The cost of goods sold (COGS) can account for 70% of a company’s expenses, according to recent discussions by the Financial Accounting Standards Board’s Investor Advisory Committee. However, some companies skimp on details around the costs they incur to produce goods. To help rectify this situation, the FASB has launched a project to study the disaggregation of income statement expenses.
Identifying the problem
In recent years, investors have clamored for enhanced disclosure of COGS items. The current guidance allows companies to lump expenses into catch-all cost buckets. Plus, significant variances in gross margins can make it difficult to compare financial statements from company to company.
For instance, say investors would like to know how much of the COGS is tied to raw materials and employee compensation — and how much of employee compensation is cash vs. stock-based compensation. Plus, they may want to understand how much of COGS items are fixed versus variable.
Working on a solution
In October 2022, the FASB refined the scope of its disaggregation of income statement project to focus beyond “cost of tangible goods sold; cost of services and other cost of revenues; and selling, general, and administrative (SG&A) to include any relevant expense line (excluding taxes).”
The project aims to address investors’ concerns that companies combine (or “aggregate”) too many expense details under one caption in the income statement. Some investors have argued that overly aggregated expenses can blur the view of what drives profits and hinder an understanding of a company’s future cash flows.
Members of the FASB’s investor advisory committee suggested that disclosures around certain types of residual costs — anything beyond employee costs and depreciation and amortization — would help investors better evaluate financial performance. Of particular interest are discretionary expense items, such as advertising and R&D, that can be material for most companies but can vary substantially by industry.
One suggestion calls for disclosures of expense items at the COGS level by nature and at the SG&A level by function. However, companies vary in the types of expenses they incur. Another suggestion involves using a “hurdle” to determine whether a line item should be disaggregated and disclosed. For example, some members support using a qualitative threshold of 10% of COGS or SG&A expenses — any residual item that exceeds that threshold would need to be disclosed in the financial statements.
As your company prepares its financial statements, consider what you’re currently disclosing about the components of COGS and SG&A expenses. Are you being transparent about the details? Companies that voluntarily share disaggregated cost data on financial statements can engender trust with investors and lenders. Contact your KraftCPAs advisor to determine the appropriate level of disclosure for your company.
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