FASB’s Disaggregation of Income Statement Expenses

Users of financial statements indicated that more detailed information about expenses captioned on the face of financial statements is very important for understanding an entity’s performance, assessing its prospects for future cash flows, and comparing its performance both over time and with that of another entity.

There is no general requirement within US GAAP to classify expenses by function or nature. SEC registrants follow a form-driven structure as laid out in SEC rules, which require Listed Companies to present expenses in specific line items that are based on function (e.g., Commercial and Industrial Companies are required to disclose costs and expenses applicable to sales, costs of services, Selling, general, and administrative expenses on the face of the statements of comprehensive income). In the absence of broad requirements in the FASB Accounting Standards Codification to disaggregate expenses presented on the face of the income statement, there is diversity in the amount of disaggregated expense information that companies provide. With an objective to improve the disclosures about public company expenses and to address requests from investors for more detailed information about the types of expenses included in financial statement captions, the Financial Accounting Standards Board (“FASB” or “Board”), issued an Accounting Standards Update No. 2024-03 (ASU) on November 4, 2024. The disaggregation of income statement expenses requires segmenting the broader categories of expenses into more detailed components. This allows investors, creditors, and management to better understand the nature of a company’s costs and make informed financial decisions.

The disaggregated expense information required in this update, along with the recent amendments related to disaggregation of segment information and income tax information, will enable investors to better understand the major components of an entity’s income statement. The specified categories will be more clearly defined, unlike the expense captions presented by entities based on the current requirements.

HIGHLIGHTS OF AMENDMENTS TO SUB-TOPIC 220-40 DISCLOSURE REQUIREMENTS

1. Disaggregating relevant expense captions into natural expense categories
2. Basis of disaggregation -Cost Incurred basis or Expense Incurred basis
3. Disclosure of expense reimbursements included in a relevant expense caption
4. Disclosure of “other items” in relevant expense captions
5. Integration with existing disclosure requirements under US GAAP
6. Disclosure related to Selling Expenses
7. Other Application matters

DEMYSTIFYING THE DISAGGREGATION DISCLOSURE PRINCIPLES:

Refer table in the pdf.

ILLUSTRATIVE EXAMPLE TO UNDERSTAND THE DISCLOSURE REQUIREMENTS

Step 1: Identification of relevant expense caption

Applying the principles of ASU, Entity XYZ identified the following Income statement captions as relevant expense captions requiring disaggregation disclosure of natural expense category-:

(a) Cost of products sold

(b) Cost of services

(c) Selling, general & administrative Note-: Income tax expense and interest expense, even though presented on the face of its income statement, do not contain any of the natural expense categories and, therefore, shall not be considered relevant expense captions.

Step 2: Exceptions to disaggregation disclosure

Asset-related exceptions – It is not applicable in the current case, since cost is capitalized only in case of inventory.

Liability-related exceptions – Cost of products sold expense caption includes an amount for the environmental obligation. The Entity is not required to disaggregate this amount since (1) it will be settled in the future and there is uncertainty amount of settlement, (2) It is based on an estimate of future expenditure, (3) It is not entirely made up of one natural expense category.

Step 3: Integration with existing disclosure requirements under US GAAP

1. Impairment of Property, plant, and equipment: The expense caption “Selling, general, and administrative expenses” includes costs relating to “Property, plant, and equipment impairment classified as held and used”. ASU requires impairment expense as a separate category in the tabular format disclosure in accordance with paragraph 220-40-50-21(c). Therefore, disaggregation of the “Selling, general, and administrative expenses” caption requires Property, plant, and equipment impairment to be disclosed as a separate category.
2. Warranty accruals: The Entity recognizes expenses associated with warranty accruals entirely within the cost of products sold and, therefore, includes warranty expense as a separate category in accordance with paragraph 220-40-50-22(k). Therefore, disaggregation of the “Cost of products sold” caption requires warranty expenses to be disclosed as a separate category.
3. Operating lease costs: The operating lease cost spans multiple relevant expense captions, i.e., cost of services and selling, general, and administrative expenses. Hence, it is not required to be disclosed separately. Instead, those expenses are included in the amount for other items for each relevant expense caption.

Step 4: Expenses reimbursement

Entity XYZ elected to recognize an expense reimbursement from the strategic partner in research and development expenses and elects to separately disclose the amount of that expense reimbursement. Additionally, the entity qualitatively describes the expense categories to which the reimbursement relates.

Step 5: Disclosure of remaining other items

Since the remaining items are not significant, hence the entity provides only qualitative disclosure.

QUESTIONS FOR FINANCE TEAMS TO ADDRESS

Some of the questions, which are relevant to the finance teams.

1. Does an entity need to change the presentation of expense captions on the face of its income statement as part of adopting the new standard?(Refer the “Background” section)
2. Which type of costs shall be included in “Purchase of inventory?” (Refer the “Purchase of inventory” section)
3. Will selling expenses in the nature of incentive payments to customers adjusted from revenue also be included in the Selling Expense disclosure? (Refer the “Disclosure related to Selling Expenses” section)
4. Which expenses shall be forming a part of selling expenses? (Refer the “Disclosure related to Selling Expenses” section)
5. Impact of change in the definition of selling expenses, and requirements to recast prior period comparative information in the period of the change? (Refer the “Disclosure related to Selling Expenses” section)