reducing complexity in financial reporting is desirable
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Reducing Complexity in Financial Reporting is DesirableTRANSCRIPT
“Reducing complexity in financial reporting is desirable, and will allow the exercise of professional judgement. Rules should never take precedence over sound accounting principles”
The word ‘complexity’ is used to describe something intricate to comprehend; putting this
definition in the context of financial reporting complexity; complexity can be described as the
intricacy experience by the investors/audience of financial reporting. There are two causes of
complexity in financial reporting, those caused by the intricacy in commercial transaction,
and those that were initiated through the fault of the financial reporting standards setter, via
regulations (ACCA, 2009). Qualifying the purpose of financial reporting insinuated that the
information in financial reporting must be understood by the targeted audience for the
message to be appreciated (Rutherford, 2013); the lack of understanding of the content of
financial reporting by the investors will inherently have some effect on the accuracy of the
decision being made based on the report. Thus, it aroused the question of how accounting
complexity affect managers financial misreporting; Dechow and Dichev (2002), research
based on the ‘mistakes theory’ argues that complexity causes managers to make more
mistakes and exercise poor judgment. For example, on complex transaction, preparer are
more likely to err when applying standards, thereby increasing the likelihood of misreporting.
As a result of making error, many preparers will instinctually throw everything into the
disclosures (Hoogervorst, 2013), to avoid been caution; consequentially investors now face
with the problem of information overloading. Another theoretical assumption on the issue of
financial reporting complexity is the ‘manipulation theory’, this theory suggests that
managers will manipulate financial information to their advantage when accounting rule is
complex, in so doing, creating uncertainty for the audience of the report usually the investors.
The issues of financial reporting complexity mostly revolves around the rule and compliance
subjectivity; rule such as the one governing revenue recognition varies depending on the
country GAAP standard, even within a country, preparer of financial reporting always find
ways around the set guidelines provided by the standard setter. For example, Tesco revenue
recognition in relation to how it recognised its rebates from suppliers, on this issue Spence
(2014) argues that the manner at which Tesco recorded the rebate revenue is a common
practice in the retail industry, however, Mr. Rogers Sainsbury's finance director cited in the
telegraph (2014) said “accounting for rebates and commercial revenues was ‘very objective’
and ‘clearly defined’ by a set of rules and regulations", dismissing comments that it was a
"subjective process". The two arguments thus bought a spotlight on the complexity of
revenue recognition in financial reporting. The inconsistency in GAAP standard across
countries and the lack of comprehensive guidance combined with the complexity in some
transaction has resulted in a large number of errors in the area of recognition of revenue
(Sondhi and Taub, 2006); on the issue of complexity and the inconsistency in revenue
recognition disclosures, Tanya Branwhite in a press release to the Telegraph stated: “The
veracity of that information cannot be vouched for and what one company says is underlying
profit may not be at all the same in definitional terms as another company’s view of
underlying profits.” . without a consistence means of verification, managers could easily
manipulate financial information at the detriment of the investors; this notion was affirmed in
the study sponsored by FASB in 1981, the research findings concluded that managers
sometimes wittingly try to structure leases differently (as operating lease) to avoid incurring
additional liabilities; in the aftermath of the Enron crises in United State, Sarbanes-Oxley Act
specifically mandate the SEC to review the concept of ‘principle-based’ accounting; after the
review, the SEC rejected the idea of a principles-based only although recommended the
adoption of an objective oriented principles-based approach to promote the exercise of
professional judgement, to minimise complexity and also enhanced the quality/faithful
representation of financial reporting. Addition to SEC proposal, in October 2002 the FASB
delivered a Proposal on the adoption of the Principles-Based Approach to U.S. Standard
Setting.
As noted by many observers, complexity in financial reporting is mostly entrenched on the
approach adopted by the preparer and the GAAP standard in used. According to the FASB,
the demand-driven nature of financial market and the complexity in accounting standards has
resulted in the exclusions to principles in the standards and increases the amount of
explanatory (footnote) and application guidance provided by the FASB and others for
applying the standards, thus making financial reporting cumbersome (FASB, 2002, pp. 2–3).
could lead to situations in which professional judgments, made in good faith, result in different interpretations for similar transactions and events, raising concerns about comparability.
Comparability may be seen as especially important in an international environment, as there is the danger that local accountants and regulators arrive at differing views on the interpretation of contentious accounting issues.
As Schipper (2003) points out, rules are likely to proliferate as accountants ask for guidance that, they hope, will protect them from criticism and lawsuits.Detailed rules and authoritative guidance also serve standard setters’ and regulators’ objective of reducing the opportunities of managers to use judgments to manage earnings (and of auditors to have to accept that practice). Standard setters can be and must show that they are active standard setters. Thus, they may tend to overproduce standards and to write detailed rules covering almost any conceivable situation.
After the aftermath of the Enrol scandal
Enron lied about its profits and stands accused of a range of shady dealings,
including concealing debts so they didn't show up in the company's accounts.
http://news.bbc.co.uk/1/hi/business/1780075.stm
“Financial accounts are supposed to provide investors and stakeholders with an understanding of
the operating performance of the business
This suggests that investors can completely process the pension information that has already
been recognized in income, but fail to fully impound the valuation impact of pension
liabilities disclosed only in footnotes
The Perils of Pensions: Does Pension Accounting Lead Investors and Analysts Astray?
Marc Picconi
The Accounting Review, Vol. 81, No. 4 (Jul., 2006), pp. 925-955
Published by: American Accounting Association
Article Stable URL: http://www.jstor.org/stable/4093156
For example, many preparers will err on the side of caution and throw everything into the
disclosures. They do not want to risk being asked by the regulator to restate their financials.
The risk is that annual reports become simply compliance documents, rather than instruments of communication
underlying profit may not be at all the same in definitional terms as another company’s view of underlying profits.”
Lawrence, A., 2013. Individual investors and financial disclosure. Journal of Accounting and Economics, 56(1), 130 –147.
Rutherford, B. A. (2013). A genre-theoretic approach to financial reporting research. The British Accounting Review, 45(4), 297-310.
Hoogervorst, H. (2013). ‘Breaking the boilerplate. IFRS Conference, Amsterdam.
Sondhi, A. and S. Taub, 2006. Miller Revenue Recognition Guide. CCH Incorporated.
Dechow, P., and Dichev, I., 2002. The quality of accounting and earnings: The role of accrual estimation errors. The Accounting Review 77 (Supplement): 35-59.
ACCA, 2009
http://www.accaglobal.com/content/dam/acca/global/PDF-technical/financial-reporting/tech-ms-com.pdf
Crawford Spence
https://www.accountancylive.com/tesco%E2%80%99s-travails-awkward-revenue-recognition-issue
Mr. Roger.
http://www.telegraph.co.uk/finance/newsbysector/epic/tsco/11132545/Tesco-accounting-questioned-by-Sainsburys.html
Leon Gettler
http://www.charteredaccountants.com.au/News-Media/Charter/Charter-articles/Reporting/2011-08-Call-for-financial-report-overhaul.aspx
Cox, C. 2005. “Remarks Before the 2005 AICPA National Conference on Current SEC and
PCAOB Developments.” Speech given by the SEC Chairman, Washington D.C., Dec 5.
http://www.sec.gov/news/speech/spch120505cc.htm.
Herz, R. 2005. “Remarks Before the 2005 AICPA National Conference on Current SEC and
PCAOB Developments.” Speech given by the FASB Chairman, Washington D.C., Dec 6.
http://www.iasplus.com/usa/0512aicpaherz.pdf.
Peterson, K. 2008. Accounting complexity and misreporting: manipulation or mistake?
Working paper, University of Oregon
Businessweek online herz
http://www.businessweek.com/stories/2002-08-18/its-like-when-someone-robs-a-bank
http://www.charteredaccountants.com.au/News-Media/Charter/Charter-articles/Reporting/2011-08-Call-for-financial-report-overhaul.aspx
http://books.google.co.uk/books?id=uTr1Vh87p6kC&pg=PA69&dq=Financial+reporting+preparer+judgement&hl=en&sa=X&ei=Ils4VJqmEYze7AaKrIHgDg&ved=0CE8Q6AEwBw#v=onepage&q=Financial%20reporting%20preparer%20judgement&f=false
Sondhi and Taub (2006) summarize the problems with revenue recognition when they write:
“The lack of comprehensive guidance, in combination with the variety and complexity of
revenue transactions, has resulted in a large number of financial reporting errors in the area of
revenue recognition.” Revenue recognition can be complex because of uncertainty about both
standards and transactions.