Investors often can’t get sufficient information about a company’s future cash flows because expense information is too dense, according to recent discussions by the Financial Accounting Standards Board (FASB). An ongoing FASB project aims to make the income statement more useful to those who read it.
What happens now?
The FASB’s financial performance reporting project would require financial reports to be based on management’s internal view of the company’s expenses. This will require more details to be provided in line items on the income statement. In the following months, the FASB will have additional discussions related to this project as they continue to conduct further research.
“I just want to make sure that we’re really focused on the users ultimately and the users’ needs, and what it is that they need this information to do,” said FASB member Christine Botosan. “And it’s one, to help them forecast future cash flows, and it’s two, to help them judge the accuracy of their past forecast.”
Botosan, who represents the academic view on the FASB, doesn’t want the FASB to require companies to provide information that is irrelevant to investors just because it’s important to managers. She considers the internal activities of a company that are most aligned with forecasting to be 1) forming budgets and projections, and 2) comparing budget to actual results.
Representing the investor’s perspective during board discussions, FASB member Hal Schroeder, agreed with Botosan. He said, “Investors don’t have access to everything, but what they are trying to do is not a budget, but a forecast. They’re trying to estimate ‘what will next year’s or next quarter’s earnings be; how will that number be used in that forecast?’”
Possible areas of advancement
Discussion and debate continue as this project is still in its early stages. FASB staff members are contemplating disaggregating functional or summarized expense line items (such as cost of goods sold or selling, general and administrative [SG&A] expenses) into their natural components (such as salaries, utilities and rent). The staff is performing outreach to understand:
- Whether or how entities review the components of lines that represent the cost of goods sold and SG&A expenses for internal reporting purposes
- The level at which accounting systems track these components
- How the components are rolled into consolidated lines
Among other questions FASB staff will address include:
- What expense information should be broken out, and how?
- What specific expense information do companies consider as part of their internal views?
As part of the research process, the FASB’s staff wants to understand which individual view or views should be considered when identifying management at an appropriate level. James Kroeker, FASB Vice Chairman, pointed out that some entities operate through independent operating companies where each subsidiary is managed separately. Though the CEO or CFO is ultimately responsible to the stakeholders, the subsidiaries may not view the chain of responsibility the same way as the top executive or investors do.
Kroeker cautioned that, in some entities, three separate people may be responsible for different functions. “You might have one group that reviews expenses, maybe the controller group does an analysis for MD&A [management’s discussion and analysis] and then somebody else is actually responsible for expenses,” he said.
The bottom line
Despite the likelihood that FASB’s financial performance reporting project will affect your company’s financial statements in the future, it’s unclear whether the changes will appear on the face of the income statement or in the footnote disclosures. Fortunately, the information that management is already collecting as part of its budgeting process aligns with the extra information that will be required. So, any additional effort and cost should be minimal. For more information, contact a Weaver professional today.
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