At the IMA® (Institute of Management Accountants) 2023 Accounting & Finance Conference, Financial Accounting Standards Board (FASB or Board) member Marsha Hunt alerted attendees that the FASB is readying a new exposure draft that, if adopted, will require new disclosures regarding the expenses that appear in the face of the income statement. In her remarks, Hunt suggested that the proposed guidelines, called disaggregation of income statement expenses (DISE), represent a carefully balanced compromise between investor demands and potential burdens on preparers.
Addressing the line items that appear on the face of the income statement has been on the FASB’s agenda for several years. For public entities in the United States, Regulation S-X has established requirements for expense captions to be presented on the face of the income statement. The guidance under U.S. Generally Accepted Accounting Principles (GAAP), Topic 205, Presentation of Financial Statements, and Topic 225, Income Statements, provides minimal additional specifics on what a reporting entity must present in the related notes.
In 2017-2018, the FASB had considered a project regarding the disaggregation of income statement items around performance-based metrics, but it was set aside. The Board returned to the project in 2022, primarily as a result of its 2021 agenda consultation. As the FASB reconsidered the project, Chair Rich Jones publicly noted the Board was reflecting users’ views that they aren’t receiving the requisite level of detail to understand a reporting entity’s operations. Simply, users seek more detailed information for insights on how a reporting entity expends its resources, and a high priority is data around compensation.
The FASB’s pathway differs from the guidance under the International Financial Reporting Standards. Unlike U.S. GAAP, International Accounting Standard 1, Presentation of Financial Statements, states in paragraph 104 that a reporting entity must classify expenses by function and disclose additional information on the nature of expenses, including depreciation and amortization expense and employee benefits expense.
The FASB disclosure guidance, as proposed, would require a reporting entity to add a new note to the financial statements with a table that provides the amounts charged to specified subcategories:
- Employee compensation
- Depreciation
- Intangible asset amortization
- Inventory expense and other manufacturing expenses
- Depreciation, depletion, and amortization (specific to oil- and gas-producing activities)
Suppose, for example, that a company has cost of goods sold (COGS) of $74,351 and selling, general, and administrative expenses of $18,872. In applying the proposed guidance, a note to financial statements would provide a table that breaks out the mandatory categories.
The disaggregated category, inventory and other manufacturing expenses, would include costs capitalized as “inventory” as well as other expense items, such as purchase price variances, shipping, and warehousing, that typically are reportable within COGS. The proposed requirements would require a second table that disaggregates total inventory and manufacturing expenses by the specified categories.
REBUILDING ERP PROCUREMENT SYSTEMS
A chief concern that preparers are raising is the tracking of expenses to comply with DISE, which differs from how companies generally track costs today.
“ERP [enterprise resource planning] systems were designed to track a very large number of transactions from initial procurement to accrual and then cash payment with general ledger account coding. They weren’t naturally built to report on financial statements, costs from a subledger, or lower-level detail,” explains Alex Eng, senior vice president, general counsel and legal office at IMA; vice president, U.S. Corporate Finance at EDF Renewables; and former IMA Global Board Chair. In addition, preparers are noting that there are allocations routinely used in financial reporting, such as corporate-level activities, that would require new breakdowns and tracking. “All this allocation and mapping to the smaller buckets would need new processes, controls, and procedures to be audit-ready for disclosure in the financial statements,” says Eng.
This could be tricky, as some preparers observe, if a financial reporting system rests on multiple legacy systems, including systems from varied acquisitions. There seems to be an assumption by many financial statement users—data aggregators and financial institutions—that companies have highly sophisticated accounting systems that can readily apply new software, applications, and algorithms to accumulate large amounts of data for various reporting purposes. Yet despite the acceleration of technological transformation, corporate reporting often is viewed as an area of the business with a lower-priority budget than other functions for new technology.
In addition, some are raising the matter of potential inconsistencies between the disaggregation of expense items for expected new segment disclosure rules and the disaggregation that may be required under DISE. For segment disclosures, the breakdown of line items isn’t prescribed but applies a management-oriented chief operating decision-maker approach.
Conversely, the DISE standard, if adopted, will prescribe specific line items that may or may not reconcile with the disaggregated amounts shown in the segment disclosure. Rather than creating clarity, the differences may be confusing to financial statement users, particularly for reporting entities that operate in multiple segments, such as a manufacturer that also sells services or has a customer financing segment.
For now, citing cost-benefit considerations, the FASB has decided to scope out private companies from the DISE proposal. But companies that eye going public in the future may want to consider implementation, particularly if the company is building internal capacity to track expenses and meet future disclosure requirements.
The clamor for more disaggregation may not stop with the income statement. According to the FASB’s research agenda, disaggregation of items on the statement of cash flows may be the next step.
August 2023
