Limitations to Financial Reporting Institute of Chartered Accountants in England and Wales - Essay Example

Limitations to Financial Reporting Institute of Chartered Accountants in England and Wales Jenny Smith 24th October Introduction Modern day financial reporting is seen to lack the quality of all round business reporting. It is identified that financial reporting falls short of consistency due to differences in governance polices, and investors find it difficult to determine which standards are more accurate. Hence, standardisation for reducing such differences is deemed extremely essential (PricewaterhouseCoopers, 2007). The present study is based upon evaluating the reformation required in accounting and reporting polices, as identified by the ICAEW (Institute of Chartered Accountants in England and Wales). The institution has identified a number of limitations with the present day financial reporting system such as disclosure of intangible asset values, the justification of fair value assumptions made and so on. The report is written from the perspective of accounts managers who perceive the regulatory environment for preparing financial reports. The report analyses the limitations faced by accounts managers in the current accounting and regulatory environment and the required changes necessary to improve the quality of reporting. Importance of Inducing Reform One of the prime limitations of the financial reporting system is identified to be the lack of existence of a single static model of reporting. Different jurisdictions are seen to have established differential requirements associated with financial reporting. Accounts managers, who have evaluated the financial regulations and their shortcomings, believe that such a crucial step reduces the integrity issue associated with accounting and its reporting. It is also seen that the jurisdictions established are governed by different regulatory authorities, leading to differences in the manner in which governance is executed. On the basis of size, ownership and business activity, governance and reporting of business activities are seen to differ. The requirements established in terms of reporting are seen to alter form year to year (ICAEW, 2011). Accounts managers, on the basis of their evaluation of the regulatory policies, have identified that accounting policies related to intangibles, current value, historical costing and disclosure are seen to have received the maximum degree of criticism and required reformation. It had been identified that backward financial reporting, lack of useful information for management and disclosure practices were seen to mislead investors, one of the prime reason that had caused the crisis. The backward looking criteria or historical costing system based on which reports had been made are often found to be lacking in terms of value. Formulating long term decisions on such information is often considered to be less effective (Aboody and Lev, 2010). Another crucial aspect which raises concern in respect of financial reporting faced by accounts managers is related to the current value system of accounting. Although the fair value system has proved to be more useful in terms of decision making than the historical system, fair value accounting norms provide adequate flexibility to organisations that have an intention to misguide investors. Such misrepresentation can easily be indulged into as the fair value system provides an adequate degree of flexibility towards basing the calculations upon various assumptions. Many critics hence have pointed out that in order to improve the financial reporting standards the degree of use of assumptions needs to be controlled (Arnold and Matthews, 2002). Required Changes There is no doubt regarding the fact that changes in reporting system is highly essential. For instance, accounts managers face numerous issues in reporting for intangible assets while preparing financial summary reports. The lack of recognition in terms of intangibles can be resolved by utilising a business combination technique. In cases where the combination technique cannot be put to use and intangible assets cannot be disclosed in the balance sheet, mangers may consider to present the information in a report format with necessary explanations. Such information disclosure would facilitate organizational executives, prospective investors and business associates to judge the value of the business in a more appropriate manner (Chua, 2006). As per the recommendations suggested by the ICAEW, it is seen that modern organizations derive a large amount of value through technological innovations research and development activities. Although they are disclosed in the balance sheet, it is identified that their valuation techniques has attracted debates amongst auditors, investors and the management. Firms are seen to value the intangible benefits arising out of research and development activities on the basis of the expenses incurred for it, which might not always be considered as an apt process. A radical change in the valuation of intangibles arising out of research is essential. Hence, ICAEW suggests that firms need to incorporate the recognition of such assets on the basis of certain universal standards and hence change is essential in this respect to influence better reporting. They can be feasibility tests that organizations needs to incorporate while valuing such assets (Ball, 2008). Changes in reporting system is also essential so that management can formulate better asset related strategies. Accounts managers are seen to derive less usefulness from the financial reports in terms of formulating the required strategies related to assets. Regulators at ICAEW have identified that such misjudgement arises out of different practices for valuation of assets (Penman, 2007). While historical costing provides the benefit of valuation of assets on the basis of the standard practice of past performance, it lacks the ability to incorporate the prospective changes and risks that are likely to arise in the future (Hopwood, 2009). On the other hand the fair value system, provides the required foresightedness, but lacks standardisation due to the flexibility of being able to incorporate a number of assumptions. Under such circumstances, regulatory authorities have suggested that firms must follow fair value system on the basis of pre-determined standards. Hence regulating policies and fixating few of them is deemed essential so as to control the degree of assumption making (Ballwieser, 2004). Accounts Managers have limited time to take decisions regarding allocation of costs and hence financial statements and related notes of transactions and accounting treatments requires being precise and explicit, a quality seen to be lacking extensively. Auditors may also judge the information quality derived from the financial reports, apart from just verifying the same for mathematical and accounting policy accuracy (KPMG, 2003). Although financial reports may be accurate in terms of accounting concepts and principles, they may lack the quality of being able to provide sufficient information in terms of taking management decisions. For instance, by verifying the values of existing and past current assets, it is difficult to understand the trend of rise or decline in the values of such items. It is essential therefore to incorporate ratio evaluations and detailed descriptions of the factors which have impacted current assets. Based on such data, accounts managers may be able to gain an idea regarding the immediate future trends in the valuation of current assets and take the required decisions. Hence a radical alteration in the information revelation standards can be considered beneficial (Basu and Waymire, 2008). Other Limitations to Financial Reporting Many regulators believe that the techniques used in financial reporting must be altered from the core as the market conditions have changed. Keeping such aspects in mind, it is essential that financial reports include aspects such as risk reporting. Risk elements, existing in the environment in which the business operates is seen to impact profits, revenue streams as well as expenses. Hence the existence of lack of systematic risk reporting leads has caused issues in respect of investment (Marshall and Weetman, 2008). Additionally the length and complexity of annual reports makes it difficult for investors to gain proper understanding of the financial position of firms. Hence they depend upon supporting documents, financial information providing websites and experts to gain an understanding of a firm’s position. Although ancillary bodies may provide the necessary information, investor’s satisfaction is more deeply impacted when the source of such data is the company itself (McInnes, Beattie and Pierpoint, 2007; Laux and Leuz, 2009). Financial reports are not just verified by investors and auditors; instead, they are also reviewed by various interest groups for diverse needs of information. Regulators have thus identified that disclosure quality of financial reports is required to be made more dynamic. (Cooper, 2007). Conclusion Post the financial crisis period it was seen that reporting and financial information provided to stakeholders was not well structured and provided adequate scope towards misguiding investors. Therefore, there is a severe need for standardisation of the policies, which will reduce the risk associated with the preparation of financial statements. Accounts managers should understand what investors and other stakeholders are likely to look for when they analyse financial reports. Accordingly, separate subdivisions can be created. Some of these sections might be for addressing the information needs of just a particular stakeholder group, while others can be for addressing the needs of all stakeholders. For instance information regarding the future incentive and performance appraisal policies will be of particular interest to employees while risk faced by a business in terms of sales revenue would be an aspect that all stakeholders would consider knowing. Reference List Aboody, D. and Lev, B., 2010. Information asymmetry, R&D, and insider gains. Journal of Finance, 55(2001), pp747–66. Armitage, S. and Marston, C., 2007. Corporate Disclosure and the Cost of Capital: The Views of Finance Directors. London: ICAEW. Arnold, J. and Matthews, D. R., 2002. Corporate financial disclosures in the UK, 1920–50: the effects of legislative change and managerial discretion. Accounting and Business Research, 32(1), pp. 3–16. Ball, R., 2008. What is the actual economic role of financial reporting? Accounting Horizons, 22(4), pp 427–32. Ballwieser, W., 2004. The limitations of financial reporting. Oxford: Oxford University Press, Basu, S. and Waymire, G., 2008. Has the importance of intangibles really grown? And if so, why? Accounting and Business Research, International Accounting Policy Forum special issue, 1(1), pp. 171–90. Chua, W. F., 2006. Extended Business Reporting: An Overview of Techniques. Sydney: ICAA. Cooper, S., 2007. Discussion of “Standard-setting measurement issues and the relevance of research. Accounting and Business Research, International Accounting Policy Forum, special issue, 1(1), pp. 17–18. Hopwood, A. G., 2009. The economic crisis and accounting: implications for the research community. Accounting, Organizations and Society, 34(6–7), pp. 797– 802. ICAEW, 2011. Developments in New Reporting Models. London: Institute of Chartered Accountants in England and Wales. KPMG, 2003. Building a New Reporting and Communications Model: A New Source of Competitive Advantage. Melbourne: KPMG. Laux, C. and Leuz, C., 2009. The crisis of fair-value accounting: making sense of the recent debate. Accounting, Organizations and Society, 34(6–7), pp. 826–34. Marshall, A. and Weetman, P., 2008. Managing Interest Rate Risk and Foreign Exchange Risk: Disclosure of Objectives. London: ICAEW. McInnes, B., Beattie, V. and Pierpoint, J., 2007. Communication Between Management and Stakeholders: A Case Study. London: ICAEW. Penman, S. H., 2007. Financial reporting quality: is fair value a plus or a minus? Accounting and Business Research, International Accounting Policy Forum, special issue, 1(1), pp. 33–44. PricewaterhouseCoopers, 2007. Measuring Assets and Liabilities: Investment Professionals Views. London: PwC. Read More