How Extreme Is the Makeover?

Two years from now, balance sheets might not balance.


A balance sheet that doesn't balance? Financing and operating classifications that depend on your company type? A cash-basis income statement?

Well, not quite, or at least not yet. But accounting standards–setters are urging investors and companies to weigh in on a proposal to radically alter financial statements. And while accrual accounting isn't going away, preparers of financial statements might be surprised to find that the above descriptions do accurately describe the look and feel that financial statements may acquire in just two years.

"This project will change the face of financial statements in a very, very significant way," Financial Accounting Standards Board member Thomas Linsmeier said in January.

Issued as a discussion paper in October by both FASB and the International Accounting Standards Board, the goal of the redesign is to address investor complaints that items on each of the financial statements are not linked across the three statements, and that dissimilar items are often aggregated.

Among the notable features: each of the three statements — balance sheet, income statement, and cash-flow statement — will be divided into two major sections: business and financing.

The business section — which is subdivided into operating and investing categories — will focus on what a company does to produce goods and provide services. The operating category will include primary or "core" revenue and expense-generating activities, and the investing category will include activities that generate a return but are not "core."

The financing section will include those activities that fund a company's business activities. For nonfinancial institutions, that would primarily include cash, bank loans, bonds, and other items that arise from general capital-raising activities.

One effect of the new format is that "the balance sheet won't balance the way we expect it to," said Linsmeier. "That is, assets won't equal liabilities and equity, because assets and liabilities will be in each category."

Management will decide whether items in the statements are related to operations or to financing, an aspect of the plan sure to generate controversy since different companies might account for the same item differently; a manufacturer might record proceeds from mortgage-backed securities as investment earnings, while a bank might record them as operating earnings.

Another big change for preparers: using the direct method to generate a cash-flow statement. Although companies have the option to do so now, that option is almost universally ignored in favor of the indirect method. PepsiCo controller Peter Bridgman says the cost to companies of using the direct method "will be significant," while the value will be low. "If there were any value to using the direct method, we'd be using it already," he notes. The next major milestone in the move toward new statements is the April 14 deadline for comments (see below).

The Financial Accounting Standards Board is accepting comments until April 14 on its proposed changes to financial statements. Interested parties should E-mail comments to, and mention File Reference No. 1630-100. For more information, including the full text of the 126-page exposure draft, see

So Many Questions…

A few of the most potentially thorny issues surrounding the financial statement presentation project:

• Would separating "business activities" from "financing activities" provide information that is more "decision useful"?

• Does information on equity and discontinued operations merit separate categories, or would those two aspects of operations fit logically into other categories?

• Would a "management approach" classification of assets and liabilities help or hurt overall usefulness and comparability?

• What are the implications of mandating the use of the direct method of presenting cash flows?


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