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Monday, March 21, 2016

Eyes on Earnings: Reporting Financial Performance


The Financial Accounting Standards Board (FASB) has revived a project that’s now aimed at improving how companies report the line items on their income statements. Before it proposes any sweeping changes to the accounting rules, however, the FASB wants to define the project’s ultimate goal. This will require feedback from investors, businesses and auditors on the perceived problems with how companies report earnings.

Old project, new twist
The FASB previously addressed the earnings issue in 2010 when it released Staff Draft of an Exposure Draft on Financial Statement Presentation to solicit comments on how to overhaul financial statements. The paper was issued as part of a joint project with the International Accounting Standards Board (IASB). But the accounting boards soon realized the effort was a bigger undertaking than they were prepared for. The project was eventually set aside to allow the FASB to focus on higher-priority projects, including standards that dealt with the fallout from the 2008 financial crisis.

In 2014, the FASB agreed to resume work on the project, but with a more limited focus on reporting financial performance. The topic resurfaced again last July when board members were discussing ways to define and distinguish the effects of re-measurements on earnings. At that time, the FASB directed its research staff to study the methods for distinguishing between different earnings components, including separating line items by nature and business activity and better describing what can be grouped within a line item.

In late January, FASB members discussed a requirement that line items be presented on the income statement by function, nature or both. But it didn’t take formal action, in part because board members wanted to make sure they agreed on the project’s purpose before proceeding.

“If we can get agreement of the identified problem or problems, I think that would drive us into the wording of an objective,” FASB Chairman Russell Golden said at the end of the meeting. “From there, we could talk about next steps.”

A new direction
FASB research has shown that the income statement tends to have 14 to 17 line items, depending on the industry. Commonly presented functional lines include:

  • Raw materials,
  • Manufacturing costs,
  • Service costs,
  • Salaries,
  • Sales expenses,
  • Rent,
  • Utilities, and
  • Other general and administrative expenses.

Investors have felt for years that some line items are less informative than others because businesses tend to aggregate too much information into one line. This limits investors’ ability to know much about a specific source of income or cost.

Some board members said they want the more detailed information in line items to help users of financial statements predict a company’s future financial performance. Others would like to see breakdowns for different types of line items based on function or nature.

Several board members said the functional lines are the ones that are usually bunched together and are less easy to understand. Line items that present items by nature include those that: 1) display the effect of an infrequently occurring event or transaction, 2) show the effect of grouping items according to their origin or source, and 3) convey the effect of aggregating items that result from the derecognition of an asset or liability or a class of assets or liabilities.

In general, the higher up an item is in an income statement, the more important it is to investors for it to not be aggregated. Investors are generally less concerned with items near the bottom of the income statement, such as nonrecurring income and expenses.

The bottom line on reporting your bottom line
Relevance is an overarching goal in reporting financial performance under U.S. Generally Accepted Accounting Principles. Although the FASB hasn’t set an official goal for this project yet, its members hope to give investors and other financial statement users more relevant information in earnings reports. This project could likely change how businesses present and break down their financial information — but only time will tell how much additional detail the FASB will require.

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