A balance sheet that doesn’t balance?
Financing and operating classifications that depend on your company type?
A (gulp) cash-basis income statement?
Well, not quite. But accounting standards-setters are online and on the road urging investors and companies to weigh in now on a proposal to radically alter financial statements. And while accrual accounting isn’t going away, preparers of financial statements might be surprised to find that the above descriptions do accurately describe the look and feel that financial statements might have just two years from now.
“This particular project will change the face of financial statements in a very, very significant way,” said Financial Accounting Standards Board member Thomas Linsmeier at a January 22 conference sponsored by the New York State Society of CPAs.
Issued as a discussion paper in October by both FASB and the International Accounting Standards Board, the goal of the redesign is to address investor complaints that items on each of the financial statements are not linked across the three statements, and that dissimilar items are often aggregated.
Among the notable features: all three statements — balance sheet, income statement, and cash-flow statement — will be divided into two major sections: business and financing.
“Users of financial statements analyze how a company creates value separately from how it funds that value creation,” said FASB senior project manager Kim Petrone in a Webcast on Tuesday. “So we want to separate the creating activities from the financing activities.”
The “business” section — which is subdivided into operating and investing categories — will focus on what a company does to produce goods and provide services. The operating category will include its primary or “core” revenue and expense-generating activities, and the investing category will include activities that generate a return but are not “core.”
The “financing” section will include those activities that fund a company’s business activities. For nonfinancial institutions, that would primarily include cash, bank loans, bonds, and other items that arise from general capital-raising activities.
One effect of the new format is that “the balance sheet won’t balance the way we expect it to,” said Linsmeier. “That is, assets won’t equal liabilities and equity because assets and liabilities will be in each category.”
Another feature guaranteed to generate some controversy is that management will decide whether items in the financial statements are related to operations or to financing. That means different companies might account for the same item differently. A manufacturer might record proceeds from mortgage-backed securities as investment earnings, while a bank might record identical proceeds as operating earnings.
“You’re going to begin [preparing your financial statements] by classifying assets and liabilities based on how the asset or liability is used by management,” explained Petrone. “That management approach is going to be very important because it allows [the accounting] to apply to many different entities. It’s been asked if this will apply to banks, and it will apply to banks.”