Presenting expenses by nature or by function
Choosing between analysing a client's expenses by nature or by function, keeping the choice consistent, and using custom lines without losing totals.
By Achekam · · 4 min read · For Accountants & audit firms in South Africa, Nigeria, Kenya
Put two small companies' income statements side by side and the expense sections can look like different languages. One lists "Employee costs", "Depreciation", "Rent" and "Other expenses". The other has "Cost of sales", "Distribution costs" and "Administrative expenses". Both may be correct. They are the two analyses of expenses the reporting frameworks allow: by nature and by function.
The choice between them is a presentation decision with consequences for comparatives, for the notes and for what readers can learn from the statements. This article covers what each analysis is, how to choose, and how to keep the totals intact when the layout is tailored.
What the two analyses are and what IFRS for SMEs allows
By nature groups expenses by what they are: raw materials and consumables used, employee benefits, depreciation, rent, advertising. It is easy to prepare because it follows the ledger, and it needs no allocation of costs between activities.
By function groups expenses by what they were for: cost of sales, distribution, administration and other activities. It tells readers more about the business model, gross margin in particular, but it needs judgement to allocate shared costs. One salary may belong partly in cost of sales and partly in administration.
IFRS for SMEs requires an analysis of expenses using a classification based on either nature or function, whichever provides information that is reliable and more relevant; where function is used, cost of sales must at least be shown separately from other expenses. Under full IFRS, an entity using the function method must also disclose additional information on the nature of its expenses, including depreciation and employee benefits. The IFRS Foundation's page on the IFRS for SMEs Accounting Standard explains the standard and notes that its third edition applies to periods beginning on or after 1 January 2027, so confirm which edition a client reports under before relying on a paragraph reference.
Choosing the analysis that suits how the client earns and spends
There is no default answer, but there are patterns:
- Service businesses, such as consultancies, professional practices and agencies, usually suit nature. Their main cost is people, and "cost of sales" is often an artificial split of the same salaries.
- Traders and manufacturers usually suit function, because gross margin is the number owners, lenders and buyers of the business care about, and the ledger already separates purchases and production costs.
- Mixed businesses, such as a retailer with a repair workshop, need judgement. Ask which analysis the owner uses to run the business; it is often the most relevant one for other readers as well.
Whichever is chosen, the basis for allocating costs to functions must be reasonable and written down. If a share of rent or salaries goes to cost of sales, the working paper should say how that share was worked out.
Keeping the choice consistent with the comparatives
Presentation should stay the same from one year to the next unless a change gives more relevant information. If the analysis changes, the comparatives must be reclassified so the two years can be compared, and the notes should explain the reclassification.
That is more work than it sounds. Comparative expenses classified by nature have to be reallocated to functions using information from the prior year, which the client may no longer have in usable form. Settle the analysis in a client's first year with the firm, and change it later only for a clear reason.
Adding or renaming lines without losing the standard totals
In Achekam, the Studio builds the draft statements from a mapped trial balance, with every figure calculated in code, and includes a detailed income statement alongside the primary statements. Where the expense lines in the draft do not suit the analysis you have chosen, a firm can add its own statement lines and groups and reword any row title, and later builds keep those choices.
Because each custom line still totals into a standard line, tailoring the expense section does not disturb the totals the rest of the set depends on. A worked example in words: a consultancy wants its expenses by nature. The firm adds custom lines for "Employee costs", "Premises costs" and "Technology costs" among the operating expenses, maps the relevant accounts to each and renames what is left "Other operating expenses". Profit before tax does not change; the presentation does.
After tailoring, run the checks. The Validation & Math Engine runs fixed, non-AI checks such as double entry and note ties, and the automated review lists findings for a person to accept, resolve or dismiss. Neither blocks signing, so a reviewer still reads the result as an outside reader would. Custom lines in general are covered in adding your own statement lines and wording.
Notes that have to follow the choice
The expense analysis shapes several notes:
- The operating profit note. If expenses are presented by function, readers still need depreciation, employee costs and other significant items somewhere, typically in a note to operating profit.
- Employee benefits. The staff cost figure should agree to the payroll records, whichever line it sits in.
- Accounting policies. Where function is used, a short description of how shared costs are allocated helps readers.
Achekam's notes take their figures from the mapped trial balance, and the standard policy wording, based on IFRS for SMEs, is labelled for review before issue. Where AI is set up, narrative wording carries the label "AI draft - review before issue". Either way, the person reviewing must check that each note describes the analysis actually presented.
The owner's long list of expenses does not vanish when the primary statement is summarised; it lives in the detailed income statement, as explained in the detailed income statement and who reads it.
General guidance only, not advice on your own circumstances. Tax and payroll rules change: check the current position with the authority or your adviser.
