justified reason to change and the effects of the change are properly disclosed.
3. Statement of Changes in Equity and Dividends
The statement of changes in equity is the bridge between total comprehensive income and the statement of financial position. It shows how each equity component moves from opening to closing balances during the reporting period.
What Must Be Included in the Statement of Changes in Equity
HKAS 1 / IAS 1 requires at least the following in this statement:
- Total comprehensive income for the period (profit or loss plus OCI), with a split between amounts attributable to owners of the parent and to non‑controlling interests in a group.
- The effects of retrospective application of new accounting policies and retrospective restatements of prior period errors, with adjustments shown separately for each equity component.
- The opening and closing balances of each equity component (such as share capital and each reserve), and the movements during the period, including share issues, share buybacks, transfers of revaluation reserves and so on.
Where Dividend Information Belongs
After amendments to HKAS 1 / IAS 1, dividends declared as distributions to owners and the related amounts per share must be disclosed in the statement of changes in equity or in the notes. They should not be presented in the statement of profit or loss and other comprehensive income.
The logic is that dividends are transactions “with owners in their capacity as owners”, not expenses that affect the current‑period performance. In typical annual reports, you will see proposed or declared final dividends clearly listed in the statement of changes in equity, together with payment status, and further details (such as the dividend per share and any post‑reporting‑date proposed dividends that are not yet liabilities) explained in the notes.
4. Notes: Structure and Cross‑Referencing
The notes to the financial statements are the narrative backbone of the whole set of accounts, not just an appendix. HKAS 1 / IAS 1 explains that the notes serve several key functions.
They:
- Explain the basis of preparation (for example, compliance with HKFRSs / IFRSs and the going concern assumption).
- Set out the entity’s specific accounting policies.
- Provide other disclosures required by HKFRSs / IFRSs (for example, financial instruments risk disclosures, lease breakdowns).
- Include any other information not presented on the face of the statements that is relevant to understanding the financial statements.
Suggested Structure and Order
The standard suggests that notes should be organised systematically. A common order is:
- General information about the entity and basis of preparation.
- A summary of significant (or material) accounting policies.
- Explanatory information for each primary statement line item, often following the order of the main statements (for example, statement of financial position items first, then profit or loss items).
- Other cross‑cutting disclosures such as financial risk management and capital management.
Modern sample financial statements place heavy emphasis on cross‑referencing. Line items in the primary statements show note numbers, and each note states clearly which line item it relates to, so users can easily move back and forth.
For learners, a very useful exercise is to take one sample annual report, pick one or two line items such as lease liabilities or revenue, and follow the note references all the way through. You will see that many crucial judgements and risk disclosures live in the notes, not on the face of the statements.
5. Accounting Policies: From “Significant” to “Material” Information
Recent amendments to HKAS 1 / IAS 1 shift the focus from listing a long set of “significant accounting policies” to providing material accounting policy information. The idea is to avoid copying standard wording and instead give entity‑specific information that truly helps users understand the financial statements.
What Counts as “Material” Accounting Policy Information?
Under HKAS 1 / IAS 1, accounting policy information is material when it relates directly to material transactions, other events or conditions and involves important judgements or choices by the entity. Examples include:
- How the group assesses control to decide whether to consolidate another entity.
- Why the entity has chosen certain methods to separate performance obligations in revenue recognition.
- Judgements about lease terms and extension / termination options.
- Reasons for choosing a particular inventory cost formula (such as FIFO or weighted average) when this choice has a real impact on the numbers.
By contrast, long policy sections that simply repeat HKFRS / IFRS wording without adding entity‑specific insight should not dominate the front of the notes.
Is Complexity a Good Indicator?
HKAS 1 / IAS 1 and related discussions note that complex areas or areas involving major judgements are more likely to need detailed policy disclosures. But complexity alone is not enough; the policy must also be material to the financial statements.
Compare two styles:
- Version A: Paragraphs that basically copy the standard and read like a textbook.
- Version B: Concise, focused explanations of the entity’s specific policy choices for revenue, leases, financial assets and so on, with cross‑references to relevant notes and to disclosures about estimation uncertainty.
More and more entities and audit firms prefer something like Version B, because it speaks directly to what investors and analysts care about.
6. Key Judgements, Estimation Uncertainty and Capital Management
HKAS 1 / IAS 1 requires management to disclose both critical judgements made in applying accounting policies and the main sources of estimation uncertainty that could lead to material adjustments to the carrying amounts of assets and liabilities within the next financial year.
Key Judgements and Estimation Uncertainty
Common areas where such disclosures appear include:
- Allowances for doubtful debts and impairment assessments.
- Inventory write‑downs to net realisable value.
- Valuation of investments measured at fair value.
- Impairment testing of goodwill or intangible assets, including key assumptions about future cash flows and discount rates.
- Judgements about lease terms and whether renewal or purchase options will be exercised.
These disclosures usually combine narrative explanations of the judgement basis with quantitative information such as sensitivity analyses or key assumption values, so users can see how uncertain the estimates are.
Capital Management Disclosures
HKAS 1 together with HKFRS 7 (and the corresponding IFRS standards) requires entities to disclose their objectives, policies and processes for managing capital, plus quantitative data related to capital. “Capital” here does not have to mean only equity in the accounting sense; some entities treat certain subordinated debt instruments as part of capital.
Typical disclosures include:
- How management defines “capital” (for example, including share capital, retained earnings and some long‑term subordinated loans).
- The objectives of capital management, such as maintaining particular leverage ratios or meeting regulatory capital requirements or loan covenant thresholds.
- The policies and processes for managing capital (for example, monitoring net debt‑to‑equity, dividend restrictions, or triggers that prompt equity issuance).
- Key ratios or indicators used to monitor performance in managing capital, such as net debt to equity or current ratio.
If the entity is subject to external capital requirements (for example, bank covenants or regulatory capital adequacy rules), HKAS 1 / IAS 1 requires disclosure of whether those requirements have been complied with. If not, the nature and consequences of the breach, and how management has responded, must be explained.
How to Disclose a Breach of Capital Requirements
Imagine a company that, after several years of losses, breaches a leverage covenant in its loan agreement, giving the bank the right to demand immediate repayment, but the bank grants a waiver. In practice, the financial statements would normally:
- Explain in the capital management note what ratio was required and what the actual ratio was.
- Disclose whether the breach has been waived, the terms and the period of the waiver.
- Describe the impact of the breach on the entity’s funding arrangements and going concern assessment, if relevant.
For users, such disclosures are often more informative than a single leverage ratio, because they show how the entity is interacting with lenders and regulators.
7. Cash Flows and HKAS 7 / IAS 7: The Link
HKAS 1 / IAS 1 states that a complete set of financial statements must include a statement of cash flows, but the detailed requirements sit in HKAS 7 / IAS 7 Statement of Cash Flows.
Before you study HKAS 7 / IAS 7 in depth, keep these points in mind:
- The statement of cash flows is a required primary statement and must show comparative figures.
- Cash flows are classified into operating, investing and financing activities.
- For some equity and liability movements, the cash flow statement and the statement of changes in equity complement each other—for example, a share issue affects both cash and equity.
This article does not go into the technical details of the direct vs indirect method and reconciliation, but you should see the bigger picture: the statement of profit or loss and other comprehensive income, statement of changes in equity and statement of cash flows tell one connected story.
8. Practical Guide: Reading an Annual Report Through the Notes
If you put all these ideas back into a real annual report, you will see that HKAS 1 / IAS 1 is not just an exam topic—it is a roadmap for how to navigate financial statements.
Start with Profit or Loss and OCI
In a sample set of financial statements, begin by:
- Finding the statement of profit or loss and other comprehensive income and checking whether the entity uses a single statement or two statements.
- Looking at how OCI is split between items that may be reclassified and items that will not be reclassified, and whether reclassification adjustments and tax effects are clearly shown.
- Following the note references to understand the underlying transactions, such as foreign currency translation reserves or fair value reserves.
Move to the Statement of Changes in Equity and Dividend Notes
Next, turn to the statement of changes in equity and track:
- How total comprehensive income flows into the different equity components.
- Whether any retrospective applications or restatements are clearly presented.
- Where information about dividends and dividend per share is disclosed, and whether there are any proposed dividends after the reporting date.
Dig into Notes: Policies, Judgements and Capital
Further into the notes, you will typically find:
- A section on basis of preparation and accounting policies, where you can identify which parts reflect entity‑specific choices or judgements.
- A section on key judgements and major sources of estimation uncertainty, usually focusing on a few areas that carry the most risk.
- A section on capital management and financial risk, explaining how the entity defines and monitors capital and whether it must meet any specific capital requirements.
Treat these parts as a combined exercise: go from the primary statements to the notes and back again, and see if you can explain in your own words the entity’s most important accounting policies, judgements and capital strategy. If you can do that, you are no longer just “reading numbers”; you are starting to understand the story behind them.
Key Takeaways for Students and Junior Accountants
- Always read the statement of profit or loss and other comprehensive income together with the notes on OCI and reclassification adjustments; this shows you which gains and losses might hit profit in future.
- Use the statement of changes in equity as a bridge between performance and the balance sheet, especially to separate owner transactions (like dividends and share issues) from comprehensive income.
- When preparing working papers, clearly label whether you are using the nature‑of‑expense or function‑of‑expense method and cross‑check that required “by nature” disclosures are still provided.
- In exams and in real jobs, expect questions around material accounting policy information and key judgements—practice explaining why a policy choice or estimate is important, not just what the rule says.
- When reviewing contracts (such as loan agreements or leases), always think about how they affect capital management, covenants and estimation uncertainty, and make sure your notes and disclosures tell a coherent story that links back to the primary statements.
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