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.
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?
