1. Classification by Nature
Entities presenting expenses by nature aggregate expenses according to their type (e.g., depreciation, purchases of materials, transport costs, employee benefits, and advertising costs). They do not reallocate them among functions within the entity.
Revenue − Raw Materials Used − Employee Benefit Expenses − Depreciation Expense = Operating Profit
  • Pros: Highly useful for smaller entities; eliminates subjective management allocations of overhead across departments.

2. Classification by Function
Entities presenting expenses by function (also known as the “cost of sales” method) classify expenses according to the program or department that incurred them (e.g., cost of goods sold, distribution/selling expenses, administrative expenses).
Revenue − Cost of Goods Sold (COGS) = Gross Profit
Gross Profit − Selling & Distribution Costs − Administrative Expenses = Operating Profit
  • IFRS Requirement: If an entity chooses to present expenses by function, it must disclose additional information on the nature of expenses in the notes, including depreciation, amortization, and employee benefit expenses.
  • US GAAP Preference: Public companies matching SEC templates almost universally present by function, demanding clear structural breakdowns of Cost of Sales versus Selling, General, and Administrative (SG&A) expenses.
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