Telling the story clearly

Paul Cooper explains how the IASB’s disclosure project is seeking to ‘declutter’ annual financial statements so that their messages come across clearly.

There is broad agreement that the content of annual financial statements needs to be reduced, and that preparers should make their main messages clearer. There is less consensus over the underlying cause of this problem: are preparers lacking in courage or the ability to ‘tell the story’ in their own way? If the former, is this due to the approach taken by regulators and external auditors? The content and structure of Accounting Standards themselves have also been criticised.

The IASB has been listening to the concerns regarding Accounting Standards. This article covers the various projects in the Board’s Disclosure Initiative. These involve formal consultations, to each of which ACCA will provide responses, based on discussions with our Global Forum for Corporate Reporting. Background factors and related work are also covered, to assist an understanding of how excessive disclosure (‘clutter’) is perceived.

History of the project, and the first consultation issued

The IASB initially gathered ideas at a discussion forum which was held in London in January 2013, and generated a feedback statement in May 2013.

The first formal consultation was issued by the IASB in March 2014. The IASB is now considering comments received, following the closing date of 23 July 2014.

This first step proposes several changes to IAS 1 Presentation of Financial Statements, to confirm that preparers should exercise judgement in areas such as the application of materiality, the disaggregation of required figures in the primary financial statements and the structure of the notes to the financial statements.

The IASB’s intention is to encourage thought. For example, many preparers hitherto regarded as compulsory all of the ‘minimum disclosure requirements’ in individual IFRS, even where evidently immaterial. This has obvious consequences in terms of the level of ‘clutter’, which risks obscuring the main messages which the financial statements should be conveying.

At the same time, the IASB strikes appropriate notes of caution, to ensure that the encouragement of judgement does not facilitate inappropriate manipulation of the financial statements. Disaggregation and the structure of the notes should not detract from the principles and requirements of IFRS. This discourages reporting entities from, for example, displaying ‘non-GAAP’ measures prominently, where they tend to give a more favourable impression than those established under Generally Accepted Accounting Practice.

The likely next steps

The IASB plans three further projects within the Disclosure Initiative, although there may be some changes following comments submitted by respondents. These projects will be developed during 2014, and some proposals may be issued for comment by the end of this year.

Firstly, the IASB aims to improve the information provided under IAS 7 Statement of Cash Flows. More broadly, the Board will consider further guidance on materiality, with particular reference to significant accounting policies. The Board will also consider the general principles for disclosure, thereby amending or replacing IAS 1, IAS 7 and IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors. Arising from this latter work, the IASB will review individual Standards for conflicts or duplication.

The importance of materiality

A more considered application of materiality by preparers will be generally welcomed, but ACCA has raised a concern about a potential undesirable consequence of the proposed practical clarification in IAS 1 that disclosure requirements are subject to the over-riding criterion of materiality. Faced with the detailed list of minimum disclosures in other IFRS, preparers and users of the financial statements may incorrectly gain the impression that there is a ‘hierarchy’ in the Standards, with IAS 1 sitting above others.

The IASB’s intended review of the disclosure requirements presents an opportunity to address this potential difficulty by, for example, making the lists of disclosure requirements in individual IFRS less prescriptive, and including an accompanying confirmation in each Standard that the requirements need not be applied to immaterial items.

Consequently, it will be beneficial for the IASB to move on, as soon it can, to review the disclosure requirements in individual Standards. Some comments have already been received on IFRS 3 Business Combinations, in response to the Post-implementation Review of this Standard earlier this year.

Furthermore, unless the users of the financial statements know what the level of materiality is, they will be uncertain as to whether the non-disclosure of a required item represents non-compliance, or the fact that it is judged to be immaterial.

The obvious solution in this case would be the disclosure of the materiality level applied by preparers. This is not required by IFRS, but we now see audit reports disclosing both materiality and tolerable error (for example, see the FRC’s Annual Report).

Regulators, external auditors and other users of the financial statements

A widely-held view is that regulators and external auditors have traditionally challenged perceived under-disclosure, whilst not regarding over-disclosure as within their remit, except to the extent that inaccurate or misleading information is thereby presented. The necessity of tackling the problem of non-GAAP measures indicates that even the threshold for action over misleading information may need to be lowered.       

Preparers mindful of their auditor, and auditors wary of their regulators, can easily take refuge in comprehensive, formulaic disclosure. This can be readily ticked off on a disclosure checklist, and reduces the risk of queries and even lengthy (and therefore costly) exchanges of views, when there is scrutiny of the financial statements or the external audit work.

There is a wide range of users of the financial statements, and certain groups of users would define themselves as ‘stakeholders’ in the reporting entity. In addition to the owners and lenders, there are analysts, employees, indirect investors (such as the members of an investing pensions scheme), and even wider society.

It is necessary to identify the groups which preparers of the financial statements should have regard to. The IASB’s Conceptual Framework does this by identifying the primary users of financial statements as the reporting entity’s existing or potential investors or creditors. It appears that analysts are not directly encompassed, although many of the parties to which they provide information could be.

It is helpful to have this identification, as it would be impractical, and go against the aim of reducing ‘clutter’, to meet all of the information needs of the wider range of users of the financial statements. However, if for example, analysts routinely make adjustments to published financial information, and there is no one accepted method of making these in order to provide relevant information to potential investors, this should not be ignored by a Standard-Setter. An important function of any set of Standards is to reduce diversity in practice where possible.

In addition to the preparers of financial statements, regulators, external auditors and other users have the opportunity to participate in the Disclosure Initiative. There are already signs that regulators will adopt an approach which supports the steps agreed to reduce ‘clutter’.

Related work (in brief)

The Disclosure Initiative complements the IASB’s ongoing review of its Conceptual Framework, which provides the basis for preparing and presenting the financial statements. The work of other bodies also assists the IASB: for example, in 2012, the EU’s European Financial Reporting Advisory Group, in conjunction with national standard-setters, issued a paper discussing a disclosure framework for the notes to the financial statements.