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Category: Accounting World

Financial Statement Disclo sures — How Much is Too Much

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Now that the IASB and the FASB’s joint projects are making steady progress in addressing key accounting areas, the two Boards are spending more time at the conceptual issues such as the presentation and disclosure in the financial statements. Earlier this year, the IASB hosted a public forum to brainstorm the topic while the FASB discussed a summary of the responses to its discussion paper on the disclosure framework.

Over the last five years, the size of annual reports of companies has increased substantially. One of the reasons attributed to the global financial crisis was the off-balance sheet exposures and the lack of adequate disclosures in the financial statements relating to these exposures by the companies. This pushed regulators, standard-setters, auditors, preparers and users of the financial statements alike in working overtime to bulge the size of companies’ annual reports without much deliberation around the usefulness of enhanced disclosures or their potential implications on loss of more relevant information among the resultant disclosure ‘noise’ in the financial statements.

Soon after, the solution began to emerge itself as a problem as preparers and auditors started feeling the burden of complying with these additional reporting requirements. Many organisations were forced to expand their financial reporting teams manifold to cope with the exhaustive data collection and analyses and to upgrade their financial reporting systems. This strain pushed forward the momentum around the Boards’ respective projects addressing the presentation and disclosure and is now creating a lot of traction among those affected.

As the participants from Africa, Asia, Europe and North America continue to debate possible solutions to the issue through the IASB and FASB forums, a message that has come out loud and clear is that while the preparers think there is too much required to disclose, users, on the other side, are suffering from information indigestion. There is a lot served, but of that there is very little that’s palatable. Much of the relevant information intended to address the needs of the key stakeholders is lost in this disclosure overload. However, if the constitution of the participants is to go by, the message is crystal clear that it’s the preparers who see this as a larger issue than users of the financial statements.

There are several ideas being mulled to achieve disclosure effectiveness, as there is also a scepticism around the practicability of these ideas. Some of these are:

• Materiality – How can this be applied to qualitative disclosures

• Principles-based guidance – Is it possible to have a single source of principles-based guidance providing conceptual framework for all disclosures

• Purpose and relevance – Is it possible to provide a ‘one-size-fits-all’ definition of purpose and/or relevance of the disclosure requirements

• Offer flexibility – Move away from the words such as ‘shall’ or ‘at a minimum’ from the disclosure requirements in the existing standards; let the preparers use discretion in deciding what’s relevant for their business

• Avoid overlap – There are areas requiring disclosures in the Management Discussion & Analysis (the front half) and also within the financial statements (the back half) of an annual report. A cross-reference mechanism may be developed to avoid repetition.

There is a high degree of engagement on this issue indicating wider approval to the disclosure framework project but a near unanimous view is that there isn’t going to be an easy fix to the disclosure problem.

The key challenges expected at this stage are:

• Finding the right balance to cater to all users with different needs

• Alignment with the overall financial statement conceptual framework

• Legal, institutional barriers

• Disclose more, not less – the cost of a disclosure failure is high

The debate continues but things seem to be moving in the right direction. The problem has been diagnosed; a solution will follow in due course. Standard-setters will need to work with regulators and other bodies who have a say in imposing the disclosure requirements and expand their outreach efforts to be able to cut the clutter effectively from financial statements without losing relevance and effectiveness from the disclosures. Let’s do our bit by getting involved in these discussions and work towards achieving a better world of financial reporting.

Thought to munch – There are so many of us who cannot find enough time to read an interesting book that’s more than 200 pages long. For an annual report with more than 200 pages!! Any takers?

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Integrated Reporting

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If we think that it’s only financial reporting that has seen substantial changes in the last 5 years, initiatives around better, more effective communication about an organisation’s sustainability and value creation through corporate reporting weren’t left far behind. As accountants, our professional responsibility primarily revolves around preparation, review and analysis of financial information. The management of an entity has even greater responsibility when it comes to communicating with shareholders and other stakeholders about how they are managing the business, how they are using the resources available to them and, above all, how they are creating value not just for its shareholders but for the environment at large in which it operates.

In this direction, a major milestone was achieved in April this year. The International Integrated Reporting Council (IIRC) issued a consultation draft of the International Integrated Reporting Framework (the ‘Framework’). The IIRC is a global coalition of companies, investors, regulators, standard setters and other key stakeholders. The main aim of the IIRC is to create a globally accepted integrated reporting framework and to make integrated reporting a globally accepted corporate reporting norm.

The Integrated Reporting (or IR) Framework sets out the purpose, provides guidance and outlines how businesses can better explain how they create, sustain and increase their value in the short, medium and long term. The aim is also to enhance accountability and stewardship and support integrated thinking and decision making in the wake of increasing challenges to traditional business models.

What is IR?
IR is defined as a process that results in communication by an organisation, most visibly a periodic integrated report, about value creation over time. It aims to communicate the ‘integrated thinking’ through which management applies a collective understanding of the full complexity of value creation to investors and other stakeholders. An integrated report is a concise communication about how an organization’s strategy, governance, performance and prospects, in the context of its external environment, lead to the creation of value over the short, medium and long term. The length of these time frames will be decided by each the organisation differently with reference to its business strategy, investment cycles, and its stakeholders’ needs and expectations. Accordingly, there is no set answer for establishing the length for each term.

IR is intended to be a continuous process and to be most effective should connect with other elements of an organisation’s external communication, e.g. financial statements or sustainability report.

IIRC identifies those charged with governance as having the ultimate responsibility of the IR. On the other side, key audience is the providers of financial capital. At the same time, it is accepted that IR benefits all external parties interested in an organisation’s ability to create value over time, including employees, customers, suppliers, business partners, local communities, legislators, regulators, and policy-makers. It is important to note that the purpose of an integrated report is not to measure the value of an organisation or of all the capitals, but rather to provide information that enables the intended report users to assess the ability of the organisation to create value over time.

To lend further credibility to the IR process, organisations may seek independent, external assurance to enhance the credibility of their reports. The Framework provides reporting criteria against which organisations and assurance providers assess a report’s adherence; it does not yet provide the protocols for performing assurance engagements.

IR Framework
The purpose of the Framework is to assist organisations with the process of IR. In particular, the Framework establishes Guiding Principles and Content Elements that govern the overall content of an integrated report, helping organisations determine how best to express their unique value creation story in a meaningful and transparent way.

The Framework sets out six guiding principles to help preparers determine the structure of the integrated report.

These are:

• Strategic focus and future orientation
• Connectivity of information
• Stakeholder responsiveness
• Materiality and conciseness
• Reliability and completeness
• Consistency and comparability

An integrated report is structured by answering the following questions for each of its seven content elements:

• Organizational overview and external environment: What does the organisation do and what are the circumstances under which it operates?

• Governance: How does the organisation’s governance structure support its ability to create value in the short, medium and long term?

• Opportunities and risks: What are the specific opportunities and risks that affect the organization’s ability to create value over the short, medium and long term and how is the organization dealing with them?

• Strategy and resource allocation: Where does the organisation want to go and how does it intend to get there?

• Business model: What is the organisation’s business model and to what extent is it resilient?

• Performance: To what extent has the organisation achieved its strategic objectives and what are its outcomes in terms of effects on the capital?

• Future outlook: What challenges and uncertainties is the organisation likely to encounter in pursuing its strategy, and what are the potential implications for its business model and its future performance?

Pilot Programme

IR is a new concept and is in its formative stage. The IIRC acknowledges this fact. Accordingly, in order to construct and test its thoughts around the Framework, the IIRC began a Pilot Programme in October 2011. This programme was soon joined in by over 90 businesses and 30 investor organisations from around the globe. Some of the business network participants are Tata Steel, Kirloskar Brothers Limited, Unilever, The Coca- Cola Company, HSBC, Microsoft Corporation, and Prudential Financial among others. [Source: www.theiirc.org]. Version 1.0 of the Framework is expected to be published in December 2013, much before the end of the Programme in September 2014, thereby allowing participants time to test the Framework during their following reporting cycle. This will also enable the IIRC to assess IR outcomes and complete its work.

IR is still a voluntary initiative so why bother now?

Well, the key results of the Pilot Programme speak for themselves. 95% of participants find that integrated reporting provides a clearer view of the business model and increases board focus on the right KPIs; 93% feel it leads to the better data quality collection, greater focus on sustainability issues, development of improved cross-functional working processes and breaking down silos between teams; and 88% agreed that IR leads to improvements in business decision making.

Currently, the industry participation is led by financial services, while more than 50% of the geographical spread is accounted for by Europe as these were the worst affected during the financial crisis. Sustainability concerns may have sowed the seeds of the IR on a global scale, but the trends emerging from the Pilot Programme provide enough evidence of much wider benefits to the organisations and their stakeholders – now and in the future.

Let’s prepare for a world of valued corporate reporting!

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