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May 26, 2015

Financial reporting – when more is less?

Global capital markets are dominated by increasingly complex businesses that often operate across multiple jurisdictions. This means that financial reports prepared by these organisations are also often complex, in part to ensure everything financial is captured and duly reported and based on an assumption that investors want and need this information to make informed investment decisions.

At the same time, the demand for non-financial information from companies covering the full range of capitals is growing apace. The consequence is that the modern annual report runs to several hundred, mostly dense and complex pages, with the financial statements section making up a significant portion.

While complexity arising from the diverse information needs of multiple users may to some extent vindicate extensive accounting standards and associated requirements that result in lengthier financial reports, there is no doubt that in many cases, there is superfluous information within financial reports. The reasons for this are varied – and warrant some investigation by the profession if we’re committed to ongoing and meaningful communication with investors.

Frequently, preparers rely on software programs, checklists, templates and example financial reports to assist them in producing the financial reports they are responsible for. While these can aid efficiency, they can also encourage complacency. Inclusion of disclosures because a checklist demands it, without questioning whether it is relevant and required can result in unnecessary disclosures. This tendency is not necessarily unique to preparers of financial statements – auditors can also fall prey to the "checklist syndrome", sometimes requiring preparers to include information in financial reports just because it is required in an audit checklist or audit program.

Sometimes the inclusion of boilerplate or immaterial disclosures can arise from regulatory pressures, where entities may feel safer taking the "kitchen sink" approach to disclosures in financial reports, rather than face the wrath of their local regulatory watchdog or authority. In other instances, disclosures may be included following recommendations from legal advisers, to address real or perceived legal risks. An accusation that is sometimes levelled against financial report preparers is the more insidious practice of providing too much information to hide bad news.

There is a clear case for preparers and auditors to focus more on entity specific conditions and ensure the financial reports are tailored to present these fairly.

Technology can assist but only to a degree. The eXtensbile Business Reporting Language (XBRL), for example, has been developed to allow financial report users to "slice and dice" information using software tools to read and analyse XBRL tagged financial reports. The ability to micro and macro analyse corporate filings has enticed many regulators around the world to mandate XBRL for lodgement of financial statements. However, anecdotal evidence indicates that there is limited enthusiasm for the voluntary take-up of XBRL amongst financial statement preparers, owing to the cost involved and perceived shortcomings surrounding the technology.

Standard setters and regulators continue to explore ways that can make financial reporting more meaningful and "user friendly", whilst delivering all the information deemed necessary in meeting financial reporting objectives. Examples include simultaneous projects examining the disclosure frameworks for financial reports by the International Accounting Standards Board and the US standard-setter, the Financial Accounting Standards Board.

Global corporate market regulators also need to ensure there is consistent messaging about what constitutes optimal financial reporting. This will help reduce excess disclosure by companies operating across multiple jurisdictions.

Auditors also have a part to play, by ensuring company-necessary information is included whilst redundant disclosures are not.

Organisations like ours have a critical part to play, not only by better equipping the profession to tackle the more immediate financial reporting challenges, but by also showing organisations how to embrace the profound paradigm shift that is Integrated Reporting. More investors are seeking information on company performance beyond the bottom line and the increasing uptake of Integrated Reporting by organisations to meet this demand signposts a significant milestone in the evolution of corporate reporting.

The reality is that information that is not understandable is not valuable. In the end, what goes in and what is left out of financial reports will continue to come down to the good judgement of the professionals charged with preparing them, armed with the right skills and an enquiring mind to understand the entity and the requirements of its stakeholders.

Related storyGlobally converged IFRS: myth or reality?

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