More flexibility needed, says ACCA and Deloitte.
The growing complexity of rules and standards is at risk of seriously limiting the usefulness of narrative reporting, warns a major new report from ACCA (the Association of Chartered Certified Accountants) and Deloitte.
Hitting the Notes, But What's the Tune? (available from the Related documents box at the bottom of this page) collates the opinions of some 230 chief financial officers (CFOs) in listed companies across nine countries on the current challenges and future shape of narrative reporting in annual reports.
The report finds that the divergent needs of shareholders and regulators are leading to overly-complicated and compliance-orientated reports.
“Companies are trying to serve two masters at the same time,” explains Professor Isobel Sharp, Deloitte audit partner. “They want to inform shareholders of what is happening in the business. They need to satisfy regulators by meeting all the disclosure rules.
“To achieve succinctly and simultaneously both outcomes in the same report is a major challenge.”
Helen Brand, ACCA's chief executive, adds: “Even before the global financial crisis, questions were being raised about the validity of current corporate reporting. As our report finds, increasingly voluminous and complex regulatory requirements are seeing the story of business performance drowned out by a mountain of detail.”
The report found that:
Meeting legal and regulatory requirements was the most popular driver (83 per cent) for narrative disclosures. Shareholders' needs came marginally (82 per cent) behind this.
71 per cent of respondents consider the top critical challenges in producing a narrative report to be the number of requirements placed on preparers, and the cost and time involved in preparing the report.
The interviewees see the five most important disclosures for shareholders to be: explanation of financial results and financial position (identified as of high importance by 87 per cent); identifying the most important risks and their management (67 per cent); an outline of future plans and prospects (64 per cent); a description of the business model (60 per cent); and a description of Key Performance Indicators (KPIs) (58 per cent).
In the aftermath of the global financial crisis, 78 per cent of preparers consider that the discussion of risks and their management is of greater interest.
Looking at improving future narrative reporting, 65 per cent of interviewees say that they would like a reporting environment with more discretion and less regulation, 58 per cent cite the inclusion of external auditor opinion, 57 per cent believe there should be more emphasis on forward-looking information and 51 per cent ask for International Accounting Standards Board (IASB) guidance. The IASB is due to issue guidance on narrative reporting, entitled Management Commentary, at the end of October 2010.
“We need to debate the future direction of narrative reporting,” says Professor Isobel Sharp. “Do we give preparers more responsibility, or do we let the relevant authorities issue more rules for preparers to obey? Less data may provide for better information.”
Helen Brand concludes: “Today's reporting is meeting the data requirements but is it information? Our results suggest not. Preparers seek more discretion and less regulation.”
Quotes from interviewees in the report:
US: Quote from Ron Dissinger, chief financial officer, Kellogg Company
Setting out how the Kellogg business has performed is, Dissinger feels, the main thing investors look for from the narrative within the company's annual reports.
“They want to know about the state of the business,” he says. “They can read and interpret our financial statements. What they want set out in the narrative are clear statements on the state of the business and drivers of performance.”
UK: Quote from Eric Hutchinson FCCA, chief financial officer, Spirent Communications Plc
Eric Hutchinson is a fellow of ACCA and he also believes in the need for greater clarity in explaining companies' business models.
“The most valuable part of the narrative report for users is the business review,” he points out. “They want to know what the company does, how it generates income and who its customers are - plus, are those customers going to come back next year, and are they going to buy more or less? With all the complexities of language that tend to sit around the business review and reporting, it can be quite difficult to penetrate.
“I think that a lot of readers of accounts do find it very difficult, with any company, to really understand what its business is. I would like to see, in the annual reporting at least, a clear statement of what the company does in plain English, followed by a clear explanation of how it generates income.”
And while many companies have increasingly complex business models, he believes that the overall rationale for a company's existence can always be conveyed concisely and clearly.
“If you can't set this out on one side of paper, in fairly large type, then there's something wrong.”
Singapore: Quote from Amos Ng FCCA, chief financial officer, Straco Corporation
Compliance has not been set up in opposition to users' needs, says Amos Ng, but to reinforce them.
“Things like the code of corporate governance and directors' remuneration are pretty important disclosures, whether you are shareholder or staff. At the end of day, regulators are there to serve the needs of stakeholders and this is the perspective from which they start.
“Achieving compliance with the laws and rules governing narrative reporting lends credibility and reliability to your annual reports. If things were left entirely to the preparer, this would lead to varying standards.”
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NOTES TO EDITORS
The Hitting the Notes but What’s the Tune? report is based on telephone interviews with 231 CFOs and group finance directors from companies based in Australia, China, Kenya, Singapore, Switzerland, the UAE, the UK and the US in April and June. Further in-depth interviews were carried out with seven other CFOs from Kellogg Company (US), Centum Investments Company Ltd (Kenya), Dubai Insurance Company (UAE), Exco Resources (Australia), Straco Corporation (Singapore), Spirent Communications plc (UK), and Time dotcom (Malaysia) and three representatives from investor organisations - the Council of Institutional Investors (US), the Association of British Insurers (UK) and the National Association of Pension Funds (NAPF).
ACCA (the Association of Chartered Certified Accountants) is the global body for professional accountants. We aim to offer business-relevant, first-choice qualifications to people of application, ability and ambition around the world who seek a rewarding career in accountancy, finance and management. We support our 140,000 members and 404,000 students in 170 countries, helping them to develop successful careers in accounting and business, with the skills required by employers. We work through a network of over 80 offices and centres and more than 8,000 Approved Employers worldwide, who provide high standards of employee learning and development.
In this press release, references to Deloitte are references to Deloitte LLP, which is among the 's leading professional services firms.
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