While proper reporting and classification is a crucial aspect of accurate portrayals of the financial positions of going concerns, FASB’s Topic 205 serves to undermine the clarity and ease of interpretation by incorporating otherwise cast-off assets and accounting for their recognition as liabilities to a liquidating concern, ultimately serving to skew the net value of the concern. Requiring items which traditionally were disclosed in notes to be disclosed on the face of financial statements will likely also cause confusion and frustration, impacting user ability to form informed and quality opinions. Ultimately, the negative impacts from Topic 205 surpass the benefits from increased disclosures.
The Liquidation Basis of Accounting Subtopic serves to provide reporting professionals guidance on when and how an entity should prepare its financial statements using the liquidation basis of accounting (Federal Accounting Standards Board, 2013). Historically, the FASB has not provided in-depth guidance on United States’ generally accepted accounting ethics and principles (GAAP) which addressed the appropriate time of when to apply the liquidation basis of accounting. As such, there has been some diversity in reporting efforts. Topic 205 addresses this issue, however, it also incorporates significant changes in the recognition and measurement of assets and liabilities, along with the requirements for financial statement preparation, using liquidation basis which, effectively, serves to increase preparation and reporting costs to businesses which fall under this guidance and further clutter the information reported within the financial statements making the overall organization and presentation of a company’s financial position more difficult to discern.
The potential cluttering from incorporating assets which, historically, have not been reported would serve to affect the net income and, because of the necessity to capture values which should not be included, would likely distract the financial statement user from the clearer, more relevant information. The potential solution would be to present reclassifications in a separate statement where comprehensive income is presented only, allowing preparers of the financial statement the ability to present reclassifications to net income in a series of notes. While this could present a problem for those going concerns with a segment or subsidiary having operational difficulties, the decision to liquidate, or identify the timing to liquidate, and then classifying the varying assets and liabilities will likely serve to utilize individual opinion on that specific timing, resulting in reporting requirements which, in effect, are still vague and non-uniform. Such was a concern voiced by preparers during an FASB public outreach in introducing Topic 205. Concerns were raised that reclassifying reporting requirements as line-item disclosures would result in cluttered statements, forcing users who were currently comfortable with the established requirements into making decisions based on non-uniform, cluttered, potentially skewed financial representations (Federal Accounting Standards Board). A potential solution would be to incorporate those disclosures into notes rather than on the face of the financial statement but, again, such allowance will likely lead to varying reporting procedures resulting in continued non-uniformity.
While the ease of adjusting information system reporting assignments will allow reclassification of many accumulated income reports, such as unrealized gains and losses or foreign currency translation adjustments, to be reassigned at relatively low cost, some comprehensive income reports are not reclassified entirely to net income during the same reporting period because some portion of the value becomes reclassified to a balance sheet account and reported in net income during a subsequent reporting period. For example, employee retirement accounts period costs are typically capitalized to balance sheet accounts, many businesses with multiple retirement benefit plans would realize significant costs in tracking and reporting those costs later on when they are required to reclassify them as net income—not only resulting in a skewed financial picture but also suffering additional potential tax penalties based on those reclassifications. Many data systems allocate retirement benefit costs into balance sheet accounts but then, once melded, will be required to separately identify those costs down the road when such systems are not able to track and separate those items.
In addition to the difficult issue of having to separate blended reportings of retirement benefit costs, tracking and reporting those accumulated incomes into earnings would only report a piece of the total of all the entity’s retirement benefit costs because some of the costs which are reclassified are often transferred to a balance sheet account. While GAAP currently requires extensive disclosure of the costs a company incurs in managing their retirement benefit costs, the information currently does not have to disclose the specific line items of where in the income statement those costs are reported. Eliminating the requirement to capitalize those costs, identified in Topic 715 will serve to ease the duplication of effort and reduce the costs of preparing the financial statements (Daveyne C. Totten, Summer 2011). Following that vein, life insurance companies also report concerns in tracking comprehensive income reclassifications to net income for intangible assets and liabilities amassed or incurred during mergers, through deferred acquisition costs, and for liabilities on some of their products and deferred annuities. Historically, these assets have been amortized under gross profits, with the calculations to arrive at those amounts excessively complex and separately prepared and reported according to individual portfolios. The calculations factor in fees, charges, and returns in excess of policy benefits and expenses, and include personal judgments and assessments of individual policy holders. FASB provides guidance on these issues to insurers allowing them to reflect the estimated and future impact of those unrealized gains and losses as if those unrealized gains and losses were realized; however, U.S. GAAP currently does not require that the amortization related to these adjustments be reported separately (Federal Accounting Standards Board, January 2010). The requirement by FASB’s Topic 205 forces reporting of items which go beyond those of US’ GAAP, not only resulting in conflicting standards but, ultimately, non-uniform financial reporting as these insurers determine the method best suited for them. Prior to enacting Topic 205, FASB must reconcile major discrepancies such as this so that different industries do not receive benefit over other industries simply because FASB has not had sufficient time to provide uniformity. Many database packages for life insurance companies do not currently separate accumulated comprehensive income into deferred acquisition costs and other insurance-related costs and balances ultimately combined into net income. Additionally, as the FASB and IASB are currently working jointly on the insurance accounting standards, the expectation is that the result of their efforts will likely have a significant impact on accounting for deferred acquisition costs and their reporting in the corporate financial statements. Without excusing insurance corporations from Topic 205, requiring that they meet those same reporting expectations and then potentially change their reporting requirements at the conclusion of the joint FASB-IASB project will result in significant costs of money and time as those companies seek to achieve compliance with Topic 205 and then additional investment of money and time when those same companies have to, again, reconstruct their systems to account for the joint FASB-IASB requirements. Time is of importance in revenue and debt recognition. Further complicating this dilemma is that the ability for insurance products to be exempt from Topic 205—even temporarily—places those same time and financial burdens on non-insurance providers as they strive for compliance in reporting the insurance-related assets and costs of their retirement benefit plans (Saslow, 2013).
Most important, however, is the impact on the end users of these financial statements. Currently, in spite of variances in reporting some retirement benefit-related expenses and other comprehensive income reports, end users questioned whether it was necessary that, and what the result would be when, the comprehensive amounts were reclassified into separate line-items on the face of financial statements rather than merely reported in the notes. Many users expressed concern that the cluttering result of separating the reclassified assets and liabilities would result in a confusing hodge-podge of the corporation’s financial picture. Further concerns expressed were that the line-item reporting of these amounts would result in an unneeded focus on these amounts as the itemization promotes their prominence. Opposition to the separation concerned the investment of funds, time and effort in the needed reporting changes when current disclosure requirements provide sufficient disclosures and accurate pictures of the company’s financial standing (Federal Accounting Standards Board, 2013).
Continuing the focus on friendliness to end users, the feedback received during public outreach highlighted a particular user group which represents both institutional investors and other financial statement users. The premise of their position was that these users typically do not ask for break-outs of the accumulated reporting Topic 205 seeks to separate primarily because of they are unaware that such accumulated reporting have any significant impact on net income and, also, because they do not have a substantial grasp of those representations. This particular group strongly lobbied for their interests, emphasizing that the ultimate impact on the financial picture and resulting impressions to end users (who are, ultimately, the reason for the extensive reporting requirements public corporations face) are not taken into consideration by the analysts charged with establishing the uniform reporting requirements. The effect of the various line items can become so convoluted that the individuals for whom the reports are gathered and prepared find the task of deciphering the details and reconciling the information with the true financial picture of the organization overwhelming. In effect, too much information results in too little comprehension. Maintaining the general presentation on the face of the financial statements with explanatory and disclosing notes, as appropriate, will serve to provide the same information without the confusing presentation. Further, note disclosures would serve to provide noninstitutional investors and unsophisticated end-users an alert as net incomes are potentially affected by reclassification of accumulated comprehensive income amounts which were previously reported in comprehensive income (Federal Accounting Standards Board). As noninstitutional users typically do not have access to the resources and systems available to institutional investors, the disclosures represented as notes rather than line-item reporting would likely be more helpful and would level the playing field for accuracy in interpretation of financial standings among those with access to sophisticated systems and those without.
Deeper and clearer understanding of financial standings of companies reach beyond the mere investor. As individuals rely on corporate retirement benefit packages, their ability to understand the financial representation of their plans’ administrator often requires use of financial statements to not only gather confidence in the security of their funds but, also and more importantly, educated determinations of how to place funds for which they are personally responsible. Many users of retirement benefit disclosures report that information about the net periodic benefit cost is less relevant in their decision-making processes than the net periodic benefit expenses (Federal Accounting Standards Board), which is currently not required to be disclosed and is also not addressed by Topic 205 (Moody, Famiglietti & Andronico, LLP, 2013). Users’ understanding of the effect of line items such as depreciation, for example, would provide benefit in their analysis of the company’s operating margins; however, those users would not likely be able to understand the effect of the changes in their retirement benefit expenses on changes in the items such as depreciation when such items are combined on the face of the financial report.
Ultimately, the proposed changes addressed by Topic 205 revolve around the reporting of discontinued operations, purporting to increase the transparency of assets and liabilities of either a component of an entity or a group of components of an entity which represents a major line of business or major geographical area of operation (McGladrey & Pullen, LLP, 2010) and for which the component has been disposed of or for which disposal is anticipated and, therefore, classified as held for sale in accordance with the criteria of paragraph 360-10-45-9 (Federal Accounting Standards Board). In addition to the reporting of those assets and liabilities, discontinued operations would require disclosure in the financial statements of the individually material components which do not otherwise quality for discontinuance—such as the retirement benefit plans of a component which is sold or incorporated into another component of the business. The result is the inclusion in financial statements of benefit plans, for example, which translate to liabilities, in turn presenting a skewed financial portrait of the component and potential concern by the user regarding the component’s financial health both in terms of the standing of their benefit plan and the impact such skewed representations have on the acquiring component or organization (Moss, Putri, & McAlister, 2013). The net result is that, because Topic 205 amends and broadens the definition of a discontinued operation, the expanded disclosure requirements, which include components that do not currently qualify as discontinued operations (Deloitte Touche Tohmatsu, Ltd., 2013), will serve to require too many reportings of the disposals of assets of discontinued operations presenting financial statements which are “not decision-useful” and the resulting “continuing involvement criterion [will be] difficult to apply and [will] not result in consistent application” (Moss, Putri, & McAlister). On its face, users can be educated on the changes or can seek professional consultation for interpretation; however, Topic 205 also requires non-public entities to disclose information about individual components which are disposed of or held for sale but which do not qualify as discontinued operations. Such disclosures include pre-tax profits or losses of that component for the period in which it is sold or classified as held for sale by Topic 205. The concern with this is that, regardless of the sophistication of the user or consultant, a component which is not actually held for sale but which is classified as held for sale under Topic 205 requires disclosure and incorporation as a line item presenting a different and inaccurate picture of assets and liabilities for which decisions will be based. Further, continued disclosures are required on components which have been identified as actually for sale or classified as held for sale when the controlling organization has continueing involvement. Such reporting continues to be required for identification and disclosure on the ongoing financial statements: ‘“For a discontinued operation in which an entity retains an equity method investment after the disposal, information that enables users of financial statements to compare the financial performance of the entity from period to period assuming that the entity held the same equity method investment in all periods presented in the statement where net income is reported.” The disclosure would include all of the following: (1) “pretax income of the discontinued operation in which the entity retains an equity method investment” for each period presented, (2) the “entity’s ownership interest in the discontinued operation before [and after] the disposal,” and (3) the “income or loss in the period(s) after the disposal transaction from the entity’s ongoing equity method investment in the discontinued operation and the line item in the statement where net income is reported that includes the income or loss”’ (Moss, Putri, & McAlister).
As is typical for many dislosure requirements, particularly recent disclosure requirement enactments, certain reporting requirements are very clear and concrete, others allow for significant subjectivity of professional judgments and, consequently, nonuniform reportings. For example, a component which was acquired for investment purposes and subsequently classified as held for sale upon acquisition could be classified for discontinued operation presentation. Conversely, the incorporation of the distinction of the effect on a “major geographical area” or “individually material component” may only come to that classification through time and protocol through the controlling organization’s individual circumstances, even though both scenarios possess the same initial characteristics (Spinelli, 2013). Topic 205 requires new disclosures for individually material dispositions (subject to, again, subjectivity and professional judgement) which did not meet the historically more restrictive criteria. Amending the requirement that controlling organizations not have any significant continuing involvement with the discontinued operation or the continuing cash flows of that operation provides for significant opportunity for subjectivity in disclosure manipulation, such that the intended result permitting the user the increased ability to compare the financial performance of an organization between periods lacking in accuracy and, in turn, effectiveness. Confusion results when the nuances of involvement turn on whether the anticipated continuance is direct or indirect. For example, if continuing cash flows are direct to the organization, they are considered not to have been eliminated from the ongoing operations of the component and labeling the component as discontinued would be inaccurate. If the continuing cash flows are indirect, the component is considered to be eliminated and the first condition for labeling the component a discontinued operation is met, regardless of the similarities of the two scenarios. For example, “a small chain of retail outlets closes several of its stores to open a single superstore in the same area. The customers who then shop at the superstore are deemed to have migrated from the smaller, closed stores, but the presumption can be overcome depending on certain circumstances post-disposal” such as a geographical change (McGladrey & Pullen, LLP). Classification of this minor change can result in the financial statements indicating a discontinued operation even though, in reality, the operation is still very much alive. To the end user, this presents a potentially skewed picture of the organization’s financial status as assets and expenses are classified and reported in a manner which indicates a significant event where none exists (Katz, Sapper & Miller, 2013).
The purpose of ensuring accurate financial reporting is to enable end users of financial statements, whether as financial professionals or merely interested persons, to gather an accurate picture of the financial health and operations of a particular entity in order to form educated opinions. Requiring line item disclosure of income, assets or liabilities which could be accurately portrayed through notes or through a disclosure section presents an accurate representation of the organization’s operations; however, Topic 205 line disclosure requirements permit too much subjectivity by the preparer, resulting in potentially skewed representations undermining the goals of clarity and accuracy of a concern’s financial picture (Ernst & Young, 2013). Ultimately, FASB’s Topic 205 serves to undermine the clarity and ease of interpretation by incorporating otherwise cast-off assets and accounting for their recognition as liabilities to a liquidating concern, resulting in a skewed net value of the concern.
Daveyne C. Totten, M. (Summer 2011). Navigating FASB Accounting Standards Codification. American Society of Pension Professionals & Actuaries, Web: http://www.asppa.org/Document-Vault/PDFs/TAJ/TAJ-Summer2011-fasbacctg.aspx.
Deloitte Touche Tohmatsu, Ltd. (2013). Titles of Topics and Subtopics in the FASB Accounting Standards Codification. Retrieved from Assets: http://www.deloitte.com/assets/Dcom-UnitedStates/Local%20Content/Articles/AERS/Accounting-Standards-Communications/us_assur_Titles_of_Cod_Topics_Subtopics.pdf
Dodyk, L. N., Smith, C. L., & Rossi, P. R. (2013). In brief: FASB finalizes guidance for applying liquidation basis of accounting (No. 2013-22). Web: http://www.pwc.com/us/en/cfodirect/publications/in-brief/2013-22-fasb-finalizes-guidance-for-applying-liquidation-basis-of-accounting.jhtml?display=/us/en/cfodirect/publications/in-brief: PricewaterhouseCoopers LLP.
Ernst & Young. (2013). 2012 Standard Setter Update. Washington: Ernst & Young.
Federal Accounting Standards Board. (2013). Presentation of Financial Statements (Topic 205): Liquidation Basis of Accounting . Norwalk, CT: Financial Accounting Foundation.
Federal Accounting Standards Board. (January 2010). Technical Corrections to SEC Paragraphs. Web: http://www.fasb.org/cs/BlobServer?blobcol=urldata&blobtable=MungoBlobs&blobkey=id&blobwhere=1175820120311&blobheader=application%2Fpdf: Financial Accounting Foundation.
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Journal of Accountancy. (2013, June). Investors told FASB that current GAAP calls too often for disposals of assets to be presented as discontinued operations. Retrieved from Journal of Accountancy: http://www.journalofaccountancy.com/Issues/2013/Jun/Financial-reporting.htm
Katz, Sapper & Miller. (2013, April 18). Standards Updates - 4/18/2013. Retrieved from News: http://www.ksmcpa.com/news-blog/standards-updates-4-18-13
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Moody, Famiglietti & Andronico, LLP. (2013, April). Significant Accounting and Reporting Matters. Retrieved from Alerts: http://www.mfa-cpa.com/alerts-and-insights/alerts/2013/significant-accounting-and-reporting-matters-q12013
Moss, S., Putri, E., & McAlister, L. (2013, April 3). Heads Up — FASB proposes to amend guidance on discontinued operations. Retrieved from Deloitte & Touche LLP: http://www.iasplus.com/en/publications/us/heads-up/2013/hu-disc-ops
Saslow, M. (2013, February 20). IASB-FASB Insurance Contracts Project. Retrieved from PricewaterhouseCoopers, LLP: http://www.pwc.com/us/en/insurance/publications/iasb-fasb-insurance-contracts-project.jhtml
Spinelli, C. (2013, April). Proposed Accounting Standards Update on Accounting for Discontinued Operations. Retrieved from Baird, Kurtz & Dobson: http://www.bkd.com/articles/2013/proposed-accounting-standards-update-on-accounting-for-discontinued-operations.htm