CFOs and CPAs Should Brace for New Expense Disclosure Scrutiny
CFOs and accounting leaders need to start preparing for changes proposed by the Financial Accounting Standards Board to expand disclosure of expenses on financial statements to investors.
A version of this article first appeared in Bloomberg Tax.
Accounting standard-setting can be a tense balancing act between the demands of investors and the constraints of companies. Investors typically seek more information to make the most of challenging investment decisions, especially in uncertain economic environments.
And while today’s widespread accounting talent shortage may make companies yearn for guidance that simplifies their disclosures, the Financial Accounting Standards Board has set a course focused on investors’ needs.
The FASB is drafting new requirements for public companies to provide more detailed information about the nature of companies’ expenses at a more granular level than what is presented on the income statement.
This investor-minded approach is evident in the disaggregated reporting technical agenda put forth by the FASB, which largely focuses on income tax rate transparency, disclosure of significant segment expenses, and, most recently, disaggregated expense disclosure.
Recently, the FASB voted to move forward with drafting a new standard requiring public companies to provide disaggregated expense disclosures in the financial statement footnotes on a quarterly basis. This would provide more detailed information about the nature of companies’ expenses at a more granular level than what is presented on the income statement.
This standard likely will be finalized by the end of the year. The effective date hasn’t been determined, but it’s likely this guidance will impact companies within the next two years.
Framing the Financial Picture
It’s no secret that investors often want more disclosure and disaggregation of the information in companies’ financial statements. Investors commonly believe that more disaggregated information will allow them to better evaluate how current economic factors will affect a company’s financial results.
With that in mind, the question becomes: “What kind of information would the standard require companies to disclose?” Some of its major provisions are:
- Incremental disclosures of employee compensation, depreciation, amortization, and inventory expense included in each relevant line item on the income statement.
- A new expanded disclosure of inventory expense—disclosure of costs capitalized to inventory that have been expensed—including purchases of inventory employee compensation, depreciation, and amortization. This would prompt companies to disclose a roll-forward of inventory in the footnotes of the financial statements.
- Greater quantitative and qualitative disclosure of selling expenses and a company’s policy for determining selling expenses.
For residual expenses not covered by specific items above, companies would need a qualitative description of those residual expenses, such as rent expense, professional fees, utilities, or other types of costs comprising that residual amount. Any residual expenses with pre-existing disclosure requirements, such as impairments, would be disclosed in the tabular format used the disaggregated disclosures.
The disclosures are expected to be presented in tabular format in the footnotes to the financial statements. While there’s been debate about the cost-benefit analysis and whether the right items are being disclosed, the provisions above are expected to make up the bulk of the new guidance.
CFOs and accounting leaders should start thinking about how their teams can be ready for this new standard by:
Assessing materiality and the auditability of expense disclosures. For most companies, the classification and composition of expenses hasn’t been subject to separate disclosure. Companies should expect increased audit scrutiny on the nature of expenses, as well as their amounts and timing.
There will also be new judgments, such as the types of expenses that constitute employee compensation. When the standard is finalized, companies should ensure that key accounting positions and judgments are documented and that the accounting and financial reporting teams are ready for increased scrutiny over expenses.
Evaluating the possible required disclosure of competitive information. Company leaders should consider whether the increased disclosures will require disclosure of potentially sensitive competitive information. While the disclosures aren’t intended to give away any competitive advantages, they will provide more information on the composition and amount of costs in an entity’s inventory and selling expenses.
For example, if operating margin is a key metric for your financials, companies should expect more focus from investors regarding the incremental disclosures of expenses comprising that metric. In addition, company leaders should coordinate with their communications teams to ensure company messaging, such as earnings calls, is informed by the level of disclosure that will be required in the future.
Ensuring the adequacy of systems, processes, and controls to produce this data. Collecting and presenting this data on a consistent and timely basis may be a challenge for companies with overly broad charts of accounts, vague expense policies, and financial reporting that depend too much on manual manipulation of data.
If a company doesn’t have systems that can provide consistent, disaggregated data in line with the requirements noted above, there likely is a need to evaluate expense recording processes—not only from a financial standpoint, but also with an eye toward internal controls over how this information is reported.
Time will reveal whether the FASB’s latest effort is worth it for companies once investors start digesting these new disclosures—at which point investors’ responses will most likely spark additional refinements.
Accounting and financial reporting leaders preparing companies for the new expense disaggregation disclosures will be better able to implement that standard. And their teams will be in a better position to implement the other incremental disclosure standards related to taxes and segments.