Ask those who prepare and use financial statements about disclosure and they will all agree one thing: there is a disclosure problem.
But what is this problem? The answer differs according to who is asked. While preparers think they are being asked to put too much information into their financial statements, users worry about whether there is enough to help build the picture they need of the company’s affairs. Meanwhile the IASB, which has taken both these points of view on board, adds a third strand: that there is ineffective communication of the information included in the financial statements.
Reviewing disclosure fits within a general IASB project to improve communication in financial reporting. It was under the auspices of this project that last spring the board issued a discussion paper, Disclosure Initiative: Principles of Disclosure. The paper sets out ideas for general principles of disclosure that would help preparers apply better judgement when deciding what to disclose; how to disclose it; and where the information should go.
This helps address a gap in the conceptual framework for accounting standards. The framework concentrates on recognition, measurement and some elements of presentation, with little thought to disclosures, says Jake Green, technical partner at Grant Thornton. “There’s no framework for the IASB to say, ‘we need to tell investors matters such as how future cash flows might be affected by an item and what information we need to tell people about that.’ Without a framework, it’s hard for the IASB to work out which disclosures might be useful.”
ICAEW broadly supports developing principles of effective communication that should apply when preparing financial statements, believing that this could provide the framework needed to help preparers apply their judgement to disclosure requirements.
Applying professional reasoning is key, says Sarah Dunn, technical manager in the Financial Reporting Faculty. “The aim is to get preparers to use their judgement – making sure the information is of good quality, it’s relevant to users, and it’s not cluttering up financial statements. If preparers think the information does not fall into these categories, they should go back to the principles of disclosure and think about whether or not it needs to be included.”
Users’ views matter
While the IASB has actively sought feedback from many stakeholders, including users, during the project, ICAEW is among those which think the discussion paper does not highlight these users’ needs enough.
Green agrees and thinks the IASB should do more work around how investors use the information that’s disclosed. “They really need to understand this as it would help them make good decisions about what needs to be disclosed. It could also help preparers make more informed decisions about what could or could not be material, helping ensure they do not obscure material information by disclosing immaterial information.”
Many users talk about information overload with listed company financial statements. However, Fitch Ratings is not among them. Kazim Razvi, director of accounting policy & research, says: “We do not consider this to be an issue because there are wider stakeholders and you have to address all their informational needs.”
The ratings agency’s response to the IASB paper talks about the importance of prescribed disclosures, which take away judgement from preparers and auditors. Its view is mandating disclosures ensures comparability between different sets of financial statements.
The IASB is trying to allow preparers a bit more judgement in drafting disclosures so they can be entity-specific, says Razvi. “Our concern is that allowing judgement risks diluting comparability. And this comparability is very important to us in performing peer analysis and in ensuring that we apply a globally consistent approach.”
Story or data store?
The problem with the Fitch view from the preparer (and auditor) viewpoint is companies face long lists of prescriptive disclosures. This can lead to a checklist-type attitude rather than considering what financial statements are trying to convey.
Some think the way standards are written makes them prescriptive, says Alan Teixeira, Deloitte director. “There is a tension between having good standards that guide you when providing information and treating disclosures as a compliance exercise. There’s a perception that preparers are being forced into compliance when what they should be doing is communicating clearly with investors and telling them what’s important.”
The conflicting views point to a key difference in approach to financial statements: whether they exist to tell a story or to act as a compendium of information. The storytellers want to present the company’s year as succinctly as possible, concentrating on what has been happening and blocking out superfluous noise. The other camp wants companies to give all the information the IASB mandates, leaving investors to choose what kind of information they use.
Fitch sits firmly in the information compendium camp. The IASB is working towards more entity-specific disclosure and not boilerplate, which Fitch supports, says Razvi. “But you need to have two tiers of information. The minimum rules-based disclosure should ensure high-level comparability. Then the principles-based disclosures should encourage issuers to provide more relevant information in a timely manner.”
The accounting world is also considering a two-tier approach, albeit rather different. The staff of the New Zealand standard setter have been working with the IASB and developed a filter to help concentrate on the most important types of information, says Teixeira. “This essentially says, let’s work out what’s important and then dig down deeper into these things. Then the preparer can have some licence to provide more summary information that is not as detailed on the parts that are not so important.”
While ICAEW recognises the disclosure problem and supports the project, it thinks having principles of disclosure is not enough. The Institute would like to start with centralised disclosure objectives developed in IAS 1 – clear objectives that explain how different types of information are used by the users of financial statements can help preparers apply judgement better. But this needs to go further.
Dunn says the principles should be supported by more granular disclosure objectives within the individual standards. “These specific objectives should make clear what information users want, how it is used, and when, for preparers to assess whether a disclosure is needed in the current year, and if so, what information to provide. Bland, high-level objectives will not on their own be sufficient.”
This could address the complementary or repetitive nature of many current disclosures. For example, IFRS 2 requires users to give information about the potential dilutive effect of share options – but so does disclosing diluted EPS, as required by IAS 33. Then there are inconsistencies and commonalities: security over assets is mentioned in several standards but all in slightly different ways.
Standards tell preparers to disclose certain things without giving a reason, says Teixeira. “Having a clarity of disclosure objective would break this checklist mentality. When developing a standard, the IASB should know what types of information investors are interested in and the decisions they want to reach using that.”
The IASB’s emphasis, he says, is not to lose information but rather to make sure the information is good quality. “There are two ways to do that: to remove the generic ‘clutter’ which is not particularly helpful, and to add information that might be missing.”
While technology did not surface in the discussion paper, AI will undoubtedly shape the presentation and analysis of information – especially as AI can already read contracts and analyse contract terms. On top of this, companies will need to file electronic versions of accounts by 2020.
Green asks: “Will we see natural reading that can scan a whole set of accounts and provide users with the data they really want? Then companies could issue all the information they are required to, and investors will use technology to interrogate that information in a way that is useful to them.”