While the threat of net income disappearing permanently is “a real one,” according to Kelly, there are several mitigating factors. Young, who is one of the stronger proponents of the move, finishes his term this year, and other board members seem considerably more sympathetic to keeping the status quo. “If people continue to demand a net income metric, we’ll provide information to calculate it,” says Herz. The head of the IASB, David Tweedie, has also gone on record as saying he thinks net income should stay.
The official board pronouncement is that companies would still be allowed to segregate OCI items in the short term, but that they must appear on the main income statement. Over the long term, the board plans a separate project to evaluate each OCI item and reconsider its placement.
Another major shift in the new model would be to require companies to use the direct method for the cash-flow statement, explaining cash changes from the bottom up to arrive at net income, rather than starting with net income and making adjustments. (Currently, most companies use the latter, indirect method.) That statement would be linked with a new form, the so-called reconciliation schedule, that would track changes in income to cash flows or fair-value changes.
The difficulty in constructing a direct cash-flow statement largely depends on the company. As controller for multinational McCormick, Kelly says he found the exercise “virtually impossible,” with thousands of transactions involving currency translations and so-called intercompany eliminations (what one division charges another for a product) gumming up the works. “If I were to get a cash-flow statement from each of my divisions around the world and try to add it up, it would never add up to my general cash-flow number,” he says.
Rickard, on the other hand, switched CVS/Caremark to the direct cash-flow method three years ago as part of an experiment, and found it so easy he never bothered to switch back. That’s in part because all of the company’s operations are stateside, and because Rickard had no intercompany eliminations.
Survey respondents were similarly split. About 40 percent said constructing a direct cash-flow statement would require major adjustments, while it would take minor adjustments for nearly 30 percent. Given such disparity, finance executives can expect something of a reprieve. The IASB, for one, doesn’t think the direct method should be required, and FASB members say they are looking closely at a hybrid direct/indirect method now used in Australia and New Zealand as a compromise.
“Radical Yet Insightful”
The concept of the reconciliation schedule, on the other hand, is gaining much wider support. Young thinks it is one of the most critical components of the new format, and more important than mandating the direct cash-flow statement. Wall Street is pushing for it as well.
“As we see more fair value coming through the financial statements, those statements need to do a better job of showing where the changes are coming from; this would help a lot,” says Pegg of Bear Stearns. Jonas of Moody’s considers the reconciliation schedule “the most radical yet most insightful” part of the project so far. “Many fundamental analysts are trying to understand the business’s ability to generate recurring, persistent cash flows,” he says, and the schedule helps them do that.