Financial Statement Presentation: A Direct Hit
While lenders and analysts are big fans of the direct cash-flow method being prescribed by FASB’s financial statement presentation project, “it’s a nightmare for preparers,” asserts O’Dell. The project fundamentally changes the way information is presented on the balance sheet, income statement, and cash-flow statement by separating a company’s business activities from its financing or funding activities.
“We don’t collect this type of information [required by the direct method],” noted David Bond, senior vice president of finance and control for Safeway, at a recent conference. Fellow panelist Steve Whaley, controller for Wal-Mart Stores, agreed: “That’s not the way our ERP system is set up to do things.”
Jay Hanson, national director of accounting with McGladrey & Pullen and a member of FASB’s Emerging Issues Task Force, calls the direct cash-flow method one of the “poster children” for the difficulties preparers will face with the financial statement presentation project. The method requires companies to start with the net income number, and add or subtract working-capital items to get down to cash flow from operations. It also requires companies to add lines that break down items into such categories as cash received from customers, cash paid to customers, and cash paid to employees.
The only way to track “real” direct cash flows is to devise a system that captures data that likely exists at the lowest levels of an organization but is not currently being extracted. From an IT perspective, that means unearthing data that can be used to support accounting-treatment judgments and fair-value estimates, testing its integrity, and building a “formal disciplined process” around reporting the data, says Steve Hobbs, a managing director with consulting and internal-audit firm Protiviti.
Lease Accounting: A Capital Idea
The right-to-use concept written into FASB’s lease rule proposal (Topic 840) essentially eliminates operating leases for equipment and real estate rentals that extend beyond 12 months. If the rules are issued in their current form, companies that lease property or equipment will have to capitalize affected operating leases and bring the associated assets and liabilities back onto balance sheets.
At the same time, lessors will be required to make risk-based assessments before choosing between two prescribed accounting models, either the “performance obligation” if lessors retain the asset risk, or the “derecognition” model if risk is transferred to the lessee. Either way, lessors must periodically estimate — on a lease-by-lease basis — the fair value of assets and liabilities.
This new influx of valuation and other data is reminiscent of “the Y2K transition,” says McGladrey audit partner Morris Oldham. Data fields constructed to handle, for example, up to $999 million in leases may have to be reworked to accept $1 billion or more in such assets.
Furthermore, the draft rule requires that lease contingences, such as lease payment or receivables based on percentage of sales, be recorded differently. Under the proposed rule, lessees and lessors are required to churn out estimates for future payment and receivables. While retailers know how much they pay in rent, “they just don’t have systems that calculate how much they will have to pay in the future,” says Ross Prindle, managing director of the real estate group for Duff & Phelps.