Ideally, investors should be able to get sufficient information about a company’s future cash flows by looking at the income statement. But they currently don’t because expense information is too densely reported, according to recent discussions by the Financial Accounting Standards Board (FASB). Here’s an update on an ongoing FASB project that aims to make the income statement more useful to those who read it.
The FASB’s financial performance reporting project would require more details to be provided in line items on the income statement. The breakdown would be based on management’s internal view of the company’s expenses. Currently, the FASB is conducting further research and will have additional discussions related to this project in the coming months.
“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 represents the academic view on the FASB. She believes that the internal activities of a company that are most aligned with forecasting are 1) forming budgets and projections, and 2) comparing budget-to-actual results. However, she doesn’t want the FASB to require companies to provide information that doesn’t matter to investors just because it’s important to managers.
FASB member Hal Schroeder, who represents the investor’s perspective during board discussions, 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?’”
Potential areas of improvement
This project is still in early stages of discussions. 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:
- If and 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, and
- 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 its research, the FASB’s staff wants to understand which individual view or views should be considered when identifying management at an appropriate level. FASB Vice Chairman James Kroeker 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.
He 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.
Although the FASB’s financial performance reporting project is likely to 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. But, the good news is that the extra information that will be required is likely to align with information that management is already collecting as part of its budgeting process. So, any incremental effort and cost should be minimal.