Trivialization of the Bottom Line and Losing Relevance of Losses

Abstract

The purpose of this article is to illustrate the growing limitations of the current methods of calculating earnings, particularly when earnings is a negative number. Earnings, presumably the most important output of a financial reporting system, is not a singular metric. It is obtained by subtracting numerous expense line items from revenues, both of which are calculated after applying a diverse, and often inconsistent, set of accounting conventions. Despite this apparent deficiency, earnings could be informative of recurring profits, if revenues are measured correctly and expenses are traced to revenues. However, both principles are increasingly violated for the cohorts of firms listed in the last 30 years, which now constitute over 80% of the set of listed firms. Revenues of recent cohorts do not capture many events that create recurring cash flows. Their operating expenses are dominated by intangible outlays that are unmatched to current revenues. As a result, newer cohorts’ profits and profit margins, especially when negative, offer little to inform future profits. Given that revenue and expense recognition rules are unlikely to change anytime soon, the current developments raise a question: Should the reporting of the summary measure of earnings be voluntary instead of mandatory?

Keywords: Earnings, Income statement, Matching, Relevance, Losses, Listing cohorts, Intangibles, Knowledge economy

JEL Classification: M41