Peeling away financial reporting issues one layer at a time

Financial Statement Presentation: The Sequel

Two readers, including Robert Bloomfield, Cornell accounting professor (my alma mater!) and Director of the Financial Accounting Standards Research Initiative (FASRI) of the FASB, were kind enough to point out an error in my previous post. Here is the gist of what Prof. Bloomfield had to say (his full comment is here):

"… you link readers to the 7-page summary document, but there is a lot more than that. …The discussion paper is quite long and detailed, including elaborate examples of a manufacturing and a banking company.

Also, one very interesting aspect of the proposal is a reconciliation footnote that would reconcile, line by line, the cash flow statement to the income statement. The differences are broken into various categories including accruals, fair value remeasurements, other remeasurements, etc.

So if you are opposed to capitalized interest, you are likely to be able to undo a fair bit of that through the footnotes."

Indeed, I mistook the summary of the DP, which was separately posted on a different page on, for the entire document. My bad. I guess the page numbering in the summary should have tipped me off that there was more to come. But as a feeble defense, the FASB could have made the project page more user-friendly by posting a link to the complete DP right on the project page itself.

Much more important, is that I am happy to have discovered that the Boards may be proposing some significant changes that can result in incremental information for financial statement users. But, in all of the extra data, what may be some of the most sensitive items are still artfully concealed. Notwithstanding Prof. Bloomfield's statement that I should be able to discover more about interest capitalization, "more" is not enough when "all" is easily achievable and principles-based.

Along the same lines, there is nary a scintilla of disaggregated information regarding the effects of foreign currency translation on earnings, assets and liabilities. As I have pointed out in previous posts, FAS 52 creates some pretty crazy effects: translating the fixed assets on the books of foreign subsidiaries at current exchange rates is nothing more than random number generation; gains and losses on foreign-currency-denominated monetary items held by foreign subsidiaries are not presented in a manner consistent with identical exposures that happen to be on the books of domestic subsidiaries.

Making Financial Statement Presentation Simpler – and Much Better

Even though the Boards hide behind a self-imposed constraint to excuse themselves from consideirng recognition and measurement issues, they can still make the effects of some of their most ridiculous rules much more transparent than they are currently proposing. Here's three frustratingly simple things, which if implemented would far exceed the benefits of their current proposal:

  1. Along the lines of the logic I presented by the name Largest Possible Entity, maintain a strict and principled separation between financial and non-financial elements in the balance sheet and income statement. Call me cynical, but I simply can no longer accept that giving management any discretion whatsoever over financial statement presentation will result in higher quality or especially more comparable information (the putative goal of IFRS and U.S. GAAP convergence). Every student of finance is apprised at some point that Modigliani and Miller received their Nobel Prizes in large part for seeding the conversation that financial decisions are fundamentally different than whatever one cares to call the rest of the things that management does. The LPE concept is merely an accounting child of their enduring insights.
  2. Mandate the direct method for the statement of cash flows. The format for the statement of cash flows proposed in the DP is pretty cool, and so is the reconciliation of cash flows to comprehensive income. I also like the new definition of operating cash flows that would comprehend expenditures on assets. But, all of that is icing on the cake compared to simply eliminating the indirect method alternative that was provided at the eleventh hour by the FASB in SFAS 95. Waiting for this simple change seven years after Enron has conditioned me to not ask for too much in this regard.
  3. Require a reconciliation of the beginning and ending balances of each account on the balance sheet (I still can't bring myself to 'statement of financial position' for an accounting that suspends rules of arithmetic I learned in first grade). If reconciliations are done properly, users can unwind all sorts of silly things – of which the aforementioned interest capitalization, random number generation through foreign currency 'translation' and inconsistent treatment of foreign exchange gains/losses are but three examples.

    The proposed reconciliation information is much too vague, and again is subject to obfuscation by management. Get ready for the naysayers to dismiss this suggestion as impracticable. But, if Worldcom's auditors had actually reconciled the beginning and ending PP&E balances, they would have been heroes instead of goats – and Cynthia Cooper, the Worldcom employee who blew the whistle on Bernie Ebbers et. al. would be memoirless. Especially in these days post S-OX 404, shouldn't each and every consolidated balance sheet account be reconciled? If not, what's the point of "internal controls over financial reporting"?

    In my next post, I'll provide a couple examples of the simple form of reconciliation I have in mind.

Some Additional Tidbits

First, the first paragraph of the DP states that Phase A of the project addressed "statements that constitute a complete set of financial statements… and … Phase B would address more fundamental issues relating to presentation and display of information … including … reconsidering the use of a direct or an indirect method of presenting operating cash flows." [para. 1.1, italics supplied]

Fundamental? More like "highly controversial"! Maybe I'm missing the boat here, but Phase A is the "fundamental" issue, and Phase B is detail—albeit important detail. The DP process could be much more constructive if the Boards would simply set forth the reasons why investors would benefit from a direct method cash flow statement; and more important, why issuers stubbornly resist the wishes of investors. The absence of a willingness to openly acknowledge the actual controversies does not bode well for a satisfactory outcome.

Second, the third paragraph of the DP states that FARSI, Prof. Bloomfield's group, "…will study investor use of financial statements prepared using the proposed presentation model by conducting a series of controlled tests." [para 1.3] To test what? What parts of the DP are even amenable to controlled experiments?

Notwithstanding the unnecessary vagaries, I have to say that I'm not sure that any testing will provide actionable results. Controlled experiments in accounting overwhelmingly tend to address very narrow research questions whose results are difficult, if not impossible, to validly generalize. My fear is that results that merely weakly support the preliminary views expressed in the DP will be over-generalized by vocal proponents of an anti-investor agenda.

But, setting that cavil aside, my greater concern is that investors will provide some "statistically significant" indication that the new presentation format represents an "improvement" over the mishmash of statement and disclosures currently being fed to them – a pretty low hurdle given the current sad state of financial reporting. That "empirical evidence" will be seen as supporting the proposed changes, tepid as they are, and thereby rendering really needed changes to the bottom of the priority pile for another twenty years. If you need evidence, see FAS 115 and that ugly "other than temporary impairment" standard that currently plagues us in the midst of our economic crisis; or SFAS 95, allowing the indirect method. GAAP is littered with disastrous standards that were passed by narrow margins with at least some board members expressing disappointment, but justifying their "yea" votes as compromises in the name of some modicum of progress. Will the Boards be playing the same sorry tune one more time?

Third, the absence of any discussion of XBRL in the DP indicates that both Boards might prefer that XBRL's significant implications for disaggregation of financial information – the more the better – be swept under the rug for a while. Soon may come the day, perhaps even before a final standard becomes effective, that the value of static presentations will fade to dust compared to simple software programs that generate financial statements in accordance with each user's very own preferences. Thus, the real reporting issue of the near future is not presentation, but rather disaggregation.

Having said all that, I'll conclude by stating that I fundamentally object to a management approach. I also have little confidence that the detailed disclosures regarding cash flows, much less the direct method, will be accepted by the IASB. Financial statement presentation was not designated as a convergence topic in the fabled Norwich Agreement, and I believe that the FASB erred in agreeing to conduct the project jointly with them. I believe they chose to form a cartel on this one, because not to have done so would have once again spotlighted the IASB's record of reluctance to push back against their funding sources.

Evidently, the FASB feels that it is a far better outcome to end up with a watered-down presentation standard that won't be revisited for another twenty years than it is to jeopardize IFRS adoption in the U.S.


  1. Reply Independent Accountant December 23, 2008

    I agree. This separation of financial assets into those not subject to mark-to-market and those subject to it is nonsense. Look at GE’s financials. GE can generate almost any income number it wants by selecting assets to sell. And it’s all kosher.

  2. Reply Eddie Thomas January 2, 2009

    “Soon may come the day, perhaps even before a final standard becomes effective, that the value of static presentations will fade to dust compared to simple software programs that generate financial statements in accordance with each user’s very own preferences.”
    This seems right to me. Wouldn’t investors be better off pushing for a more robust XBRL so that they can make their own decisions about what is relevant information and what is not? It seems like an effective end run around the politics of the FASB and the IASB.

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