In an effort to improve financial reporting and provide more useful information to financial statement users, the regulatory bodies have proposed a new exposure draft on changing the format of the financial statements. The new exposure draft has many new changes to the look and feel of the financial statements. Four significant changes that are proposed are the format of the balance sheet, the format of the income statement, reclassification of equipment in the cash flow statement, and the elimination of the indirect method for the cash flow statement.
What is changing?
The new proposed balance sheet will be broken into the three sections: assets, liabilities, and stockholders’ equity. It will no longer be in a format where all of the assets, liabilities, and stockholders’ equity are grouped into their individual sections. Instead the new balance sheet will look more like the current statement of cash flows. It is going to be broken into four sections: operating, investing, financing, and equity. The operating section is going to include the assets and liabilities contributed the company’s normal business with a netted figure at the bottom. The investing section would include the company’s investments and the financing section would include the company’s short and long term debt.
The new proposed income statement will be similar to the new balance sheet. It will also be broken operating, investing, and financing sections. Each section will have the income and expenses related to the company’s operating, financing, or investing operations. These income and expenses will be netted in each section so user of the financial statement will now the amount of income or loss a company has generated from each category. The three figures are netted to compute net income or loss at the bottom of the statement. A section for other comprehensive income is found after the net income figure.
Currently the purchase and disposal of long term assets such as equipment are investing activities but the exposure draft is going to reclassify them into operating activities. I believe classifying the purchase and selling of equipment in the operating section is better because for many companies equipment is a normal expenditure and part of their normal operations. Even though they do not sell the equipment, it is used to make the widget which the business sells to make money. Equipment is not necessary an investment in my opinion. Equipment depreciates over time and most of the time is not worth what you bought it for. It does not appreciate and one cannot expect to make a gain from it like securities.
Lastly, the indirect method of reporting cash will no longer be allowed. Under the direct method, cash is reported based on how much is received or paid as a result of various activities. With the proposed changes, companies will no longer have the option to start with the net income figure and make adjustments to arrive at cash flows from operating activities. The cash flow from operating activities will include the expenditures on equipment as stated above and other cash outlays related to a company’ s core business. Cash outlays such as cash paid for goods, cash paid for pensions, cash collected from customers, and other various items. The investing section will include cash received from dividends and interest while the financing section will have dividends and interest paid.
Does it make financial statements more useful?
I believe all of the proposed changes will enhance the usefulness of the financial statement. I believe the new look financial statements will give the users of the financial statements a better understanding of each item presented on the balance sheet, income statement, and statement of cash flows. The users of the financial statements will now how many assets or income a company has generated from its core business and not from other sources. It has increased comparability across the three statements and has made the calculation of ratios a lot simpler as well.
What are the negatives?
Although there are positives to the proposed financial statements, they do have negatives as well. Some of the negatives to the proposal are the cost of the new accounting software to companies to switch their accounting system to conform to the new format. Other negatives include the cost to restate prior year financials for comparability purposes, the new statements are more complex because debits and credits are in the same sections. Also the new statements might not be comparable across companies and will need more notes. Most importantly, assets will not equal liabilities and stockholders’ equity.
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