The Inconvenient Truth about Reporting Simplification

Australia, in common with many countries, requires that Australian companies preparing information for investors apply IFRS (International Financial Reporting Standards). These standards theoretically provide a common set of rules, with the aim of ensuring that financial statements provide the necessary information in an understandable way.

 It is very important that investors obtain understandable information so they can determine whether or not they should invest, continue holding their investment or divest their investment. Theoretically, Australian financial statements should provide the necessary information in an understandable way - given they are compliant with IFRS.

 But, do they? 

I suggest that in the majority of cases, they don't. The primary reason is that a set of financial statements is simply too long. When even small entities with single (or no!) operating activities produce financial statements in excess of 80-100 pages, it is safe to say that few people will read the statements in sufficient detail to be able to understand what the financial position and performance of the company is.

 Even if an investor did read the financial statements, the voluminous (and dreaded) Note 1 - Statement of Accounting Policies is normally sufficient to make accountants eyes glaze over, let alone the poor investor, particularly if they have no accounting knowledge.

Financial statements have other, more enduring issues which have been the subject of many debates historically - they are (certainly in Australia) historical looking - forward statements of any sort are not found in the audited financial statements. They are based on historical costs (although this is changing - with highly confusing results) and hence are not a good indicator of the value of assets. Perhaps the most glaring oversight is that financial statements include the complete lack of non financial metrics - no details on number of sales, etc. 

Putting aside the enduring issues for a minute, Australian auditing firms, accounting bodies and ASIC have been promoting "Reporting Simplification" - an attempt to make financial statements more understandable by focussing on materiality of events and by reducing (in some circumstances) the disclosures required.

 Given the requirement to comply with IFRS, the Reporting Simplification program has had, to put it mildly, an uphill task. Most audit firms provide example "Simplified" financial statements, mainly focussed on grouping accounting policy disclosures and disclosure matters (for example risk disclosures) with the relevant note. This is helpful, but is similar to filing emails from your inbox into separate folders - sure, you can now go to a particular folder to find an email, but you still have hundreds of emails to sort through.

 A key point of focus to reduce unnecessary length has been on encouraging companies to only disclose "material" information and events. For those non-accountants reading, a "material" item is one which influences an economic decision made by the reader. So, an item is "material" if ONE reader would change their decision based on the disclosure (or non-disclosure) of an item.

Given the current commercial environment business operates in (which can be generally characterised as litigious) you can imagine how enthusiastic Directors and Auditors (as well as company and auditor insurers) are to remove information from financial statements. Whilst there are numerous (politically incorrect) ways of communicating this lack of enthusiasm, I will be restrained and simply say they are not enthusiastic at all.

Not only that, but in the event one of the parties (say the Board) choose to omit information on the basis it is immaterial, it is highly likely that the other will decide the information is material, and request it be disclosed.

Case in point, I recently helped a small listed company prepare financial statements. There was an item which was clearly immaterial, however the final financial statements included two extra notes and several extra lines on the main statements in respect of it.

 None of this is to say that company Boards and their auditors are not serious about providing quality, understandable information to investors. I'm sure they are.

 The inconvenient truth is that Reporting Simplification efforts focussed on materiality or reformatting are doomed to fail, and fail expensively. In terms of costs, simplification exercises can be hugely expensive, for example:

•  many hours of accounting staff and audit time are required to change the financial statements and audit format changes) 
•  Changes to accounting and reporting systems to reflect new formats or groupings of information 
• Decisions to exclude items based on materiality take up huge amounts of Board, audit partner and manager (plus technical review teams), adviser and legal adviser time debating the issue.

And, at the end of it all, you still end up with 80 pages which only a few people will read in full.

A more effective solution 

 So, to all those companies about to undertake a reporting simplification process I urge you.....Don't.

Instead, devote that time and attention to improving your analysis included in the Annual Report, or your Investor Presentation. Develop your internal systems to track key non financial performance measures and report those to investors - show investors what really drive your results. Talk about your cashflows in more detail and how the non financial measures drive your cashflows.

A greater reliance on discussion and analysis is where Australia needs to go to ensure our investors get quality understandable information. Many other jurisdictions require discussion and analysis - and companies comply with varying degrees of detail - but that's kind of the point. Do you want to invest in a company that appears to be genuinely informing you - or someone who is ticking the boxes?

Tis the Season to be ........ preparing for your next audit/review?

As the Australian reporting season winds up, with the vast majority of AGMs over now, it is an appropriate time for each business to reflect.....on how much of a nightmare the audit was.

Hopefully, your audit season was smooth sailing, with the audit starting on time, no late issues identified, accounts and reports finalised a week before the Audit Committee (or Board Meeting) and no uncomfortable audit fee overrun discussions.

Actually, if you scored any two of those, you are probably doing well and are looking forward to a relaxing break over the holidays - as you have the half year (or full year) under control already.

However, this post isn't aimed at businesses who have their audit processes under control, it's more for those that don't.  Set out below are some practical tips for those businesses who didn't have a smooth audit season last time and are hoping that because this is a half year, things will be easier this time.  Without a plan, that's probably not going to happen.

Improve your Forecast Reporting - Integrate your Forecast Details!

Nearly all businesses spend considerable time and effort in preparing an annual budget or forecast.  Generally, time spent in looking forward at what is expected to happen is a good thing, for a variety of reasons.

The problem with Budgets or Forecasts is that at some point you compare it with actuals.

Excellent, all good...or is it?

So, from the above picture, should a user be happy that things are going to plan? Revenue down, but operating costs down, slightly higher maintenance bit overall profit up.  Looks ok, right?

Well, it could be ok, or it could be not.  The main issue is that this picture alone doesn't tell you context - are those variances simply timing differences (ie, actions that were done at a different time to the budget) or permanent (ie actions that weren't forecast/budgeted at all).

Being a high level view, another issue is that large offsetting variances in a line item net off.  So, in operating costs, significant overruns in salaries might be offset by lower materials costs (due to poor accruals.

What is a business to do?

Managing Non-Financial Information in business reports.

Managing Non-Financial Information!

I'm pretty sure that most business routinely incorporate at least some non-financial information into daily and monthly reporting.  Hopefully, non-financial information is a critical part of your daily and monthly reporting, because having the right non-financial information in your reports is the quickest way to improving business performance!

However, non-financial information poses a number of issues when used in financial reports and if businesses aren't careful these issues can quickly erode users faith in the report.

What are the primary issues and how can we practically deal with them?

Accruals - Are they worth the effort?

Accruals - Are they worth the time and effort?

Because.....Star Trek?

Soooo, accruals.  In my experience, accruals are bottlenecks in every medium to large company - in some cases even in small companies.  Typical issues include late delivery, incomplete or inaccurate numbers and time consuming processes to collate and post.

On top of that, in many businesses, monthly costs are comparatively consistent - so the monthly result isn't particularly different if you don't post accruals.  Depending on the focus of your management reports, it may not matter at all (for example, if your management reports are cash focussed or primarily focussed on non financial performance indicators).

With that context, why do businesses spend the time and effort to collect data and post accruals (at least on a monthly basis) ?  For compliance reporting, such as half and full year accounts, you obviously have to take the time, but why every month?

Shorten Your Month End Close - Starting now!

Welcome all, to 2015 - an auspicious year in which you WILL improve your work/life balance by cleaning up and speeding up your month end close.

Why do you need a shorter month end close?  Simple you get performance information back to the business faster - which is the entire point of the process.  As a side benefit, shorter closes also tend to refine processes so they are more efficient throughout the business.  

Essentially, you need to be shooting for at worst a work day ("WD") 5 close - my personal view is that you should have completed your reporting by that time as well, but some are saying you can have an extra 3 days to complete that.  Ideally, WD 3 is better and is a target I tend to shoot for.

Why not WD1?  Practically you need a lot of resources in the Finance team to get that to work.  Most businesses without business intelligence systems are better off accepting a slightly longer close.

So, the key question is - how do you go about shortening up your close?

How FAST is your Excel?

Standards - making life easier

Excel is a remarkably versatile program.   It, or one of the alternatives to it, will undoubtedly be found in just about every business which has a computer.  Businesses use it in many different ways, from simple lists, through reporting to simulations and financial modelling.  However, Excel's flexibility means that for any task, the effectiveness, reliability and results produced will be dependent on the skill of the user who develops the workbook.

What this means is that the chances are really high that for any given task, the excel workbook in one business won't be structured, formatted or use the same formulas as a the same task in another business (except when one person moves to another place and takes the workbook with them).

The fundamental result of this is that huge amounts of time are wasted in business, either re-developing a workbook to do the same task, or trying to troubleshoot (and rebuild) existing workbooks.

Wouldn't it be great if there was a Standard governing how to structure excel workbooks?