The Financial Reporting Disclosure - Essay Example

 The Financial Reporting Disclosure Introduction Financial reporting has evolved over the years to meet the changing needs of the users. With increasing complexity of business and capital markets, the financial reporting needs to get changed. Companies need to use fair value accounting to take into consideration the complex and judgemental measurements of a business. This underlines the importance of disclosure of more information which is relevant to the users, even though such information is subjective and less reliable in nature. The financial reporting disclosure requirements and norms needs to respond according to the changes like breaking down of items in the report to providing more detailed disclosures of the items like disclosure of assumptions, sources of estimation, models used, alternative measurement bases etc. Hence in today’s world disclosures in the annual report have become the balancing item to provide a credible report. The auditors need to disclose the accounting policies used while preparing the report to enable the user of the report to understand the report comprehensively. Majority of these disclosures were derived from the accounting system. There are many types of disclosure which are important, but a majority of them was related to the numbers in the annual report. Discussion Answer 1 With increasing complexity of the financial reporting the financial statements now have to include a variety of disclosures in addition to the traditional disclosures. The following are the list of disclosures which have to be included in contemporary financial statements. Annual report now have to include description of the accounting policies which is adopted by the relevant entity so that it becomes easier to understand the line items of the financial statements and the accounting policies on which it is based upon. Information about each entity such as names of the group entities, addresses, the composition of the share capital and the dividend payment terms needs to be mentioned. Information about each component of the line item and breaking down of each items into smaller categories of items so that they can be analysed (Morunga and Bradbury, 2013, p. 43). The disclosure should include the judgements made in the process of applying the accounting policies and the reasons of choosing the above policies and decisions. For example the disclosure of material uncertainties as per the going concern basis of accounting is to be made. The disclosure includes description of internal processes like risk management policies and practices adopted by the company (Ott and Hardie, 1997, pp. 53-57). The firm has to disclose polices and the procedures adopted for managing their financial risks. Annual report includes estimation of sensitivity analysis disclosures. This disclosure helps the users to understand the variability measurements of the items in the annual report. For example the annual reports include the disclosure of value at risk. Annual report also has to include Objective based disclosure requirements like the objectives of the disclosure which is to be provided rather than any specific disclosure. Hence it is clear that such disclosures in the financial statements are becoming important and forward-looking and it represents the new policies which every annual report has to maintain. Answer 2 There has been major impact of increased amount of disclosure by firms to the external users and to the company as well. It has made the task of communicating the complex business transactions to the investors challenging and has raised the concerns about how well the management can communicate to the interested users so that they can make an informed decision based on the report. U.S. Securities and Exchange Commission has criticized companies for making the annual report too complex for the small investors to understand. Lower readability of the annual reports will result in increasing the cost of processing the information and hence the investor has to go to the analyst for their services. Hence if the annual report becomes more complex it will be difficult for the investor to forecast accurately the return of the company and as a result the investor may not invest in the company. In the financial market any kind of uncertainty is not seen in good terms. Hence the firms need to see that the accounting reports should be explained in detail to enable the company to reach out to the interested users in a more certain way. For the company making the annual report longer means that they have to supply more information in their annual report to bring transparency in their operation. Some companies may not be comfortable in disclosing all the details. Not all investors invest in a company based on the annual report. They invest just on the basis of the brand name of the company. For such investor companies don’t have to disclose much. It may happen that in spite of being a large and well reputed company, the company may face problem in a fiscal year, and hence their profitability becomes an issue (Brennan and Hughes, 1991, pp. 1665-1691). Seeing this investor may not invest in such companies though their underlying principle remains same. Hence the company may loose on the potential money which they might have got, if they didn’t disclose too much in their annual report. Though this is unethical from the point of general investor, much of the companies are doing this to avoid such costly mistake. Another problem which the company faces is the cost in preparing the annual report (International Auditing and Assurance Standards Board, 2011, p. 9). Since annual report is prepared by auditing firms like Deloitte, PwC, they have to pay consulting fees to these firms hence their cost will rise. But as far as investors are concerned they need to be aware of all the financial performance of the company and they need the company to be transparent regarding all the items listed like the amount of debt included which can affect their earning potential (Lehavy, Li and Merkley, 2011, pp. 1087-1115). Hence with longer annual reports the communication to the investors is enhanced. Answer 3 The example of the annual report of Starbuck’s Corporation for 2004 has been considered to analyse its disclosure. The annual report of the company shows that is using basic accounting principles while reporting their statements. They have used GAAP principles for reporting and recording their cash and cash equivalents. They report this item as one item on their balance sheet (Hopkins, Houston and Peters. 2000, pp. 257-281). They have included several disclosure notes in Notes to “Consolidated Financial Statements” which give details about the item that go in this category and how they are managed. In Note 1 of “Summary of Significant Accounting Practices” Starbucks has given a basic description of what is meant by cash equivalents. They have stated cash equivalents as “all highly liquid instruments with a maturity of three months or less at time of purchase”. In Note 1 they also have given a short description of the cash management and balance maintenance system. In the cash management section in Note 1, they have explained the management of “all major bank disbursement accounts” which can be reimbursed on a daily basis along with the classification of the cheques issued but not presented for payment to the banks (FASB, 2013, p. 1). In Note 3 there is “Notes to Consolidated Financial Statements” which gives the breakdown of items included in cash and cash-equivalents. Likewise they have given a detailed illustration of the items included in the annual report. Hence it shows that Starbucks have mentioned all relevant details in their annual reports according to the proper disclosure norms. Conclusion and Suggestion Though in the annual reports the company gives a detailed analysis of the information needed by investors to make informed decision it has some shortcomings. One of the major shortcomings is that the company don’t give a detailed representation of the future plans that company is looking forward to carry out. Hence it must give the key performance indicator for the coming years based on their future strategies. They must provide quantitative analysis of the key financial ratios so that it can help the investors to make an informed choice. Again nowadays with the introduction of IFRS the length of the report is increasing. The companies must consider all the above factors while preparing the annual report. Reference Brennan, M. J. and Hughes, P. J. 1991. Stock prices and the supply of information. The Journal of Finance. Vol. 46(5). FASB. 2013. Standards. Retrieved from: http://www.fasb.org/jsp/FASB/Page/LandingPage&cid=1175805317350. [Accessed on 4 December 2013]. Hopkins, P. E., Houston, R. W., and Peters, M. F. 2000. Purchase, pooling, and equity analysts’ valuation judgments. The Accounting Review. Vol. 75(3). International Auditing and Assurance Standards Board. 2011. The Evolving Nature of Financial Reporting: Disclosure and Its Audit. Available at: http://www.ifac.org/sites/default/files/publications/exposure-drafts/IAASB-Disclosures_Discussion_Paper.pdf . [Accessed on: 29th November 2013]. Lehavy, R., Li, F. and Merkley, K. 2011. The Effect of Annual Report Readability on Analyst Following and the Properties of Their Earnings Forecasts. The Accounting Review. Vol. 86(3). Morunga, M. and Bradbury, M.E. 2013. The Impact of IFRS on Annual Report Length. Australasian Accounting Business and Finance Journal. Vol. 6(5). Ott, B. B., and Hardie, T. L. 1997. Readability of advance directive documents. The Journal of Nursing Scholarship. Vol. 29(1). Read More