Financial reporting is undergoing major change. Not only is the style and contents of companies’ reports to their shareholders moving on – sometimes voluntarily as companies see the need to make annual reports pay their way, but also under the influence of regulators, increasingly driven by an international agenda. The speed of development is rapid and unlikely to diminish, placing onerous burdens on accountants and finance directors as they seek to keep up to date.
While it is fascinating for some to become engrossed in the technicalities of the subject, it is important that we do not lose sight of the overall purpose. What is financial reporting for? Some would say it is to give newspapers copy for abusive headlines about directors’ pay, but fundamentally it is to enable properly informed decisions in the markets for capital.
Informed and knowledgeable markets for capital are essential to the future of companies. Sound reputations in those markets take time to create but can be lost extremely quickly. If markets feel uncomfortable with or, at worst, lose confidence in companies’ reports, then not only will the cost of capital rise but investors will look elsewhere for investment opportunities.
In the 1980s, after some spectacular failures, there were serious questions asked about the credibility of companies’ accounts, which led in turn to the creation of the current infrastructure for the management of accounting standards by the Accounting Standards Board (ASB) and the Review Panel, under the supervision of the Financial Reporting Council. The early work of the ASB in the 1990s received some criticism, with complaints about new rules denying finance directors any ability to exercise judgement, but now most people see that it was a lack of precision in the old SSAPs which allowed a variety of interpretations, hence the financial disasters of the late 1980s.
Happily, we are now virtually through the phase of recovery, credibility has been re-established and we can concentrate on the wider issues. The ASB’s Statement of Principles was a welcome attempt to establish a framework within which more detailed work could proceed. But new issues have emerged which have created new opportunities for the future.
An important influence is the growing importance of international standards.
Many companies want to see harmonisation of financial reporting across the world in order to facilitate the raising of new capital in global markets, especially in the US. The International Accounting Standards Committee (IASC) is striving to achieve its objective of having a core set of standards ready by March this year which will ensure that companies complying with IASC standards have access to the stockmarkets of the world.
This will offer global companies unprecedented opportunities and, not surprisingly, is very welcome; but is the price worth paying?
The powerful influence of the US regulators on the IASC has already caused those in the UK much heartache. A particular case in point is the field of financial reporting for deferred taxation and pension costs, where the adoption of US-style reporting could cause UK companies to change their accounts, their profits and possibly their pension fund investment policies, sometimes in a very dramatic way. There is a point where the laudable objective of international harmonisation costs too much. In such circumstances the UK may choose to opt out, either where there are particular legal or fiscal problems or where the ASB genuinely believes the international approach is wrong. The ASB has the overwhelming support of the Hundred Group of Finance Directors for this approach.
Companies are increasingly adding voluntarily to disclosures and producing special reports in addition to their annual reports. For instance, environmental reports have improved significantly in recent years and often include much quantitative detail.
The prize-winning report from British Airways is an admirable example.
ICI goes further and also reports on health and safety performance. Many companies produce special reports for their employees, often in the form of a newspaper.
Timing is also important. Markets react to companies’ performances at the time they make interim and preliminary announcements. It is at these times when share prices move and valuations are changed. This creates doubts about the usefulness of the full accounts. They are published some time after the market has taken a view and are becoming ever more complex, lengthy and hard to understand. The annual report itself is trying to fulfil so many different needs and satisfy so many different audiences that we need to think carefully whether some alternative structure is needed.
Indeed, the Royal Society of Arts suggests that there should be an overall structure to companies’ external communications. They advocate a core report to all “stakeholders” – customers, suppliers, employees, shareholders and the wider community – with special reports for each group providing more detail. For example, the detailed accounts could be included in a subsidiary financial report in a similar way to that used by some companies who already provide summarised accounts in their annual review.
The ASB itself has reacted to these thoughts by creating a talented group to examine the structure of year-end financial reporting and of interim and preliminary announcements. This is very welcome and the ASB’s proposals are eagerly awaited. They should give companies opportunities to develop their approach flexibly to suit the needs of their various audiences.
Growing use of the Internet also provides companies with new and novel opportunities to disseminate information of all kinds, including financial information. Many companies are already experimenting with new technologies which are especially useful to those with very large share registers, such as the privatised companies and building societies. As experimentation grows, further exciting possibilities will open up.
Hence the future for financial reporting is likely to witness continued rapid development and change, with emphasis not only on the technical challenges of reporting ever more complex transactions but also on the wider issue of how to convey knowledge and understanding to markets and stakeholders.
Brian Birkenhead is deputy chairman of the 100 Group of Finance directors.
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