Thursday, November 14, 2013

Time For A Better Income Statement: McKinsey&Company

From McKinsey&Company, Insights & Publications, November 2013, "Building a better income statement: If neither companies nor investors find GAAP reported earnings useful, it’s clearly time for a new approach." by Ajay Jagannath and Tim Koller:
A company’s annual income statement should be a transparent disclosure of its revenues and expenses that investors can readily interpret. Most aren’t, largely because income and expenses classified according to generally accepted accounting principles (GAAP) can be difficult to interpret. In fact, many sophisticated investors tell us they have to reengineer official statements to derive something they’re comfortable using as the starting point for their valuation and assessment of future performance. In response, many companies—including all of the 25 largest US-based nonfinancial companies—are increasingly reporting some form of non-GAAP earnings, which they use to discuss their performance with investors.
A modest proposal to revise GAAP requirements
It would make life easier for everyone if GAAP requirements themselves were adjusted to require what companies and investors already use, after making all their adjustments, instead of making everyone do twice the work. That wouldn’t require big changes; simply separate operating and nonoperating items in a standardized manner and combine acquired intangible assets with goodwill without amortizing them (exhibit). Such an approach would enable investors to quickly understand a company’s true earnings and operating performance. It would provide them with the detail they need to assess the economic significance of nonoperating and nonrecurring items and decide for themselves how to treat them. And it would enable them to notice trends and patterns and compare performance reliably with peers.

Commonsense changes would make for a better income statement.


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