The FASB’s Disaggregation Proposal Is A Great First Step But Can Go Further

The new proposal integrates the functional mode of presentation of the income statement with the nature of expense approach for a few line items. However, even a smaller retailer, Reliance Retail, in an emerging market (India) discloses far more information about its operations relative to the world’s biggest retailer, Walmart. What will it take for US companies to be more forthcoming?

Over the previous year or two, I have commented about the relative opacity of expense line items in financial statements of US public companies. In particular, I had asked why US public firms don’t tell us much about materials, labor, capacity, fixed and variable costs, how businesses add value in general, maintenance capex, acquisitions, stock based compensation, technology spending, economics of network businesses, worker compensation, foreign currency’s impact on revenues and expenses, segment disclosures, income tax expense, what’s in SG&A, R&D spending, and expenditure (or is it investment) on political lobbying.

The FASB’s disaggregation proposal applied to Walmart:

The FASB just released a proposal on “Income-Expense Disaggregation,” that addresses at least some of these concerns. The proposals ask for detailed information about the types of expenses (including employee compensation, depreciation, and amortization) in commonly presented expense captions (such as cost of sales, SG&A, and research and development).

Of these, inventory and manufacturing expense and employee compensation are among the biggest steps forward. In an earlier piece, I was disappointed that the FASB’s definition of “employee” did not include contingent or contract labor.

In this piece, I want to ask why stop with these disaggregated categories? Why not go further? To appreciate the magnitude of this problem, consider the 2022 income statement of Walmart. Walmart reports revenues of $611 billion. The expenses reported are (i) cost of sales of $463 billion; (ii) a one-line expense item titled, “operating, selling, general and administrative expenses” of $127 billion; (iii) net interest expense of $1.8 billion; (iv) other income of $1.5 billion, followed by (v) tax expense of $5.7 billion.

The accounting policy footnote states that “cost of sales includes actual product cost, the cost of transportation to the Company’s distribution facilities, stores and clubs from suppliers, the cost of transportation from the Company’s distribution facilities to the stores, clubs and customers and the cost of warehousing for the Sam’s Club segment and import distribution centers. Cost of sales is reduced by supplier payments that are not a reimbursement of specific, incremental and identifiable costs.” That’s all a reader knows about $467 billion of cost of sales from Walmart’s 10-K.

Of course, I can get the opening and closing inventory numbers from the balance sheet and try and back out the residual consisting of some combination of product cost, transportation costs and warehousing. But I would have a hard time decomposing that residual into more granular detail. The new FASB proposal would help a great deal, as page 37 of the FASB’s proposal, suggests that Walmart will have now have to report purchase of inventory, employee compensation, depreciation, intangible asset amortization, other inventory and manufacturing costs capitalized into inventory, and warranty expenses. This is a huge step forward.

Consider the $127 billion blob otherwise known as operating SGA. The accounting policy footnote states that “operating, selling, general and administrative expenses include all operating costs of the Company, except cost of sales, as described above. As a result, the majority of the cost of warehousing and occupancy for the Walmart U.S. and Walmart International segments’ distribution facilities is included in operating, selling, general and administrative expenses.”

A closer look at the 10-K helps me back out details of around $24 billion of the SG&A number (share based compensation in operating SG&A is $1.57 billion as per page 65 of the annual report; $3.3 billion relates to litigation settlement on page 40; depreciation and amortization is $10.9 billion, spilt between cost of sales and operating SG&A; advertising expenses are $4.1 billion as per page 64; operating lease expenses of $2.3 billion as per page 70; finance lease expenses of $852 million and variable lease expenses of $899 million as per page 70 of Walmart’s 10-K). The remaining $100 billion of operating SG&A remains, by and large, unexplained in the 10-K.

Will the new FASB proposal help? The sample disclosure for SG&A on page 37 of the proposal asks companies to decompose SG&A into employee compensation, depreciation, intangible asset amortization, and other SG&A. I am still not sure whether employee compensation or depreciation, under each major line item such as Cost of Sales and SG&A, will be reconciled to employee compensation or depreciation for the entire firm. I acknowledge that the FASB’s proposal is helpful but a lot of relevant detail a user might need is still left out.

What could be improved?

I was reminded of the extra ordinary detail I used to see in Indian income statements when I worked as an articled clerk to get my chartered accountancy qualification in India. Part of the reason for the arguably more informative statements in India is the regulatory insistence on the “nature of expense” method of presenting information in the income statement. In particular, Indian Accounting Standard 1 (Ind AS 1) states, “In the analysis based on the ‘nature of expense’ method, an entity aggregates expenses within profit or loss according to their nature (for example, depreciation, purchases of materials, transport costs, employee benefits and advertising costs), and does not reallocate them among functions within the entity. This method is simple to apply because no allocations of expenses to functional classifications are necessary.”

The FASB’s new proposal is an attempt to integrate the nature of expense method with the so-called, “functional” method of presentation. To present a concrete comparison with Walmart, I pulled out the latest available income statement of India’s largest retailer, Reliance Retail India Limited. To give you a sense for the numbers involved, Reliance Retail booked revenue of 1.69 billion Indian Rupees (INR) (roughly $2 billion USD) for fiscal year ended March 31, 2022.

Under the expense line, Reliance Retail reports (i) cost of materials consumed of a negligible amount; (ii) purchases of stock in trade of 1.54 billion INR; (iii) changes in inventory of finished goods and stock in trade of -0.76 billion INR; (iv) employee benefit expenses of 0.15 billion crore INR; (v) finance costs of 0.19 billion INR; and (vi) 1.07 billion INR in other expenses.

Reliance Retail goes on to further decompose (iii) above into opening and closing finished goods and stock in trade. The FASB proposal will also require this decomposition. Here, the FASB’s proposal is superior because Reliance, were it following US GAAP, would now have to report employee compensation, depreciation, intangible asset amortization, other inventory and manufacturing costs capitalized into inventory, and warranty expenses.

Line (iv) of Reliance’ income statement referred above gets decomposed into salaries and wages, contribution to retirement funds, and staff welfare expenses. Pension costs related to defined benefit retirement funds are further broken down, as in the US, into various standard components comprising of service costs, interest costs, actuarial gains and losses, benefits paid, and the like.

It is somewhat unclear whether the FASB will require a subline item disaggregation of employee compensation into salaries, wages, pension contributions, pension costs and staff welfare expenses or will they allow firms to merely report one line titled “employee compensation.”

Line (v) in Reliance Retail above related to finance costs is straightforward and skipped for the purposes of this analysis. Line (vi) is broken down by Reliance into four broad sub-categories: (a) selling and distribution expenses; (b) establishment expenses; (c) auditor expenses; and (d) CSR (corporate social responsibility) spending.

Under selling and distribution expenses, Reliance Retail further reports (a1) sales promotion and advertising expenses; (a2) store running expenses; (a3) royalty; (a4) brokerage and commissions; and (a5) warehousing and distribution expenses.

Under establishment expenses, Reliance Retail reports (b1) stores and packing material; (b2) machinery repairs; (b3) building repairs and maintenance; (b4) other repairs; (b5) rent including lease rentals; (b6) operating lease rentals; (b7) insurance; (b8) rates and taxes; (b9) travelling and conveyance expenses; (b10) professional fees; (b11) loss on sale/discarding of assets; (b12) loss on sale of businesses; (b13) exchange differences; (b14) electricity expenses; (b15) hire charges; (b16) charity and donations; and (b17) general expenses.

I am going to skip discussing auditor expenses as that is disclosed in US proxy statements. I am also going to skip CSR spending as that is mandatorily required to be disclosed in India.

In essence, a smaller retailer in an emerging market discloses far more information about its operations relative to the world’s biggest retailer, Walmart. Most of this improved disclosure appears to be driven by social convention and not a specific definition of materiality or detailed guidance in the Indian accounting standards or regulations issued by the Ministry of Corporate Affairs in India. What will it take for US companies to be more forthcoming about their expenses?

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