The Next Big Wave in Accounting Change: Debt vs. Equity and Performance Reporting

By Dianora DeMarco
Just as companies are starting to see the light at the end of the tunnel on implementation of the new revenue recognition standard, they are being faced with the challenges involved in operationalizing the new lease accounting standard. There is no doubt about it—accounting policy groups are hard at work to keep up with the changes the FASB is making to accounting guidance.  And there is little indication that the FASB will be slowing the pace of accounting change. The Board just added two new projects to their agenda, which will require the attention of financial executives in the months and years to come.
At the FASB’s September 20th decision making meeting, the Board considered stakeholder feedback on projects outlined in their Agenda Consultation, and ultimately decided to add projects under two broad categories; (1) distinguishing liabilities from equity, and (2) financial  performance reporting. 
Liabilities vs. Equity
Distinguishing liabilities from equity is an area of financial reporting that has been a point of contention for over thirty years. As financial instruments have evolved and have become more complex, the guidance for accounting has failed to keep up in a clear and meaningful way. The result: a patchwork of guidance that is often improperly applied in practice.
This is evidenced by the fact that “debt, quasi-debt, warrants” and other securities with beneficial conversion features have been identified as the number one area of restatement for over ten consecutive years, according to a recent report from Audit Analytics.

In a comment letter to the FASB, the New York State Society of CPAs (NYSSCPA) wrote, “…Distinguishing Liabilities from Equity is the highest priority issue discussed in the Agenda Consultation. The topic needs an updated framework for analysis and potentially has the most wide-reaching impact on financial statement users and preparers. Financial instruments are one of the more complex accounting topics for users of financial statements to understand."
This reaffirms the importance of the Board’s objective of the project—to improve understandability and reduce complexity in this area, without loss of information for users. The project will focus on indexation and settlement (in the context of the derivative scope exception), convertible debt, disclosures, and earnings-per-share.
A Focus On Financial Performance Reporting
Financial performance reporting (FPR) also has a long standard setting history.  In 2001, the FASB added a project on FPR to its agenda, and worked on the project jointly with the International Accounting Standards Board for many years. As the project progressed, both Boards realized that significant staff resources would be needed to complete the project, more resources than were available.  The Boards decided to focus on higher priority projects and to readdress FPR once such resources became available.
However, U.S. stakeholders continued to express support improvements to the financial statement presentation. CFA Institute, an advocate of the investor perspective, ranked FPR as the top priority for the FASB to tackle in their comment letter on the Agenda Consultation, writing, “Improving the presentation of financial statement line items has been a long-standing investor priority for the overall improvement of financial reporting information as it can help investors to better assess the performance, liquidity and financial condition of reporting entities…” At last week’s meeting, the FASB voted to add to its technical agenda two projects to improve FPR:  one on disaggregation and the other on segment reporting.
Disaggregation of Performance Information
The FASB has issued limited guidance on how performance information is aggregated on the income statement. This information tends to be aggregated into a few primary lines in the income statement (revenues, expenses, gains, losses, etc.) Because of this limited guidance, entities have some flexibility in aggregating and presenting this information, and users have little insight to the different sources and characteristics of earnings. 
This project will focus on the disaggregation of performance information and will consider disaggregation either through presentation in the income statement or through disclosure in the notes. The project will base the disaggregation on requiring functional lines to be disaggregated into natural components.
Segment Reporting
Current guidance requires certain information to be disaggregated on the basis of its operating segments. Once identified, operating segments may be combined into a reportable segment if certain aggregation criteria are met. Certain disclosures are also required for each reportable segment. The objective of the project is to improve this segment aggregation criteria and to improve these disclosure requirements.
Resources for Financial Executives
Earlier this month, the FASB launched a new webpage, Implementing New Standards, which will be a helpful resource to accounting policy groups. The leases hub provides educational resources such as the FASB In Focus, information on the costs and benefits of the standard, and more. Financial executives should keep implementation of new standards a top priority. 
Financial executives should also stay in-tune with upcoming FASB meetings, where developments on these two new projects will be discussed. Of course, FEI will continue to provide updates on the latest in accounting news from the FASB in a timely and concise manner.