Will earnings figures soon be abolished from international financial statements?
Responding to a report in Thursday’s Financial Times, Sir David Tweedie, chairman of the International Accounting Standards Board, told CFO.com editors that eliminating net income from financial statements using U.S. generally accepted accounting principles or International Financial Reporting Standards was by no means a done deal.
On the contrary, he said, the elimination of a net-income total on the income statement is just one of three or four options that are likely to be served up at the end of the first quarter of 2008 in a discussion paper authored by IASB and the Financial Accounting Standards Board. Advocates of earnings elimination contend that under IASB-FASB plans for streamlining financial reports, “we don’t need an earnings number, you can work it out for yourself,” said Sir David. “Well, I think we do.”
The idea of eliminating net income is one of the more striking possible outcomes of a long-running project to improve the way financial statements present information. In essence, the income statement would look more like — and be easier to reconcile with — a cash-flow statement, with income divided into income from operations, financing, and investing.
That, in turn, would allay many companies’ fears about the volatility created by recent accounting pronouncements that rely on fair value — that is, the market value of an asset — rather than historical cost. For example, changes in pension funds or revaluations of property would appear in Other Comprehensive Income. “One of the real benefits is you would have a cash-flow statement and an income statement and you would see how you get from one to the other,” said Tweedie.
The joint FASB-IASB project, known as the “financial-statement presentation” project — formerly the “performance-reporting project” — has seen several iterations over the years. In 2003 the IASB floated an income statement in a so-called matrix format, with four quadrants representing different types of income.
The concept proved so startling to companies, however, that it was dropped. “The field test was a failure, really,” Tweedie told CFO magazine at the time. Intended to be a complete statement of all changes in equity, with no profit figure presented at all, the proposal was field tested in part because it lacked support among some IASB members.
But the test also inadvertently alarmed the business community. “People saw massive change coming through the performance-reporting project, and that wasn’t the intention,” said Tweedie. The project was restarted in April 2004 as a joint FASB-IASB effort, and its first phase — which brought an IASB standard on comprehensive income into line with FASB’s stricture on the issue — was finished in September 2007.
As part of the second phase of the project, the FASB-IASB discussion paper slated for release at the end of the first quarter of 2008 will ask questions about principles for putting together or breaking down information in financials and how to define the totals and subtotals reported. It will also ask whether components of Other Comprehensive Income should be reclassified to profit or loss and look at two FASB statements about cash flows.
Asked in 2005 whether the project would mean dramatic changes to the income statement, Robert Herz, chairman of FASB, said it would. But he carefully added that “the project doesn’t really redo any of the accounting. It’s all [about changing the] display and disaggregation to give a richer picture of what’s really going on.”
At the time, Herz said he expected the new income statement will “differentiate between [income from] operating activities, financing activities, and maybe other gains and losses,” just as a cash-flow statement does today. That, hopes Herz, would allow users “to see that the income statement and cash-flow statement are two different ways of looking at performance — one on an accrual basis and one on a cash basis — and use them together.”
Of course, changing the presentation would still have a big impact. For one thing, the two boards chose to pursue an approach created by the IASB that would require management to conform to a standardized definition of financing, instead of allowing management to determine whether income was the result of operations or financing, which has been FASB’s approach. That constraint could displease companies with big financing arms, such as General Electric Co. and Caterpillar.