Loan Covenants and Bonus Plans After IFRS 18: Net Profit Does Not Move, but Operating Profit, Finance Costs and Operating Cash Flow Do
IFRS 18 changes no recognition or measurement, so net profit, and a covenant EBITDA built up from it, stay where they were. What moves is everything defined from the face of the statements: operating profit as shown, the finance cost and finance income captions, and operating cash flow. One company's covenants worked through, from operating profit falling from 267 to 197 to a debt service cover that rises with no change in cash, plus a clause checklist and the budget and bonus decisions.
IFRS 18 changes no recognition or measurement (paragraphs 3 and 4; the C7 associates option aside), so net profit stays where it was, and so does a loan covenant figure built up from it with each add-back defined by nature. Yet one company's unchanged transactions show operating profit falling from 267 to 197, interest cover from 5.3x to 3.8x, and debt service cover rising from 2.05x to 2.16x with no extra cash.
IFRS 18 applies to annual periods beginning on or after 1 January 2027, so a calendar-year quarterly reporter's first IFRS 18 figures, and the first compliance certificate on them, come with its first-quarter 2027 interims (paragraphs C4 and C5), after the 2027 budget and bonus targets are approved. ESMA told issuers on 17 February 2026 to assess the effect on debt covenants and management pay plans.
This page covers covenant inputs; classification after a breach is in Debt Covenant Breaches and Refinancing.
Net profit does not move: why most leveraged-loan EBITDA survives
Company B, a manufacturer owned by a US group, reports in SAR millions. IFRS 18 moves its deposit and associate income out of its own IAS 1 "operating profit" into investing (paragraph 53), brings an impairment and a trade-payable exchange loss in, and puts its dollar loan's exchange loss in financing (B65, B66).
| Company B, SAR m | IAS 1, own policy | IFRS 18 |
|---|---|---|
| Gross profit 400, less selling 100 and administration 80, plus disposal gain 5 | 225 | 225 |
| Murabaha deposit income | 12 | Investing |
| Share of associate's profit | 30 | Investing |
| Impairment (IAS 36) | Below | (25) |
| Exchange loss, trade payables | Below | (3) |
| Operating profit | 267 | 197 |
| Impairment 25 and exchange losses 5 | (30) | None |
| Investing income | None | 42 |
| Profit before financing and income taxes | None | 239 |
| Interest: bank 40, lease 6, end-of-service 4 | (50) | (50) |
| Exchange loss, US dollar loan | In the 30 | (2) |
| Profit before zakat and income tax | 187 | 187 |
Pre-tax profit is 187 both ways (SOCPA's endorsed text labels the 239 "profit or loss before financing and Zakat and income taxes", paragraphs 69(b) and 71). A covenant EBITDA built up from profit, common in leveraged loans, survives if each add-back is defined by nature, not caption; built down from operating profit, it moves.
| EBITDA, SAR m (depreciation and amortisation 64) | IAS 1 | IFRS 18 |
|---|---|---|
| Built up: 187 plus finance charges plus 64 | 301 | 301, or 303 on the financing category |
| Built down: operating profit as shown plus 64 | 331 | 261 |
| Paragraph 118(b): operating profit before depreciation, amortisation and IAS 36 impairments | None | 286 |
IFRS 18 does not define EBITDA; the 118(b) subtotal is not a management-defined performance measure, and other EBITDAs are tested in Is EBITDA an MPM Under IFRS 18?
Four places a covenant can move, worked on one company
Definitions keyed to operating profit as shown
Keyed to operating profit as shown, Company B's earnings fall 26%, from 267 to 197. Interest cover falls from 5.3x (267 / 50) to 3.8x (197 / 52): against a 4.0x floor, a compliant borrower is in breach. The nearest match for the old EBIT over interest is profit before financing and income taxes over financing, 239 / 52 = 4.6x. The direction is not a rule: where lease, end-of-service or provision interest sat in operating expenses, operating profit rises, because B54 moves it to financing. Company B's US GAAP package shows 192.
Finance cost and finance income captions
Paragraph 75's required line items include no "finance costs" line. The financing category takes its place: interest on borrowings, leases and end-of-service obligations, provision unwinding (B54) and exchange differences on borrowings (B66), so Company B's 50 becomes 52. Income from cash and deposits goes to investing (paragraph 53), so "finance costs less finance income" may name two captions that no longer exist. In the Kingdom, SOCPA's paragraph 85A requires disclosure of interest on conventional loans and bonds separately from other finance costs such as finance leases and murabaha, however small: a note figure to key to.
Cash-based covenants
The amended IAS 7 sends interest paid to financing and interest and dividends received to investing for a company without a specified main business activity (paragraph 34A), and starts the indirect method at operating profit (18(b)). Company B paid interest of 46 (bank 40, lease 6) and received deposit income of 12 and an associate dividend of 18, all in operating activities under its old policy. Debt service is 146: interest of 46 plus principal of 100, lease principal of 22 included.
| Company B, SAR m | Old IAS 7 policy | Amended IAS 7 |
|---|---|---|
| Net cash from operating activities | 300 | 316 |
| DSCR: operating cash flow / 146 | 2.05x | 2.16x |
| DSCR: operating cash flow plus interest paid 46, / 146 | 2.37x | 2.48x |
The 316 is 300 plus the 46 paid, less the 12 and 18 received: the ratio rises with no change in cash. An interest add-back written for the old basis now adds back an amount never deducted, 362 instead of 346. Company B's US GAAP package shows 278 on the lease difference alone, because an ASC 842 operating lease keeps the whole payment in operating activities. More in The Cash Flow Statement Under IFRS 18.
Frozen GAAP clauses and the second calculation
Some agreements freeze the basis at the original audited accounts, some only if a party elects, some require a reconciliation or good-faith renegotiation with the old basis as fallback, and some let changes through unless a party asks for a freeze. With no clause, IFRS 18 figures apply.
Once a freeze bites, Company B tests 267, 50 and 300, not 197, 52 and 316, every period. IFRS 18 reconciles only the comparative year's profit or loss lines (C3, and C5 for interims; C6 merely permits more), and nothing bridges cash flow. The old basis becomes the borrower's own calculation, so document the policy behind 267 while the 2026 accounts still use it.
As at November 2026 we found no IFRS 18 guidance from the Loan Market Association, the Loan Syndications and Trading Association or the three global rating agencies.
A clause-review checklist, and questions for the agent bank
| Clause | Check | Company B |
|---|---|---|
| Accounting principles | Frozen, elective or floating; who elects, by when | 267 or 197 tested |
| EBITDA | Built up from profit, or down from operating profit | 301 holds; 331 becomes 261 |
| Finance charges | Caption, or interest by nature | 50 or 52 |
| Cash flow cover | Reported operating cash flow; interest add-back | 2.05x to 2.16x; 46 counted twice |
| Associates | In earnings? Dividends in cash flow? | 30 and 18 leave |
| Compliance certificate | Basis, reconciliation, auditor procedures | First on first-quarter 2027 figures |
Then ask the agent bank, in writing, before the first 2027 certificate: has anyone elected under the accounting principles clause? Will lenders test IFRS 18 figures against reset levels, or the old basis with a reconciliation? What does "finance charges" now mean? Does cash available for debt service drop the interest add-back? Will restated 2026 figures feed any look-back test or margin ratchet? Settle it in an amendment now: under IFRS, a waiver signed after the reporting date does not keep a breached loan non-current.
Budgets and bonus plans: rebase, state the formula, decide in advance
Budgets and bonus plans that say "operating profit" were built on the company's own subtotal. From 2027 the figure changes meaning and 2026 is restated (paragraph C2), so an old-basis budget shows a variance on day one. Our recommendation, not a requirement: rebase 2026 actuals and the 2027 budget to IFRS 18 before approval, write each bonus metric as a formula (IFRS 18 operating profit before named items, say), and minute now whether targets restate for definitional changes.
Do not restate by subtracting 70: Company B's gap is 42 of investing income out and 28 of impairment and exchange loss in, each with its own driver. Decide before the year starts whether managers paid on operating profit carry the impairment of 25 that used to sit below it.
A bonus metric that is published and is a subtotal of income and expenses is presumed to show management's view (paragraphs 117, 119 and B119): unless rebutted, or unless it is a subtotal that IFRS 18 requires or lists in paragraph 118 (paragraph 117(c)), it becomes a management-defined performance measure in the audited notes.
Lender packs and public communications
In June 2026 the IFRS Interpretations Committee tentatively concluded that a private entity's presentations to a few identifiable shareholders or potential investors, under confidentiality and no-redistribution terms and not otherwise published, are not public communications. Lenders are not named, but a confidential lender pack fits the same reasoning, by our reading. Comments closed on 9 September 2026 and the decision was not finalised in September; check the November 2026 IFRIC Update.
The same meeting tentatively concluded that a measure including hypothetical income and expenses can be a subtotal of income and expenses (paragraph 117). So a pro forma EBITDA with run-rate synergies in a results presentation can become a reconciled note item, with the tax effect of each adjustment (paragraph 123).
Where to practise this
On the CPA exam, covenant arithmetic is FAR Area II, Group H, Topic 2, at Application; BAR tests capital structure's effect on loan covenants in Area I, Group B, Topic 2, at Application (the topic's highest skill is Analysis). Both test US GAAP; the 2026 and 2027 Blueprints contain no IFRS. IMA's CMA Part 2 covers interest coverage (LOS A.2.j) and bond covenants (B.2.c), in sections weighted 20% each.
Prepito's FAR course and BAR course practise these tasks with full explanations; the CPA programme lists all six. The CMA Part 1 and Part 2 courses open soon (CMA programme). Ratios are defined in Financial Ratio Analysis, a full restatement is in IFRS 18 vs IAS 1, where operating profit moves from 230 to 186 and net profit stays at 180, and Saudi listed companies' dates in IFRS 18 for companies on Tadawul's Main Market, first statements within 30 days.
Sources: IFRS 18 (IFRS Foundation), read in AASB 18 (same numbering); IFRIC Updates of June and September 2026; ESMA public statement on IFRS 18; SOCPA endorsement document, item 42; AICPA 2026 Blueprints and 2027 changes; IMA Learning Outcome Statements. Company B is illustrative and nothing here is legal advice; tentative decisions can change, and lender practice will settle after the first 2027 certificates.
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Question 1 of 5
An entity reports revenues of $8,400,000, cost of goods sold of $5,100,000, selling expenses of $960,000, a loss on sale of equipment of $140,000, interest expense of $310,000, and a loss from discontinued operations of $700,000 before tax. What is income from continuing operations before tax?
