Quality business reporting - the building blocks
The recently published report by the International Federation of Accountants (IFAC) 'Integrating the Business Reporting Supply Chain' opens with the timely reminder that high-quality business reporting lies at the heart of strong capital markets and sustainable economic growth. In the final phase of this project, IFAC interviewed 25 key business leaders, representing all of the links in the business reporting supply chain, to obtain the views which form the basis of its report.
The U.K. Financial Reporting Council (FRC) has also published a report in recent weeks 'Effective Company Stewardship: Enhancing Corporate Reporting and Audit'. A key recommendation in this report is that directors should take full responsibility for ensuring that an Annual Report, viewed as a whole, provides a fair and balanced report on their stewardship of the business.
These are two of the many reports and initiatives being taken in order to focus attention on improving the quality of reporting and the underlying governance processes.
The business reporting supply chain
A comment made by many IFAC interviewees is that business reporting is not a compliance exercise, but a communication exercise with an entity's shareholders. Taking this on board adds to the debate as to whether or not the current reporting system is fit for purpose, and the report debates this in three key areas:-
- Good governance is the foundation on which business success is founded
- Financial reporting in isolation can only paint a limited picture
- A key link in the business reporting supply chain is auditing
Each of these issues generate their own significant challenges which were commented on in earlier IFAC reports and other commentary documents. These have been the subject of developments and work in progress in such areas as updated corporate governance codes and new or substantially revised international accounting standards, and a range of other initiatives.
Good governance is fundamental
The financial crisis has stressed that good governance counts, with failure to appropriately govern being at the core of many of the more unfortunate events and issues arising from the crisis.
Interviewees of IFAC stressed the importance of the following:-
- A principles-based stakeholder-driven approach to governance implementing guidelines in accordance with the "apply or explain" principle is preferable to a heavy legislative approach
Boards of directors should routinely check their own actions against the applicable governance principles, with particular regard to independence, competence and focus on sustainable organisational performance
- Useful governance disclosures will show the actual governance performance of the organisation, not only the governance policies and principles.
The report emphasises that governance codes should strike the right balance between providing oversight and driving long-term performance. Directors need to make sure that compliance with regulations does not override their obligations for making decisions in the overall best interest of the organisation, with well-managed organisations having directors who stay focused on the achievement of long-term, sustainable organisational success.
A fundamental element of good corporate governance is the growing strength of audit committees in holding management and auditors to account, and the FRC report calls for fuller reports by Audit Committees explaining, in particular, how they discharge their responsibilities for the integrity of the Annual Report.
Improvement of financial reporting
Increasing complexity of accounting standards is seen as a major challenge, with the pace of change compounding this. The recent financial crisis has highlighted potential deficiencies with interviewees commenting on such matters as off-balance sheet accounting, warehousing of financial instruments, mark-to-market accounting and many other such matters. Detailed disclosure requirements have also added to the opaqueness and complexity of financial reporting, and it is notable that the International Accounting Standards Board has recently launched a project with the aim of reducing the volume of disclosure requirements in standards.
This goes some way to responding to a major call for improving the understandability of financial reporting standards, so that standards are not only comprehensive but also as simple as possible, with stakeholders being able to understand and implement them properly. The issue of whether and how standard setters should take account of the wider effects, or consequences, of the accounting standards they develop has been a subject of debate for decades, without what many would consider a satisfactory resolution.
The use of fair values is an area on which there are widely divergent views and while seen by some as being the most relevant information for financial decision making, the financial crisis has made apparent that preparers, auditors and all stakeholders need much clearer guidance to understand the inherent risk involved before they can put a fair value on an asset.
The convergence to global accounting standards is considered vital because the increasingly globalised supply of capital needs this to enhance comparability and analysis of investment opportunities globally, and ultimately increase investor confidence.
The FRC and its related bodies have published reports and initiated other developments in relation to such matters as the disclosure of principal risks and uncertainties and the assessment of going concern and liquidity. It has also repeatedly commented that companies have provided inadequate explanations of business models and strategy in their Annual Report. The U.K. Corporate Governance Code 2010, which has been taken on board in Ireland, includes requirements in this regard.
Auditing - a corner-stone of financial reporting
The main objective of financial statements is to provide reassurance to shareholders by expressing an opinion on the financial statements. Interviewees recommended a principles-based approach to financial reporting and auditing which would allow for professional judgement and a more risk-based audit approach.
Chartered Accountants Ireland (CAI) have some weeks ago published its Discussion Paper 'Statutory Audit: What the future holds'. This comments on a number of questions currently being raised, which include:-
- The value and usefulness of the current output from statutory audit
- Is the statutory audit in its present form 'fit for purpose'
- How should the 'public interest' be reflected in the scope of audit, and
- Obligations on auditors with regard to matters of systemic importance.
The Discussion Paper sets out a range of options or potential developments for consideration and helping to lead to change if considered appropriate by legislators and standard-setters.
It is important that the lessons to be learned from the recent financial crisis and global economic recession are taken on board.
What should be aspired to is that the example set by the best in corporate reporting is adopted across the market so that Annual Reports, including audited financial information, delivers greater value to investors and serves the public interest in the best possible manner.'.
First published in Finance Dublin Online.