RSS feedsChanges are required to the presentation of the primary financial statements. Pressure is growing among professional users for revisions which analysts say are necessary and overdue. The current set-up has inconsistencies and investors can be forced to obtain extensive adjustments to obtain fundamental metrics such as return on capital.
The International Accounting Standards Board agrees with the need for change and, along with the US Financial Accounting Standards Board, is set to discuss an initial discussion paper on financial statement presentation in the final quarter of this year. The two boards have already made progress on the issue and have reached some conclusions which have seen the light of day.
One of the aims of the standard setters in revitalising financial statement presentation is to achieve cohesiveness. This means consistency of classification across the primary statements so that, for instance, operating income, operating cashflow and net operating assets are consistently presented and could be related to one another by users of accounts.
One of the current outputs of the IASB/FASB thinking is that the measure of earnings as currently presented in the income statement may disappear altogether. Some standard setters have been worried that the concentrated focus on an earnings per share-type number has been unhealthy and has led preparers to worry excessively about the EPS numbers and for analysts to lose sight of other important figures and ratios.
This stance of the standard setters has set alarm bells ringing in the analyst community and prominent analyst Stephen Cooper of UBS has already raised his concerns. IASB/FASB is discussing that the measure of earnings/net income as currently presented in the income statement would be replaced by summary measures of (pre-financing) operating income and bottom-line comprehensive income, which would include fair value changes and all other types.
Investors are primarily interested in profits and cashflows and the ability of the business to maintain and grow these flows, rather than the value of individual assets owned by the company. For their part IASB/FASB say their objectives in this project are to present information in the financial statements in a way that improves understanding of the company’s past and present financials and the past operating and financing activities that caused the financial position to change. Perhaps the hardest element IASB/FASB is trying to achieve is to “use the financial statement information – along with information from other sources – to assess the amounts, timing and uncertainty of an entity’s future cashflows”.
For investors, the key outcome of this project would be the revision of the primary financial statements in a bid to achieve consistency between the different statements. An example given by Cooper is that “net income is a difficult to interpret amalgamation of gains and losses that have different characteristics, and there is little conceptual logic behind many of the current classifications and methods of presentation.”
The complexity surrounding this project is that the problem of presentation of financial statements segues into other areas currently being worked on by IASB/FASB, including measurement of assets and liabilities, pension accounting and accounting for debt and equity instruments. The question here is how to present gains and losses.
Behind the problems of presentation lies the equally intractable problems of measurement. As part of its IASB/FASB conceptual framework project, IASB believes it uses at least half a dozen measurement bases – these include past gross entry price, accumulated past entry price, allocated past (gross) entry price, combine price and value in use. This does not help give users the one-stop-shop they are looking for in financial statement presentation.
The final element surrounding the revision of the presentation of the primary financial statements is the question of detail. The IASB wants principle-based standards and the accounting standard on the presentation of financial statement could be a test of that resolve. On that basis, the accounting standard should not provide detailed prescriptions of the items and structure within a performance statement because the variability of companies means that flexibility is needed, but that a few key items should be provided as standard.
The toughest problem for IASB/FASB to crack is that financial statements are undergoing ‘mission creep’. The primary objective of financial statements is to provide information to help decision-making for shareholders. But there has been tacit acknowledgement that the needs of creditors are increasingly taken into account. This emphasis on information which is useful to investing and credit decisions has rendered accounts both lengthy and hard to understand and has led to much of the measurement complexity that the IASB has revealed. How much a radical review of the presentation of financial statements can solve these problems must be open to severe doubt.
