Accounting: Complex solution

The idea that the Financial Reporting Council is working on a project
reviewing complexity in corporate reporting could be greeted with a degree of
cynicism. Finance directors have witnessed a sustained increase in the volume
and difficulty of accounting, and related rules their companies must follow, and
when politicians or regulators promise to reduce red tape, you can only expect
another level of laws, codes and guidance teetering on top of all that has gone
before. A prime example of unfulfilled expectations is the Company Law Review
started amid the New Labour dawn in the late 1990s that promised to build from
the bottom up, but ended three years later in a damp squib.

This is not what the FRC is trying to do. Instead, it is trying to analyse
what is meant by complexity, and to whom. Breaking down the corporate reporting
process suggests there are three main groups involved in the process of
corporate reporting: those who prepare, those who explain and those who analyse.
Those three groups all have different views on the complexity issue and those
perspectives must be considered and understood by those who inform the corporate
reporting process ­ the law makers, standard setters and other regulators.

The first goal for the FRC is to understand the causes of complexity in
corporate reporting and then engage in a debate on how to stop complexity
increasing further. To achieve this, the FRC needs to understand the different
perspectives of finance teams, directors, investors and analysts.

One example the FRC working group is looking at is share-based payments. The
equation may go something like this: FDs and their teams may find accounting for
share-based payments a difficult task that requires some steady thinking and
detailed modelling that takes up a lot of time. Therefore, should that
requirement be adjusted? The answer may well be ‘no’ if those tasked with
explaining the company performance and those charged with understanding
performance ­ analysts, shareholders and debtholders ­ find those numbers
meaningful and useful. So there may be no simple answers and one stakeholder’s
complexity may well be justified by the response of others.

Yet some areas of complexity are more difficult to justify. At present, a
company reports on aspects of liquidity in half a dozen places within its annual
statements and it should be possible to plan such information flows which would
improve the process for all three main stakeholders.
And it is worthwhile re-examining some of the motherhood and apple pie
principles many of us hold dear. For instance, many are convinced that
accounting standards should be based on principles rather than detailed rules,
but it is less than clear whether anyone really understands what principle-based
standards look like and how they might operate.

The scope of the FRC project includes requirements relating to financial
statements plus the accompanying management commentary and other reports. This
area of complexity seems even more difficult to tame than the numbers. The past
few years saw annual reports increasingly targeted by lobby groups and
government as the location where companies should report on essentially
non-financial matters such as the environment, or corporate social
responsibility. An example of this is the European rules on takeovers, requiring
corporates to disclose material contracts that contain a clause about change of
controls. The idea is to unearth embedded defences against hostile acquisitions
by materially impacting the value of the company. But in implementing the idea,
presumably no one thought of who benefits and at what cost to others? Define
material contracts, then set up a system to capture all the relevant
information. No problems.

Complexity is a trend that has been festering for some time. The fuss in 2007
over the HSBC annual report was a trigger highlighting how far we have travelled
down the path of complexity ­ or not, in the case of the postmen who were
cautioned not to carry too many of the bank’s 454-page, 1.47kg annual report.
The consultation paper the FRC will produce will not offer immediate solutions.
In this complex, global world it is no longer sufficient to convince the UK’s
Accounting Standards Board or the Department for Business, Enterprise &
Regulatory Reform, progress will only be made if the IASB and the European
Parliament are convinced. This is the start of a process which looks unlikely to
have a neat ending. A huge web starts to become clear once the idea of
complexity in corporate reporting is scrutinised more carefully and more calmly
than the usual one-dimensional approach of judging individual standards or laws.

Attempts to simplify or streamline reporting requirements are usually met
with resistance from at least one group of stakeholders. So change will only
happen if consensus can be reached among a myriad of groups scattered across the
globe. That underlines the importance of what is being attempted. It may be
difficult, but is not futile; complexity is one of the more serious threats to
regaining and maintaining confidence in corporate reporting and corporate
governance.