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Deciding on Disclosure in the Income Statement

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After a business decides on the format for reporting its income statement (multi-step or single-step), the next main decision concerns how much information to disclose about its expenses. Public companies are subject to financial disclosure rules issued by its national securities exchange commission.

A publicly owned business has no choice but to abide by these rules. Otherwise, trading in its stock shares could be suspended by the SEC.

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Income statement disclosure standards for nonpublic businesses (that is, those not subject to the SEC’s jurisdiction) are surprisingly vague and permissive. Generally accepted accounting standards (GAAP) say little about how much information should be disclosed about expenses in the income statement. Generally speaking, businesses that sell products report their cost of goods sold expenses, and almost all businesses report their interest and income tax expenses. But, it’s much more difficult to generalize about the disclosure of other expenses.

Okay, “expenses….Some businesses disclose only this expense because they’re very stingy about revealing any more detail about their operating expenses. Other businesses report five or ten operating expenses in their income statements.

In deciding how much expense disclosure should be included in income statements, businesses make three main considerations:

Confidentiality: Many businesses don’t want to reveal the compensation of the officers of the business, for example. They argue that this information is private and personal.

Materiality: Most businesses don’t see any point in reporting expense information that’s relatively insignificant and would only clutter the income statement.

Practicality: Businesses limit the income statement contents to what fits on one page. A business can put additional detail about expenses in the footnotes to its financial statements, but many argue that shareowners and lenders have only so much time to read financial statements and putting too much information in their financial reports is counterproductive.

Assume that you are one of the major shareowners of the private business whose annual income statement is shown in. You aren’t a manager of the business or on its board of directors, but as an outside investor, you’re vitally interested in how the business is doing financially. So you carefully read the business’s financial statements, especially its income statement.

You depend on the business making a profit in order to pay dividends from profit to its shareowners. Are you satisfied with the extent of expense disclosure in the income statement? Do you want the income statement to report one or more of the following expenses?

  1. Compensation of officers
  2. Salaries and wages of employees
  3. Repairs and maintenance
  4. Bad debts
  5. Rents
  6. Taxes and licenses
  7. Depreciation
  8. Advertising
  9. Pension and profit-sharing plans
  10. Employee benefit plans

 

In all likelihood, the business keeps accounts for these expenses because they have to be reported in its annual income tax return. So the information is available and could be reported in the business’s income statement. When giving a consultation to a management team, who was on the stage to just about present income statement to their shareholder, I found the Income Statements reports all these expenses. On the other hand, I saw many income statements (by other management team) that didn’t disclose these expenses.

If I were a major outside shareowner in this business, I would request that, either in the income statement itself or in the footnotes to the financial statements, information be reported about four expenses: repairs and maintenance, advertising, pension and profit sharing plans, and employee benefit plans.

 

Why these four?

Repairs and maintenance expense can be manipulated by management to push profit up or down for the year.

Advertising is a very discretionary expense that I’d want to compare to sales revenue.

Pension and profit-sharing plans and employee benefit plans can be very large encumbrances on a business.




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