Accounting Boards Hang on to the Bottom Line

Revising their plan to ditch earnings from the income statement, FASB and IASB issue a proposal to revamp financials.
David KatzOctober 16, 2008

Even though times are tough, reports of the death of earnings have been greatly exaggerated.

At least on corporate income statements. To be sure, early staff drafts of a paper by the Financial Accounting Standards Board the International Accounting Standards Board on how companies should present their financial statements included a choice to eliminate the “net income” line. But in the final paper released for comment today, the boards chose to “proceed with proposals that build on established practice,” IASB chairman Sir David Tweedie said in a press release.

Thus, the jointly done project, which is likely to lead to an accounting standard that would hold sway in the United States and overseas, seems sure to retain the bottom line. At the same time, if the boards have their way, investors could have a much easier time establishing that the information contained in a company’s income statement, balance sheet, cash-flow statement, and equity statement all stems from a common source.

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At the same time, the boards intend the paper, “Preliminary Views on Financial Statement Presentation,” which is up for public comment until April 14, 2009, to push companies to report certain data separately rather than lump it all together in less-than-transparent ways.

Indeed, the boards appear to be using the current meltdown as a way to galvanize financial statement issuers and users to participate in an effort to make financial reporting more lucid. “The credit crisis has highlighted the need for clear presentation of financial information that is often complex,” said Sir David. “If you have an interest in the future presentation of financial information, now is the time to get involved.”

Similarly, FASB chairman Robert Herz said: “Providing investors with the most transparent, consistent financial reporting possible is more critical than ever to the efficiency and soundness of our capital markets. By working together to create one common, high quality global standard for financial statement presentation, the boards are aiming to increase the usefulness of financial reports while enhancing their comparability across international capital markets.”

In their paper, which introduces a “principles-based format” for financial reporting, IASB and FASB say that “cohesiveness” and “disaggregation” are their two main goals for financial statement presentation. By cohesiveness, they mean that a reader of financials should be able to follow the flow of information through a corporation’s financial statement. By disaggregation, they mean that an issuer should show items that respond differently to economic events separately.

In line with the goal of cohesiveness, the boards propose that companies should “classify income, expenses and cash flows in the same section andcategory as the related asset or liability,” according to an executive summary. For instance, if a company classifies inventory in the “operating” section of the balance sheet, it would place changes in inventory in the operating category of the in the income statement as partof cost of goods sold. The company would also classify the related cash payments to suppliers in its cash-flow statement’s operating category.

Concerning disaggregation, FASB and IASB want “to introduce a clear separation between an entity’s financing activities (how it obtains capital) and its business activities (how it uses thatcapital to create value).”

Currently, IFRS and GAAP “provide only limited presentation guidance,” the boards say. Further, U.S. GAAP scatters presentation guidelines across different standards. Users of financial statements also have often expressed dissatisfaction that information isn’t linked across the different statements and that dissimilar items are in some cases aggregated in one number, according to the release.

Thus, “the resulting variation and inconsistency in presentation formats create difficulties for users who want to understand and analyze an entity’s activities,” according to the paper itself. For instance, while some companies separate direct product costs, like materials and labor, general and administrative costs, like rent and utilities, others lump them together.their statement of comprehensive income. “Such aggregation [as in the latter case], makes it difficult for users to study the relationship between revenue and costs for an entity’s principal activities as well as to perform a benchmark analysis of those activities across an industry,” the boards say.

A lack of disaggregation also makes it harder for users to grasp the relationship between line items in different financials. The boards offer the example of a company that reports its research-and-development expenses on a single line on its income statement. If that company groups its cash outflows related to R&D activities with “other” or “general” operating cash outflows in its cash-flow statement, users would find it hard “to understand the cash demands of the entity’s research and development efforts,” according to the paper.

During the comment period on the discussion paper, a number of companies will take part in a field test in which they will recast, two years of financial statements using the boards’ views on financial statement presentation.