Do Annual Financial Reports have to be so lengthy and cluttered - Essay Example

? Do Annual Financial Reports have to be so lengthy and cluttered? October 26 Introduction Deloitte, one of the leading management accountancy and consultancy firms, says that company annual reports have grown in size and the average report has more than 101 pages. These reports are supposed to provide a comprehensive view about the significant activities of a firm for the preceding year (Deloitte, 2010). Investors, bankers and regulatory authorities read these reports to obtain information about the company for evaluation and investment purpose. At the minimum, the financial report must have the balance sheets, cash flow statements, profit and loss accounts, accounting policies and declarations, notes and annexures, director’s reports, operating and financial review and other such information necessary to understand the financial health of a company (Adelberg, 2012). Besides, as per the rules of regulatory authorities such as the IFRS and GAP standards, listed firms must publish the audited statement of accounts (ASB, 2009). A chartered accountant must qualify and audit these reports or, if the accounts are still under audit, an unaudited statement of accounts must be published (ASB, 2011). The annual report also provides an opportunity for the firm to highlight its achievements, speak about the plans, market share, its strategy and many other topics that the company wants to share with the public (Baker, 1992). Some other criticise this practice and they argue that such bulky reports often take the attention away from important and vital tasks of assessing the financial health of a firm(ACCA, 2012). This essay discusses the issue of excessive length of annual reports and analyses if such lengthy reports are really in need. 2. Reasons for Increase in Length of Finance Reports According to a recent report by Deloitte, many of the larger firms have reports that are more than 309 pages in length. Companies disclose their business risks, the key performance indicators, and these disclosures are in response to the EU Transparency Obligations Directive (Deloitte, 2010). A few areas that lead to clutter are immaterial disclosures, needless explanations that prevent the reader from understanding important information. Other areas for clutter are long explanations given as declarations and footnotes that do not change every year. Other examples are detailed notes on line items, share based payments and so on. These are included more as behavioural influence from the previous years (Campbell and Slack, 2008). Accountants fear comments from regulatory agencies that the reports do not disclose all the required information and hence they include a number of declarations and narrations about even minor items. Other areas that lead to excess clutter is information on corporate social responsibility, deferred tax, directors’ report and statutory information, financial instruments, intangibles, principal subsidies, movement tables, post retirement benefits, principal risks and remuneration report (Holmes, et al, 2008). One of the most abused areas that have excessive clutter is the Corporate Social Responsibility section. Many firms, such as BP and Wall-Mart, actually devote more areas on providing information and high gloss pictures on the CSR activities than they do for the actual financial reporting (Kindleberger and Aliber, 2005). While the information given in this section is entertaining and helps to understand that the company does social work also, the large volumes of information, data about various committees, sub activities, and so on do not help an investor to allot resources or to understand the health of the firm (Humpherys, et al, 2011). Another area that sees the most clutter is the section on governance. The UK Corporate Governance Code has 52 provisions but firms can show compliance to only 18. In the annual report, the firm can demonstrate how it has complied with these 18 codes. For the remaining codes, it can give the number and state briefly the reason for non-compliance. However, many firms give out detailed explanations of why these 34 codes are not applicable and why they have not complied (Johnson, et al, 2002). 3. Issues with Increased Length of Reports The financial failures and frauds such as those of WorldTel, Enron, the dotcom bust, the sub prime crises and many other such events have shown that management cannot be trusted to disclose the intricate details of their financial activities. As a result, many regulations such as the Basel III, International Accounting Standards Board’s - IASB, IFRS and other regulatory mechanisms were brought in to curb non-compliance of financial managers with the required rules and regulations of disclosure. To evade censure, many firms started writing elaborate narrative about even minor entries in the financial reports. This resulted in an overall 56% increase in the volume of data included in 1996 to 2010. By making the reports exhaustive and voluminous, no one could accuse the financial managers of hiding any facts (Li, et al, 2008). The other side of this practice is that financial reports have become generic boilerplate disclosure reports that do not provide continuity and link between the notes and create a huge information overload. The business story is obfuscated and the narrative becomes filled with jargon, clause numbers, directive and regulation numbers and so on. As a result, the lay investor who wants to understand the profit, loss, dividend per share, share price history, return on investment and other such key indicators, is left confused (Wiseman, 2002). The auditor audits the book of accounts and the figures presented in the books. However, the auditor does not read the notes and clarifications in the narrative. Other content in the annual report includes details of the financial model, the business model; sales break-up, market segmentation and other such issues. Other topics, on which excessive narration is written, include share, movement robustness of the supply chain, the competitive and legal environment and other issues of stakeholders and financial regulations. These are supposed to be true but large firms such as Barings Bank, Northern Rock of USA, Bear Stearns Bank, Madoff Investments and other very large and respectable organisations have misrepresented facts, mislead investors, committed frauds and caused losses of billions of Pounds (Adelberg, 2012). 4. Examples of Lengthy Reports Many financial reports have excessive notes, images, needless illustrations often printed with dark fonts on dark background and this makes reading difficult. The reasons for these vary from providing ‘interactive reports’ using creativity, displaying concern for people with learning and reading disabilities and so on. Some examples are given in the Appendix section. 5. Conclusion The paper has examined the relevance of lengthy financial reports. It appears that many firms use these lengthy reports to meet the regulatory requirements of the government and other agencies. The result is that the profusion information tends to obfuscate the financial information and some investors may not be able to get the correct picture of the financial health of the firm. The impression that one gets is that when these large firms give excess information, they are probably trying to hide something. This important point is often hidden behind rules and notes in the narrative. A lawyer or the chartered accountant can trace this weakness but an ordinary investor cannot understand the details. These are the problems associated with increased length of reports. The suggestion is that this clutter should be removed from financial reports. If needed, another document that gives information about the business model, CSR and other details should be created. References: Adelberg, H., 2012. Narrative Disclosures Contained in Financial Reports: Means of Communication or Manipulation? Accounting and Business Research, 9 (35), pp. 179-190. ASB, 2011.Cutting clutter: Combating clutter in annual reports. [Online] Available at http://www.frc.org.uk/about/cuttingclutter.cfm [Accessed 20 October 2012] ASB, 2009.Rising to the Challenge. [Online] Available at http://www.frc.org.uk/images/uploaded/documents/Rising%20to%20the%20challenge%20October%202009.pdf [Accessed 19 October 2012] ACCA, 2012.Lost in the narrative by ACCA. [Online] Available at http://www.accaglobal.com/en/member/cpd/stakeholder-management/communication/narrative-reporting.html [Accessed 21 October 2012] Baker, E., &Kare, D. D., 1992. Relationship Between Annual Report Readability and Corporate Financial Performance.Management Research News, 15 (1), pp. 1-4. Campbell, D. & Slack, R., 2008.Narrative reporting: Analysts’ perceptions of its value and relevance: ACCA research report 104. [Online] Available from http://www2.accaglobal.com/general/activities/research/reports/narrative [Accessed 21 October 2012] Deloitte, 2010.Swimming in words. [Online] Available at http://www.deloitte.com/view/en_GB/uk/services/audit/corporate-governance/51212f776d3cb210VgnVCM3000001c56f00aRCRD.htm [Accessed 20 October 2012] Holmes, G., Sugden, A. & Gee, P., 2008.Interpreting Company Reports and Accounts, 10th ed. London: Prentice Hall. Humpherys, S. L., Moffitt, K. C., Burns, M. B., &Burgoon, J. K., 2011. Identification of fraudulent financial statements using linguistic credibility analysis.Decision Support Systems, 50 (3), pp. 585-594. Kindleberger, C. P. & Aliber, R., 2005.Manias, Panics, and Crashes: A History of Financial Crises, 5th ed. London: Wiley Publications. Johnson, E., Khurana, I. K., & Reynolds, J., 2002. Audit-Firm Tenure and the Quality of Financial Reports. Contemporary Accounting Research, 19 (4), pp. 637-660. Li, F., 2008.Annual report readability, current earnings, and earnings persistence.Journal of Accounting and Economics, 45 (2-3), pp. 221-247. Wiseman, J., 2002. An evaluation of environmental disclosures made in corporate annual reports. Accounting, Organizations and Society, 7 (1), pp. 53-63. Appendix Example 1 Given below is an example of a needless content in annual reports. The annual report was for an automobile parts company and the graph shown below indicated various formats in which catalogues were provided over the years. The information is of now use to a investor but the graph was still placed in the report mainly to decorate the pages. Figure A 1. Content format provided in a website (Deloitte, 2010) Example 2 The following graph was taken from an annual report used by a travel agent that used different online marketing tactics. The graph shown below does illustrate the tactics used by the travel agent but it refers to tools used globally by all other travel agents. The graph is not related to the firm and it does not help the investor to make an investment decision. Figure A 2. Online marketing strategies used travel sites (ACCA, 2012) Read More