A clearer view
29 Jun 09
The FRC’s paper on reducing complexity articulates a cry from the heart for financial statements that are more straightforward to produce, and easier for users to comprehend. Robert Outram reports on the bid to clear up the tangled mess in financial reporting
by Robert Outram
The Financial Reporting Council’s project on reducing complexity in corporate reporting has finally borne fruit in the form of a discussion paper outlining principles for change and a call for action on no fewer than five fronts. The paper’s title – Louder than words: principles and actions for making corporate reports less complex and more relevant – is intended to remind all of those involved in corporate reporting that it is what happens in practice that affects the quality and readability of corporate reports.
The paper seeks to address growing concerns about the complexity of corporate reporting. Many people point to the increasing length and detail of annual reports – and the regulations that govern them – as evidence of a problem, the FRC says.
The paper recommends reducing complexity based on eight guiding principles – four for better communication in reports and four for improving the quality and effectiveness of regulations. It also recognises that there is no easy solution and that change will only happen if all of those involved in corporate reporting make a concerted effort.
According to Ian Wright, the FRC’s director of corporate reporting: “The FRC and many others agree that regulations themselves should be principles or outcomes based. So shouldn’t those setting the regulations and standards also do so within a principles-based framework? Regulations should be targeted, proportionate, co-ordinated and clear.”
The paper also makes five calls for action where the FRC believes further investigation may reduce complexity. These are:
1. Cash flow and net debt reporting: the paper asks whether this could be better aligned with user needs such as by including a net debt reconciliation, possibly through producing guidance on best practice.
2. Disclosures: the paper calls for an examination of the process for creating disclosure requirements, and suggests setting up a project investigating “the characteristics of useful disclosures.” This could lead to guidance about when disclosure requirements can be deleted as no longer relevant.
3. Wholly-owned subsidiaries reporting requirements: the FRC asks: “Could we find ways to reduce the reporting burden by reducing the filing or disclosure requirements?” The paper recognises that this could entail changes in UK and/or European Union law, so any reform would need to be over a period of time.
4. Improving the usability of IFRS: the FRC calls on the IASB to consider a project to reorganise its standards, accompanying documents and interpretations.
5. Cut clutter: could preparers reduce immaterial information (with the support of regulators) that may be undermining the quality of reports? The FRC recommends a two-step approach, first for preparers to reduce unnecessary and immaterial disclosures and, second, for an investigation into the way that various sources of regulation are contributing to clutter in annual reports. The FRC plans to carry out a review of 2008 annual reports over the course of this summer and will publish a paper on its findings.
The FRC carried out interviews as part of the research for the report, and identified areas in financial reporting where complexity could be addressed.
To take just a few examples:
• acquisition accounting – users and preparers say that valuation of acquired intangibles is unnecessary • corporate social responsibility – while CSR information is important, there is concern that “overloading” reports with this has made them cluttered.
• defined benefit pensions – users and preparers said that there is significant underlying complexity in relation to the valuation of pension plans. They also expressed that pension disclosures should include future cash flows relating to pension scheme funding.
• embedded derivatives – the FRC says many respondents observed that the “witch hunt” for embedded derivatives and the process of valuing them is “complex and time-consuming”.
• financial instruments – users and preparers are concerned, the FRC says, about the underlying complexity of financial instruments as well as the “very complex and detailed” accounting standards in this area.
Paul Boyle, chief executive of the FRC, says: “Complexity in corporate reporting is a multi-faceted problem that will require changes in behaviour from all members of the corporate reporting community, including standard-setters, company directors, auditors and regulators. We hope that this paper will stimulate change.”
The FRC would like the discussion paper to lead to debate within the UK and global financial reporting communities, and also hopes that respondents will help to identify priorities and offer to take on projects to help reduce unnecessary complexity in the future. n
Full and summary versions of Louder Than Words are available to download from the Financial Reporting Council website at www.frc.org.uk
Comments are invited by 30 October 2009 to Melanie Kerr, Financial Reporting Council, 5th Floor, Aldwych House, 71-91 Aldwych, London WC2B 4HN. Alternatively, email the FRC at complexity@frc.org.uk