Usefulness of the annual report for investment decision making purposes - Essay Example

?Usefulness of Annual Reports Usefulness of Annual Reports Professionals of the accounting sector perceive that annual reports are the best way of communication between stakeholders and management of an organization. There are several stakeholders of all organizations, including investors, government, banks, creditors and shareholders. Investors are one of the stakeholders that utilize the financial information obtained through annual reports to make investment decisions. Certain investors have gained knowledge in accountancy and they use the figures provided in annual reports before coming up with an investment decision. Others use information that is related to organization’s financial conditions and does not contain figures but only facts to make investment decisions. Annual reports and their structures have changed over time to facilitate both kinds of investors. Now annual reports contain information about profit and loss, cash flows and overview of the finances of organizations. The length of these reports has increased as the required number of details has grown. Annual reports contain statements provided by management (Bartlett 1997). All these kinds of information were not previously a part of annual reports. Investment decisions are not only based on analysis provided by management and directors of an organization; the profit and loss information provided through annual reports is superior while making investment decisions. These statements are highly important for those who are literate in accountancy. Individuals having literacy in accountancy are investment analysts who provide information to investors on how well a company has performed and how well it will perform in future, and through this analysis, investors make their investment decisions. According to a study conducted by Hines (1968), the section in which the chairman provides his/her analysis is the most read pages of an annual report and the profit and loss section is mostly used for making investment decisions (Hines, 1968). Previously information provided through annual reports used to be obsolete or this information used to focus on what already had happened and not on what was going to happen. This characteristic of annual reports increased the uncertainty amongst investment decision makers because they had no idea how organizations would perform in future and what initiatives the organization would take to make the company operate successfully in future years. Due to lack of information about future activities, investment decision makers used to be dependant on old data and their confidence in their investment decision used to lack confidence in success. This led to the introduction of management’s statements within annual reports. In these statements management provides insights into what future steps the management is going to take to make the company successful in future. This information helped investors and investment decision makers make investments on the basis of future operations, and these investment decisions lacked uncertainty. For example, during 1996, a study conducted by Abrahamson and Amir (1996) proved that annual reports containing the president’s letter are a useful insight for the investor trying to predict future performance of the organization. Similarly, a study conducted by Bryan (1997) states that the management of a company is required to disclose information about future operations through annual accounting reports of their organization, and these disclosures help investors in assessing whether the firm will make profit in future and align investment decisions accordingly. Information that profit and loss statements provide is quite limited, for example: Rogers and Grant (1997) argue that financial statements are limited to providing information regarding only one quarter of a company’s operational period. On the contrary, information provided by management gives insight into a longer period of time including past performance and expected future performance. There are certain shortcomings of the information provided by management in annual reports. The main issue with information provided by management is that this information is not governed by local auditing standards. Due to lack of governance, managers may indulge in impression management and try to paint a fake picture of the organization’s health. They may even try to minimize the negative message that is produced by financial statements through the use of vocabulary (Smith, 1995). Due to such events, annual reports lose their credibility amongst investors. Similarly, the information provided by management may even signal that the company is not in good health. For example, Smith and Taffler (2000) stated through their study in 2000 that the messages provided by management may give a perception to the organization that the organization is going to be bankrupt. A major concern of annual reports is linked with the neutrality of these reports. The problem is that the management is working in the best interest of the company and they end up being biased. A study was conducted by Tauringana (2004), which showed that an annual report gives a higher degree of positive news rather than negative ones. The accounting information provided within annual reports is of great importance to investors and impacts the investors’ decision making process. The time at which the annual reports are made public also has an impact on decision making. Investors, who work on a daily basis and are smaller in size and buy and sell shares on day to day basis, change their investment strategy in accordance with information obtained through annual reports (Rippington, 1995). Certain investors who hold certain stock for a very long period of time decide whether to further hold the stock on the day the annual report is announced. A study by Ball and Brown (1968) states that if there is a prolonged delay between the year-end period and annual result announcement period, the results will have fewer effects on stock prices of a company. When the annual results are negative, it is normally believed that the investors will try to pull out their money from the stock by selling it. But this is not always the case as Ball and Brown argue that even though announcements are negative, stock prices continue to rise during the initial days after the announcement of the result. Information provided by annual reports is used by investors in making decisions regarding investment. This information is used by both accounting professionals and those who are not proficient in the field. Those who are professional heavily rely on figures and those who are not proficient rely on messages provided by management. The information supplied through figures is dependent on previous data, whereas information provided by managers informs investors about the future of the organization. The information provided by management has certain limitations; this information is not governed or regulated by accountancy standards. Due to lack of governance, investors might indulge in providing wrong information. References Abrahamson, E & Amir, E 1996, ‘The information content of the president's letter to shareholders’, Journal Of Business Finance And Accounting, vol. 23, pp. 1157–1182. Ball, R & Brown, P 1968. ‘An empirical evaluation of accounting income numbers’. Journal of Accounting Research, vol. 6, pp. 159–178. Bartlett, S & Chandler, R 1997. ‘The corporate report and the private shareholder: Lee and Tweedie twenty years on’, British Accounting Review, vol. 29, p. 245. Bryan, SH 1997. ‘Incremental information content of required disclosures contained in management discussion and analysis’, Accounting Review, vol. 72, pp. 285–301. Hines, RD 1982, 'The usefulness of annual reports: the anomaly between the efficient markets hypothesis and shareholder surveys', Accounting and Business Research, Autumn, pp. 296–309. Rippington, FA Taffler, RJ 1995, ‘The information content of firm financial disclosures’, Journal of Business Finance and Accounting, vol. 22, no. 3, pp. 345–362. Rogers, RK & Grant, J 1997, ‘Content analysis of information cited in reports of sell-side financial analysts’, Journal of Financial Statement Analysis, Fall, pp. 17–30. Smith, M & Taffler, J 1995, ‘The incremental effect of narrative accounting information in corporate annual reports’, Journal of Business Finance and Accounting, vol. 22, no. 8, pp. 1195–1210. Smith, M & Taffler, J 2000, ‘The chairman's statement – a content analysis of discretionary narrative disclosure’, Accounting, Auditing and Accountability Journal, vol. 13, no. 5, pp. 624–646. Tauringana, V & Chong, G 2004, ‘Neutrality of narrative discussion in annual reports of UK listed companies’, Journal of Applied Accounting Research, March, pp. 74–107. Read More