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FASB

U.S. Income Statement Accounting Rules Could Change to Require Specifics About Labor Costs

Denise Lugo  Editor, Accounting and Compliance Alert

Denise Lugo  Editor, Accounting and Compliance Alert

The FASB is studying a plan that could require companies to break out more information in income statements about labor costs—expenses that can amount to up to 60 percent of revenues.

The nation’s top 100 companies skimp on disclosing information about salaries and other benefits, leaving investors scratching their heads, according to July 27, 2022, board discussions. The board aims to change that. No decisions were made.

“There’s one cost that every company has and that is labor,” FASB member Fred Cannon said. “And we also know that labor costs are something that a broad spectrum of investors have been requesting for a significant amount of time, so in my mind lets make labor costs explicit rather than implicit in this,” he said.

At minimum, companies could be required to disaggregate employee compensation, depreciation and amortization from all expense captions presented on the face of the income statement. This could be supplemented by a break out of any remaining expenses using a qualitative threshold or principle. They could be required to break out expenses that result from the derecognition of sold inventory such as cost incurred that are capitalized during the period, including purchases, employee compensation, depreciation, amortization and others, rather than disaggregating pure expenses recognized.

“On conference calls companies are talking about short-term inflationary impacts on labor costs, raw material, transportation costs…so companies have the information,” FASB member Gary Buesser said. “And it’s really needed by investors to better understand the company’s incremental operating profit margin analysis – some people call it fixed versus variable, it’s looking at ‘can I move the company better, better understand the margin structure’ and make better forecasts in the future,” he said.

The discussions were specific to the board’s project, “disaggregation of income statement expenses,” a topic investors flagged as one that it should make a top priority. The scope of the project includes the following expense captions: (a) selling, general, and administrative (SG&A) expenses, (b) cost of services and other cost of revenues, and (c) cost of tangible goods sold.

But what is the best approach to tackle the topic? FASB had asked it of its advisory bodies and got an earful.

During the July 27 discussions, FASB members said they favored an alternative approach floated by staff that would move U.S rules closer to IFRS, pointing out the IASB has a project to revise financial statement information, much of which is interrelated, and that they could learn from.

“For reference, we understand that certain entities applying IFRS today, may be presenting employee compensation, depreciation and amortization costs incurred, rather than expenses recognized in total,” consistent with the example that exists in paragraph 102 of International Accounting Standard (IAS) 1Presentation of Financial Statements, FASB staff told the board. Focusing on cost incurred and capitalized into inventory “potentially avoids issues that we’ve heard about in the past associated with cost that loose their natural identify when they are capitalized into inventory.”

Board members pointed out that efforts to disaggregate income statement expenses would ultimately require systems changes for some companies, resulting in added costs, including audit costs. Other insights surrounded the need to require more consistency in financial reports, which means differentiating different types of costs explicitly.

“One of the challenges for me in this project was I can pull 10 income statements and they all look differently,” Chair Richard Jones said. “And it would be great if everyone I pulled had a line item called SG&A – unfortunately they don’t,” he said. “And we have some folks who are doing very good disclosure today right on the face of the income statement by nature, we have others who do it by function, we have some who have chosen different caption for those functions, and we’re attempting to come up with a one size fits all standard that can be applied.”

Jones said trying to write a principle “sounds great until we try to write the principle and actually see if people can understand it—so I am supportive of the alternative approach.”

 

This article originally appeared in the July 29, 2022 edition of Accounting & Compliance Alert, available on Checkpoint.

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