Critics Pan New Financial Statements

It's been called the most dramatic overhaul of financial statements since the cash flow statement was introduced more than two decades ago. But when the comment period closed last week on the ideas for radically changing financial statements, the proposed design from the world's accounting standard setters had been called a few other things too: "poorly defined," "confusing," cluttered, "information overload," "inconsistent with management's internal reporting," and, frequently, "costly."

In October 2008, the Financial Accounting Standards Board and the International Accounting Standards Board jointly issued a discussion paper laying out their preliminary ideas for changes to financial statements that would fundamentally alter the way information is presented on the financial statements. Comments were due last week.

The two boards said their goal was to tie the different financial statements more closely together, provide deeper dives into financial numbers that are often aggregated at a very high level, and also provide a heavy emphasis on cash and liquidity. A key feature of the proposal is that managers would separate a company's actual business activities from its financing or funding activities. As a result, each of the three statements — balance sheet, income statement, and cash-flow statement — will be divided into two major sections: business and financing.

The financing section will include those activities that fund a company's business. For nonfinancial institutions, that would primarily include cash, bank loans, bonds, and other items that arise from general capital-raising efforts.

The business section — which would be further subdivided into operating and investing categories — would focus on what a company does to produce goods and provide services. The operating category will include primary or "core" revenue and expense-generating activities, and the investing category will include activities that generate a return but are not "core."

Many preparers, particularly banks, commented that FASB and IASB needed to do more to clearly define 'operating' and 'investing' activities. "They're using the same terminology that we use in FAS 95 for cash flows," Grant Thornton partner John Hepp told CFO.com, "But they have completely different meanings from what they meant [in FAS 95]." Indeed, Hepp's sentiments are echoed in Grant Thornton's official comment letter, which notes not only that the distinction between the operating and investing sections is "very confusing," but also that "the [discussion paper] itself uses three different descriptions."

"I don't think FASB or IASB is real clear on what these terms mean, so I don't know how management would apply them," Hepp added.

Some of the debate, of course, may come down to FASB's and IASB's desire to have management itself define what activities it considers to be part of their company's business model for adding to shareholder value, versus simple investment returns.

"Users of financial statements analyze how a company creates value separately from how it funds that value creation," said FASB senior project manager Kim Petrone in a webcast at the beginning of this year. "So we want to separate the creating activities from the financing activities." Petrone explained that companies will begin by classifying assets and liabilities based on how they are used by management. "That management approach is going to be very important because it allows [the accounting] to apply to many different entities. It's been asked if this will apply to banks, and it will apply to banks."

But banks themselves were less than thrilled with that portion of the proposal. While conceding that it might be useful for investors of non-bank institutions to see financing activities separated from business activities, the American Bankers Association said "this kind of breakout will have little or no value to users of financial statements of banking institutions. . . . In essence, both investing activities and financing activities normally are operating activities at a bank."

"The nature of the banking industry would lead, in our opinion, to the vast majority of activities being presented within the business activities (operating category)," concurred the British Bankers Association, adding that, for financial institutions, "we do not believe that the separation of business activities from financing activities will provide users with information that is more decision-useful than the current presentation method."

While banks might find it impossible to distinguish between financing and operating activities, it is interesting to think that some of the distinctions proposed might have helped banks highlight the difference between actual losses and the writedowns that many were forced to take as a result of changes in fair value. Indeed, that's what at least one analyst, not speaking specifically about the banking industry, suggested just over a year ago. "As we see more fair value coming through the financial statements, those statements need to do a better job of showing where the changes are coming from; this would help a lot," Janet Pegg, a senior managing director and an accounting analyst at Bear Stearns, told CFO magazine in Feb 2008.

• 1
• 2
• next »

LinkedIn Company Connections:

• IBM |
• Shell |
• Grant Thornton |
• Bear Stearns |
• FirstEnergy |
• Intel