5(a). Income statement, including core earnings and comprehensive income
Leading view
Core Earnings:
Most users following the fundamental approach need information about the portion of a company's reported earnings that are stable or recurring and that provide a basis for estimating its expected repeatable normal earnings over a span of future years (core earnings).
* Although core earnings are difficult to define (and users don't want accountants to do so) and may exclude or include certain items depending on the user's view, users develop such earnings [p, 1-3, 7-9, 11, 13-14, 19, 23, 29, 34-35, 40-41]
* Users consider the development of core earnings as a concept of financial analysis and not necessarily of financial reporting [p. 34-35]
* Users rarely compute core earnings directly; rather they adjust net income. Users usually adjust reported net income for all or some of the following:
(a) nonrecurring, unusual, and infrequent items in reported revenues, expenses, gains and losses [p. 1, 3, 6, 8, 13, 22]
(b) tax expense [p. 14]
(c) interest expense [p. 26]
(d) extraordinary items [p. 8]
(e) discontinued operations [p. 2]
(f) accounting changes [p. 2]
(g) noncash charges such as depreciation and amortization [p. 26]
* In general, financial statements already separately display items (b) through (f). Further, the statements and notes generally include sufficient information about those items to permit users to compute core earnings
* In contrast, financial reporting does not contain sufficient information about nonrecurring, unusual and infrequent items to meet users' needs in computing core earnings. The information is insufficient because (1) the statements do not identify a sufficiently broad range of potential nonrecurring, unusual, and infrequent items and (2) the descriptions and details of items labeled as nonrecurring, unusual and infrequent are sometimes insufficient to permit users to evaluate for themselves whether those items are part of core earnings [p. 22- 23, 27]
* Users also review operating income to determine whether it contains items that are not judged to be part of normal operations [p. 3]. As an example, they want to know that a very material new customer has been secured which will result in a dramatic increase in sales [p. 12].
Despite wanting to compute or recompute core earnings for themselves, users would not object to separate display of a caption titled core earnings, provided that the statements also include sufficient information about nonrecurring, unusual, and infrequent items.
* The disclosures would include the description and amount of potential nonrecurring, unusual, and infrequent items that are close calls for either inclusion or exclusion in core earnings [p. 3].
Regardless of whether a separate caption titled core earnings is displayed on the income statement, users need improved information about nonrecurring, unusual, and infrequent items including close calls.
* The financial statements and notes should separately describe the type and amount of those potential items in sufficient detail to permit users to reach an informed opinion about whether those items are part of core earnings [p. 1, 3, 11-12, 26, 30-31]
* Users find acceptable either management determination of nonrecurring, unusual and infrequent items subject to auditor verification (although credit users are not confident of management's ability to make the determination) or the establishment of special criteria on which to base the determination with a slight preference for the establishment of special criteria [p. 24, 26, 40].
Display that improves users' understanding of the business:
Users would find helpful improvements in the display of information on the income statement that would assist with their analysis of the business.
* Users have stressed the importance of understanding as much as possible about the businesses of the companies that they consider and the close linkage between the financial statements and actual events. The current form of display already provide useful information about the company's business and actual events. For example, revenue is reported apart from expense and certain types of expenses are separately reported. That display enables analysis of trends and relationships that could not be done if those items were offset or aggregated. Some examples of potential improvements follow:
* Divide operating expense into fixed and variable, or controllable and noncontrollable, or discretionary and nondiscretionary categories [p. 15-16, 23, 28]
* Display the types and amounts of costs included in certain major captions, for example:
* disclose the portions of cost-of-sales that relate to purchased materials, salaries, fringe benefits, occupancy costs, property taxes, and other major components of costs [p. 16, 28]
* disclose selling expenses separately from general and administrative expenses [p. 15, 28]
* disclose the portion of cost-of-sales and SG& A expenses that is depreciation [p. 16-17, 28]
* disclose the portion of costs and expenses that relate to employees versus those that do not [p. 16, 28]
* disclose research and development expenditures [p. 16-17]
* disclose the cash versus non-cash parts of expenses [p. 22]
* disclose details of the equity income line item in financial statements [p. 10]
* disclose amortization and its nature, separately from depreciation [p. 25, 26]
* for financial institutions, separate disclosure of securities gains and losses from operations [p. 41].
Comprehensive income:
Users have no strong view about whether items that are charged directly to equity, such as currency translation adjustments, should be displayed on the face of the income statements as separate elements of comprehensive income.
* Many users don't care about the geography of items that are direct charges or credits to retained earnings as long as they are fully disclosed, generally, gross and net of tax, with detail sufficient for the user to assess whether they are part of core earnings [p. 1, 3, 12- 14, 27, 39-40].
Alternative view
A comprehensive income approach should be adopted.
* The AIMR states that the FASB should develop and implement an accounting standard that is based on a comprehensive income approach [p. 5-6, 9]. However, some users may view this as a call for adoption of a method that insures the detailed disclosure of all income and expense items that are not part of core earnings [p. 7-8].
5(b). Balance sheet
Leading view
Users would find helpful improvements in the display of information on the balance sheet that would assist with their analyses of opportunities and risks.
* Users are not satisfied with the current balance sheet display [p. 9, 13]
* Users have emphasized the importance of understanding opportunities and risks related to the businesses of the companies that they follow, including risks of not realizing assets at their reported amounts [p. 2, 3, 14]. The current form of display on the balance sheet already provides useful information about certain opportunities and risks. Some examples of potential improvements include:
* Provide more detail of items in other assets and other deferred charges and credits, using a lower materiality threshold than is currently used in practice [p. 9, 13]
* Display separately past-due receivables or an aging of receivables [p. 4, 6-7, 9-10]
* Display separately slow-moving inventory or an aging of inventory [p. 4-7, 9-10, 12]
* Provide more details about the nature of and changes in valuation reserves [p. 3, 14].
Users also would find helpful improvements in the display of information on the balance sheet that would assist with their understanding of a company's business and the linkage between the financial statements and actual events.
* Some examples of potential improvements include:
* Display separately the assets and liabilities that result from unusual transactions and events [p. 9, 13]
* Display separately the assets and liabilities that result from nonoperating activities [p. 9, 13]
* Provide more detail of items in other assets and other deferred charges and credits, using a lower materiality threshold than is currently used in practice [p. 9, 13].
5(c). Cash flow statement
Leading view
A majority of users prefer a direct method of reporting cash flows from operations over the indirect method. Some users would find it most useful if the cash flows from operations portion of the cash flow statement included the same captions as on the income statement (i.e. a cash-basis income statement). However, the details of presentation of the direct method were not definitively discussed.
* Users prefer a direct method for the following reasons:
* The direct method more closely tracks real-world events (such as the receipt of cash from customers, payment of cash to suppliers, employees, and others). Thus, it improves the users' understanding of the company's business [p. 1-2, 13-14, 20, 22]
* Users use the cash flow statement in part to assess the "quality" of the company's reported income. That assessment is made easier by a line by line comparison of captions on the income statement to the cash flow equivalent of those captions on the cash flow statement [p. 16-17, 22]
* Users need to know the cash flows related to certain captions of the income statement to assist in their predictions of core income and core cash flows [p. 20-21]. Those captions include the cash portions of (a) restructuring charges, (b) nonrecurring, unusual, and infrequent items, (c) discontinued operations, and (d) extraordinary items [p. 22]
* The breakdown of gross cash flows in the direct method into general categories such as cash received from customers, and cash paid to employees and vendors provides insight that is not available from the reconciliation of net income to cash flow using the indirect method [p. 20].
Notwithstanding their interest in the direct method of reporting cash flows, users would still want and use the indirect reconciliation of earnings to operating cash flows if the direct method is provided.
* The reconciliation helps in identifying certain items; for example, non-recurring items that are hard to determine under the direct method [p. 16, 19]
* There is a concern that information from use of the indirect method might be lost without the reconciliation [p. 18].
Some users would like to have a quarterly cash flow statement.
* Quarterly information would assist greatly in trend analysis [p. 12-13].
Alternative view
Some users prefer the indirect method.
* In the view of a few users, in the direct method, obtaining information about cash received from customers and paid to suppliers and employees is worthless [p. 10].