As part of our series of guest blogs on CEO insights, Martin van Roekel invites Andrew Buchanan, BDO’s Global Head of IFRS, to share his views on the importance – and future -of financial reporting
Financial reporting has come in for a fair amount of criticism in recent years. Some of this has been unjustified, such as the accusation that accounting standards were to blame for the global financial crisis. In my view the crisis was caused by management and business model failure, and to blame the accounting standards that reported the outcome of those failures is a classic case of shooting the messenger. However, a more justified criticism might be that financial statements have, in recent years, become ever more lengthy and complex, making it harder for readers fully to understand the financial performance of an entity, the underlying reasons for that performance, and the key risks that are faced.
In part, expanded reporting requirements have come from the increasing complexity of transactions that entities enter into. Others have come from improvements in financial reporting that have shone light into corners that some might have preferred to have gone unnoticed (such as off balance sheet transactions, and charges for share-based payments that tell shareholders how much of their investment has been given away to others). These have, almost inevitably, been accompanied by increased disclosure requirements. Whilst these have often been added in response to calls from users of financial statements, some feel that it has become difficult to see the wood for the trees.
The increasing amount of information that is now being crammed into financial statements has prompted the issue of documents that include proposals and suggestions for ‘cutting the clutter’, such as the ICAS/NZICA publication ‘Losing the Excess Baggage’ and the EFRAG/ANC/FRC Discussion Paper ‘Towards a Disclosure Framework for the Notes’. The IASB will hold a Discussion Forum in early 2013 on disclosures in financial reporting, and accounting standard setters elsewhere are looking at how the effectiveness of disclosures in financial statements could be improved.
While these initiatives are a necessary and valuable contribution to the debate, the trouble is that as soon as there is a suggestion that certain disclosures should be removed, someone will say ‘but I need that information’.
Some of the excess could be trimmed by focusing more on whether certain disclosures really are material for an understanding of an entity’s financial performance and position. However, a more fundamental and radical review is required of what financial reporting needs to be in the future, and what that will involve. This will take time.
So what can be done now? I would start by leaving the detailed disclosure requirements of individual accounting standards alone. Instead, I would make a modest, but significant, change to IAS 1 (the accounting standard covering presentation of financial statements).
IAS 1 already requires disclosure of:
· key judgements that management has made in applying accounting policies that have the most significant effect on amounts reported in financial statements, and
· assumptions and other major sources of estimation uncertainty that have a significant risk of resulting in a material adjustment to the carrying amounts of assets and liabilities within the next financial year.
While this is useful information, there is no requirement for these disclosures (and related notes covering items that they have highlighted) to be grouped together in one place. In practice they are often not grouped together, and the quality of the key judgements, assumptions and estimation uncertainty disclosures in some financial statements could, being polite, be improved.
So the change I would make to IAS 1 would modify the layout of financial statements so that the accounting policies and notes would be separated into two sections. The first, coming immediately after the primary statements, would be for those accounting policies that cover the most significant or unusual transactions (whether from a quantitative or qualitative – including risk – perspective), the IAS 1 disclosures outlined above, and related notes. All of the more routine accounting policies and other note disclosures would be relegated to a second section.
This would have the potential for users of financial statements to be directed clearly, within the space of just a few pages of accounting policies and notes, to the most significant and critical areas that affect the company that they are looking at. The increased focus on these disclosures might also result in a welcome increase in their quality. For those readers who would like to delve deeper into the detail, the other information would still be there.
That would be a short term move and could be implemented relatively quickly. Ultimately, in the longer term, financial reporting will need to change as paper documents eventually disappear, electronic reporting becomes the norm and financial reporting as a whole evolves (perhaps towards a form of integrated reporting). As I’ve suggested above, that will need a much more fundamental review of what financial reporting needs to convey, how this should be done, and to whom.