Major Revision to Fin'l Statements from the FASB & IASB

[HenryTo]

A must-read, courtesy of the WSJ. This will provide a significant amount of work for CPAs, CFAs, attorneys, consultants, etc., for many years to come. However, this is just what the US needs after the scandals of recent years, as no-one that I talk to believe net income numbers can be trusted anymore.

A sample of the new proposal from the FASB can be found here: http://online.wsj.com/public/resources/documents/WSJ0507-fasac_march07.pdf
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Profit as We Know It Could Be Lost
With New Accounting Statements
By DAVID REILLY
May 12, 2007; Page A1

Pretty soon the bottom line may not be, well, the bottom line.

In coming months, accounting-rule makers are planning to unveil a draft plan to rework financial statements, the bedrock data that millions of investors use every day when deciding whether to buy or sell stocks, bonds and other financial instruments. One possible result: the elimination of what today is known as net income or net profit, the bottom-line figure showing what is left after expenses have been met and taxes paid.

It is the item many investors look to as a key gauge of corporate performance and one measure used to determine executive compensation. In its place, investors might find a number of profit figures that correspond to different corporate activities such as business operations, financing and investing.

Another possible radical change in the works: assets and liabilities may no longer be separate categories on the balance sheet, or fall to the left and right side in the classic format taught in introductory accounting classes.

ACCOUNTING OVERHAUL

Get a glimpse of what new financial statements could look like, according to an early draft recently provided by the Financial Accounting Standards Board to one of its advisory groups.The overhaul could mark one of the most drastic changes to accounting and financial reporting since the start of the Industrial Revolution in the 19th century, when companies began publishing financial information as they sought outside capital. The move is being undertaken by accounting-rule makers in the U.S. and internationally, and ultimately could affect companies and investors around the world.

The project is aimed at providing investors with more telling information and has come about as rule makers work to one day come up with a common, global set of accounting standards. If adopted, the changes will likely force every accounting textbook to be rewritten and anyone who uses accounting -- from clerks to chief executives -- to relearn how to compile and analyze information that shows what is happening in a business.

This is likely to come as a shock, even if many investors and executives acknowledge that net income has flaws. "If there was no bottom line, I'd want to have a sense of what other indicators I ought to be looking at to get a sense of the comprehensive health of the company," says Katrina Presti, a part-time independent health-care contractor and stay-at-home mom who is part of a 12-woman investment club in Pueblo, Colo. "Net income might be a false indicator, but what would I look at if it goes away?"

The effort to redo financial statements reflects changes in who uses them and for what purposes. Financial statements were originally crafted with bankers and lenders in mind. Their biggest question: Is the business solvent and what's left if it fails? Stock investors care more about a business's current and future profits, so the net-income line takes on added significance for them.

Indeed, that single profit number, particularly when it is divided by the number of shares outstanding, provides the most popular measure of a company's valuation: the price-to-earnings ratio. A company that trades at $10 a share, and which has net profit of $1 a share, has a P/E of 10.

But giving that much power to one number has long been a recipe for fraud and stock-market excesses. Many major accounting scandals earlier this decade centered on manipulation of net income. The stock-market bubble of the 1990s was largely based on investors' assumption that net profit for stocks would grow rapidly for years to come. And the game of beating a quarterly earnings number became a distraction or worse for companies' managers and investors. Obviously it isn't known whether the new format would cut down on attempts to game the numbers, but companies would have to give a more detailed breakdown of what is going on.

The goal of the accounting-rule makers is to better reflect how businesses are actually run and divert attention from the one number. "I know the world likes single bottom-line numbers and all of that, but complicated businesses are hard to translate into just one number," says Robert Herz, chairman of the Financial Accounting Standards Board, the U.S. rule-making body that is one of several groups working on the changes.

At the same time, public companies today are more global than local, and as likely to be involved in services or lines of business that involve intellectual property such as software rather than the plants and equipment that defined the manufacturing age. "The income statement today looks a lot like it did when I started out in this profession," says William Parrett, the retiring CEO of accounting firm Deloitte Touche Tohmatsu, who started as a junior accountant in 1967. "But the kind of information that goes into it is completely different."

Along the way, figures such as net income have become muddied. That is in part because more and more of the items used to calculate net profit are based on management estimates, such as the value of items that don't trade in active markets and the direction of interest rates. Also, over the years rule makers agreed to corporate demands to account for some things, such as day-to-day changes in the value of pension plans or financial instruments used to protect against changes in interest rates, in ways that keep them from causing swings in net income.

Rule makers hope reformatting financial statements will address some of these issues, while giving investors more information about what is happening in different parts of a business to better assess its value. The project is being managed jointly by the FASB in the U.S. and the London-based International Accounting Standards Board, and involves accounting bodies in Japan, other parts of Asia and individual European nations.

The entire process of adopting the revised approach could take a few years to play out, so much could yet change. Plus, once rule makers adopt the changes, they would have to be ratified by regulatory authorities, such as the Securities and Exchange Commission in the U.S. and the European Commission in Europe, before public companies would be required to follow them.

As a first step, rule makers expect later this year to publish a document outlining their preliminary views on what new form financial statements might take. But already they have given hints of what's in store. In March, the FASB provided draft, new financial statements at the end of a 32-page handout for members of an advisory group. (See an example.)

Although likely to change, this preview showed an income statement that has separate segments for the company's operating business, its financing activities, investing activities and tax payments. Each area has an income subtotal for that particular segment.

There is also a "total comprehensive income" category that is wider ranging than net profit as it is known today, and so wouldn't be directly comparable. That is because this total would likely include gains and losses now kept in other parts of the financial statements. These include some currency fluctuations and changes in the value of financial instruments used to hedge against other items.

Comprehensive income could also eventually include short-term changes in the value of corporate pension plans, which currently are smoothed out over a number of years. As a result, comprehensive income could be a lot more difficult to predict and could be volatile from quarter to quarter or year to year.

As for the balance sheet, the new version would group assets and liabilities together according to similar categories of operating, investing and financing activities, although it does provide a section for shareholders equity. Currently, a balance sheet is broken down between assets and liabilities, rather than by operating categories.

Such drastic change isn't likely to happen without a fight. Efforts to bring now-excluded figures into the income statement could prompt battles with companies that fear their profit will be subject to big swings. Companies may also balk at the expense involved.

"The cost of this change could be monumental," says Gary John Previts, an accounting professor at Case Western Reserve University in Cleveland. "All the textbooks are going to have to change, every contract and every bank arrangement will have to change." Investors in Europe and Asia, meanwhile, have opposed the idea of dropping net profit as it appears today, David Tweedie, the IASB's chairman, said in an interview earlier this year.

Analysts in the London office of UBS AG recently published a report arguing this very point -- that even if net income is a "simplistic measure," that doesn't mean it isn't a valid "starting point in valuation" and that "its widespread use is justification enough for its retention."

Such opposition doesn't surprise many accounting experts. Net income is "the basis for bonuses and judgments about what a company's stock is worth," says Stephen A. Zeff, an accounting professor at Rice University. "I just don't know what the markets would do if companies stopped reporting a bottom line somewhere." In the U.S., professional investors and analysts have taken a more nuanced view, perhaps because the manipulation of numbers was more pronounced in U.S. markets.

That said, net profit has been around for some time. The income statement in use today, along with the balance sheet, generally dates to the 1940s when the SEC laid out regulations on financial disclosure. But many companies have included net profit in one form or another since the 1800s.

In its fourth annual report, General Electric Co. provided investors with a consolidated balance sheet and consolidated profit-and-loss account for the year ended Jan. 31, 1896. The company, whose board at the time included Thomas Edison, generated "profit of the year" -- what today would be called net income or net profit -- of $1,388,967.46.

For the moment, net profit will probably exist in some form, although its days are likely numbered. "We've decided in the interim to keep a net-income subtotal, but that's all up for discussion," the FASB's Mr. Herz says.

Write to David Reilly at david.reilly@wsj.com

[rffrydr]

SEC wants to pull back the veil on your Money Market Fund. The Street cries foul. That one article of faith, the buck shall not be broken! This is for some reason seen as vital to the industry

The truth is, the market is always wrong--and no one knows this better than the market itself!
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Today is the Tomorrow you worried about Yesterday!

[rffrydr]

Hey, Alphaville starts to wake up! The counter-cyclicals, like DTA's, like banks marking their own debt buyback costs, like the marks to maturity, like the spike-high bonds AKA german/treas--like the buybacks, like the CDS, like the insurance, like the move from debt to deposits....like TARP, like TALF, like HAMP.... Not just this list, they were screaming about this vis-a-vis Citi! There was never going to be another profit? Just another lever in the leverage inherent in these financials. If HGX keeps this up we'll finally not only have that financials rally but achieve a quantum shift in all those little "fundamentals":

http://ftalphaville.ft.com/blog/2012/01/12/828721/recapturing-the-losses-of-the-crisis/



It's not a yang/yang world.
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Today is the Tomorrow you worried about Yesterday!

[rffrydr]

Neither transparency nor trust come from a market stamp....and investors know it:

http://www.housingwire.com/2010/10/19/kbw-two-thirds-of-investors-oppose-fasb-accounting-proposal
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Today is the Tomorrow you worried about Yesterday!

[rffrydr]

We forget that most quotidian leverage: the lease. It's all coming back to us now:

Lease accounting

Published: August 17 2010 09:36 | Last updated: August 17 2010 14:22

[rffrydr]

Mark-to-Market is only good...when it's bad. This counter-cyclical should be embraced. Sign of the times:

http://www.bloomberg.com/news/2010-07-11/bank-earnings-depending-on-debt-writedown-abomination-in-latest-forecast.html
_________________
Today is the Tomorrow you worried about Yesterday!

[rffrydr]

http://ftalphaville.ft.com/blog/2010/05/28/246171/fasbs-mark-to-mayhem/
_________________
Today is the Tomorrow you worried about Yesterday!

[rffrydr]

Pension accounting

Published: May 19 2010 09:37 | Last updated: May 19 2010 16:03

[rffrydr]

Bob Lutz has some parting shots for the american business school (having graduated top-class, Haas School of Berkeley) plan of producing for optimization--inputs, outputs, marketing...management. In the long run optimization is compromise. Differentiation will come from not from differential equations but boldness and reaching for the impossible. --In short, and more directly, the Socratic Method. Starbux over "Folgers' Cyrstals et.american al. is his metaphor.
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Today is the Tomorrow you worried about Yesterday!

[rffrydr]

The Scientific Method is no excuse, these guys just don't get it. They need to go back to logarithms:

http://ftalphaville.ft.com/blog/2010/04/15/203286/from-level-i-to-level-iii-the-myth-of-fair-value/

It was this same fact-gathering that begat the models that begat the 95% confidence levels that begat the leverage that begat the disaster. The fact of the matter...doesn't exist.
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Today is the Tomorrow you worried about Yesterday!

[rffrydr]

The time factor owing nothing to them, The FED finally, and ...rightly, believes there's a market worth marking to:

http://ftalphaville.ft.com/blog/2010/04/01/194061/maiden-lane-goes-public/

To put in terms the true believers out there can understand: A "market" is like any other asset: it must earn its own mark. Quotes this past two years were "below investment grade."
_________________
Today is the Tomorrow you worried about Yesterday!

[rffrydr]

Mark-to-Market...the musical! Yes Enron led that charge. How one economist guages the cycle:

http://m.ft.com/cms/s/0/733dcc38-1b30-11df-953f-00144feab49a.html?catid=127&SID=0196077917bf00957bbfce8be75f8370

[HenryTo]

Goldman will no doubt be broken up in a few years. The trouble is not that it made tons of money on the way down - it's not even the fact that it made tons of money at (arguably) the taxpayers' expense. Many companies have done this over the years - and yet, they have either been off the radar screen or better yet, in troubled situations (such as the Chrysler rescue).

The trouble with Goldman is that it not only made money on the way down, but worse yet, continue to make money as the U.S. economy crashed into its worst recession in nearly 30 years at taxpayers' expense. It was obviously highly visible - but to add fuel to the fire, Goldman is inherently an exclusive club that really no-one can get in unless they graduated from a top 20 undergrad school or a top 10 business school. Throughout American history, the middle class has been relatively content with these practices - but only if we think, one day, we (or our kids) could be in that position as well. Goldman is too exclusive - even the best and brightest in the hedge fund space would like to see the company destroyed or taken apart (and it would also create more inefficiencies).

[rffrydr]

How this nonsense played out with no-nonsense money:


http://www.nytimes.com/imagepages/2010/02/07/business/07aig1_g.html
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Today is the Tomorrow you worried about Yesterday!

[rffrydr]

Quality over quantity: "fair value" to be stricken from the lexicon and in the place of a number, will go numbers.....many other numbers.


http://cachef.ft.com/cms/s/0/bce55386-c3e4-11de-a290-00144feab49a.html

[rffrydr]

Much ridiculed for its self-contraction this small artifact of compiling large numbers is one of the very few stabilizers to the much larger fiction of quarterly earnings reports and mis-matched time cycles.

http://ftalphaville.ft.com/blog/2009/06/04/56642/profiting-from-your-own-crap-creditworthiness-redux/

As it stands, you have to be german, and Exxon shareholder or Warren Buffett, to stand free of "the market."
_________________
Today is the Tomorrow you worried about Yesterday!