The devil is in the details when it comes to financial reporting, and investors want to know exactly what those details are, according to Financial Accounting Standards Board (FASB) Chair Richard Jones. “Investors and other allocators of capital have indicated support for more disaggregation of financial reporting information,” said Jones during a Securities and Exchange Commission and Financial Reporting Institute Conference held virtually in June.
The income statement has been targeted as a key area where investors want more granular information. “This would help them better assess the results of operations and estimates of future cash flows and risks, such as risks relating to earnings, foreign currencies, legislation, reputation and income taxes,” said Jones.
Jones’ comments were made following a May meeting of the FASB’s Investor Advisory Committee (IAC). The IAC advised the FASB that the disclosures that companies are providing about income statement accounts — including the cost of goods sold, advertising, and selling, general and administrative (SG&A) expense — are woefully inadequate in today’s volatile environment. The discussions indicate that lack of sufficient details about those expenses make it tough to forecast earnings.
One major concern is the increased volatility in raw material costs over the last year. Cost of goods sold — which includes raw materials, direct labor and overhead expenses — refers to how much it costs a company to produce the goods it sells. The IAC concluded that some companies aren’t breaking out cost of goods sold figures into their correct components, and those costs aren’t clearly defined.
Another area that investors want more details on is advertising expense. That expense usually represents a significant percentage of SG&A expense, but it isn’t being consistently disclosed. Companies also aren’t providing sufficient details about SG&A expenses, including wages, which makes it more challenging for stakeholders to understand a company’s cost structure.
A possible solution would be for the FASB to require further disaggregation (splitting out) of those costs either in the income statement or in related footnote disclosures. IAC members suggested that the numbers companies provide don’t necessarily have to be precise, rather the company could disclose percentages or even ranges for those line items.
Work in Progress
The IAC’s discussions were intended to provide the FASB with feedback about financial performance reporting. The project aligns strongly with the FASB’s work to amend Accounting Standards Codification Topic 280, Segment Reporting.
The existing guidance advises businesses to connect the information for reporting segments based on the person or group of people described by the disclosure requirements and implementation guidance as the chief operating decision maker (CODM). Businesses are required to disclose certain information about their segments if the information is regularly reviewed by the CODM. This is more commonly known as the so-called “management approach” to segment reporting.
Under the existing rules, segment totals must be reconciled to the consolidated amounts if the segment totals are significant. In general, a business must report information about an operating segment if:
- Its revenue — including sales to external customers and intersegment sales or transfers — is 10% or more of the combined internal and external revenue of all operating segments, or
- Its profit or loss is 10% or more of the greater of either the combined reported profit of all operating segments that didn’t report a loss or the combined reported loss of all operating segments that did report a loss.
A segment that includes assets that are 10% or more of the combined assets of all operating segments also must appear in the financial statements.
Investors often complain that the financial reporting that conforms to Topic 280 leaves them with too little information. They say large multinationals often report one or two business segments when other evidence indicates they should report more.
In recent years, the FASB has surveyed stakeholders about ways to improve segment reporting. But no formal changes to the existing guidance have been introduced yet. The FASB is currently studying how to clarify the meaning of “regularly reviewed information,” with a particular focus on technology changes and information that’s reviewed by the CODM only on an irregular basis.
Recent comments from Chairman Jones indicate that the FASB has a renewed interest in segment reporting and the disaggregation of financial information, especially what’s reported on the face of the income statement and in related footnote disclosures. This could lead to new accounting guidance under U.S. Generally Accepted Accounting Principles. Contact your CPA to ensure your financial statements are transparent and in compliance with the latest accounting rules.