Changes 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.
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.