Financial reporting: calling time on the blame game

27 Aug 2014

Hilary Eastman on why it’s time to stop talking and start doing

“If it were easy, everyone would be doing it” – that old saying is relevant for so many things. And when I read the Financial Reporting Council Lab’s newest insight report on clear and concise reporting, it was one of the first thoughts to spring to mind.

But the report also made me wonder: whose fault is it that everyone is not doing it yet? Is it the standard setters for having too many rules? The regulators for requiring the rules to be followed even when they aren’t material or relevant? The auditor for having a checklist mentality? Companies for being too verbose? Or even the users of accounts, for not being clear about what they want companies to disclose?

The new insights in Towards Clear and Concise Reporting released in August followed the Lab’s detailed July report Accounting policies and integration of related financial information. Both are shooting at the same target. Some of the suggestions are pretty straightforward – writing financial reports in plain language, for starters. Others are more technical and require a great deal more scrutiny and experimentation. I’m thinking of things like which accounting policies are significant and therefore which must be disclosed.

But these accounting policies have a single raison d’être – meeting the needs of investors. Clearly, the users of a company’s accounts need to be able to understand why management accounted for a transaction or an item the way they did. But although we got to this place for a number of good reasons, many of them related to financial crises and bubbles, we’re in a place where there’s a critical mass of investors demanding change.

For many of the reporting ‘conundrums’ at the moment, such as how to order the notes to the financial statements, there’s a solution. It might not be simple, and it might involve a little experimentation, but I think that most investors would understand that companies might need to test a few approaches to get to the right place. According to the Lab’s reports, investors mainly want you to tell them what you’re doing and why you’re doing it. The Lab’s work with investors – and ours too – shows that investors are particularly keen on having unusual things explained to them, whether that’s by reconciling it to another amount, putting it in a table or building a narrative around a particular choice. From an investor’s perspective, I guess it’s a little bit like maths homework – you might not get the answer spot on first time, but you’ll get marks for showing how you got there.

When you try to lump all of the problems together in a list, they seem to naturally fall under two main headings: attributes and quality. For example, you should disclose an accounting policy if it has the following attributes: it is material, there is a policy choice under IFRS or there is a need for management to apply significant levels of judgement or estimation. As for quality, policies should be written in plain language and judgements should be described clearly, along with their rationale – whether we’re talking about the application of an existing policy or the impact of new IFRS requirements.

As for the FRC’s piece on being clear and concise, there are many good tips in there, and they all are common sense. Yes, it’s a good idea to think about taking out standing information and putting it on the company website if you can. No, don’t put in the life stories of your directors. Yes, sit down and think about what your users’ needs actually are – would they benefit from a standalone strategic report within or outside the annual report? No, don’t put old, now irrelevant, information in there just because it was in there the year before.

The Lab’s reports show that different investors want different things. Retail investors, for example, do want a full list of all the accounting policies used, but institutional investors don’t. So for a company with significant institutional shareholders, that would be a prime example of a place where a company could put all of those policies on its website or in an appendix – where they can be easily updated – and draw attention to only the significant ones, or departures from the norm, in their annual report. But above all, companies need to take care to meet the information needs of their particular shareholders and analysts.

Many companies are perfectly aware that a lot of this advice is possible to put into practice. They just don’t do it. Maybe they’re scared of regulators – and in some cases, rightly so – especially since movements like integrated reporting are asking for more forward-looking information that is difficult to get assured. Taking caution can be wise. But these are also companies that pay their executives a fair whack on the basis that if they don’t there’ll be a brain drain. So many large companies clearly have the knowledge, talent and leadership to innovate around these problems. There isn’t an iron curtain between companies and regulators – they can talk, experiment and ultimately change practice. They have in the past.

In both of its reports, the Lab is for all intents and purposes asking companies to read their old report and then sit down with a blank sheet of paper. That’s a good bit of advice, but I’d add to that the idea that we all have to take responsibility, and do it now.

The time has come to stop discussing and debating whose problem it is and actually start identifying – and addressing – the individual, company-specific problems with reporting. And now may be the best time to do it – as companies go through systems changes to report information about revenue, hedging, impairment, fair value, subsidiaries and so on, they can use this as an opportunity to make an investment in really improving the overall quality of their disclosures, rather than thinking of it as yet another cost to be incurred in preparing them.

Occasionally some bright spark will say that reporting doesn’t influence behaviour. But as a colleague pointed out to me, there is tangible evidence that trust is the lifeblood of the modern economy, and tangible evidence that good reporting builds trust. And if we can’t all do the sums on that, then it’s time to quit!