“Annual reports are getting longer but not necessarily more useful”.
Critically evaluate the above statement including comments from the current literature and debate, and provide examples from annual reports and make reference to the IASB conceptual framework, where appropriate to support your arguments.
Annual reports communicate and present in truth and fairness the activities of the companies during the past financial year. Reports contain both financial (statements) and non-financial (strategic report, corporate governance report, audit report etc.) information in various forms, which are largely regulated by standards (governed by the IASB conceptual framework) and statutes to ensure accurate and consistent reporting.
According to the IASB conceptual framework, the objective of the annual report is “to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity”. This definition can be further broken down into two main objectives; stewardship and decision usefulness, which by purpose contradict each other.
Reports are used by a wide variety of users such as those above and other stakeholders e.g. employees. Each of these users requires different information from the company to fulfil their needs. Ideally the information in the report should be useful to all parties, but due to mandatory requirements from regulation such as the Companies Act 2006, standards (IASs, IFRSs) and other codes (Corporate Governance 2016), it is hard to strike a balance, resulting in much narrative, some of which is again mandatory e.g. management report, corporate governance report etc., and some which is voluntary. For example, Britvic’s 2014 annual accounts include a brief overview of the business background and its main products (p.4) as part of the strategic report. Similarly, BP’s 2015 annual report gives a relatively detailed breakdown of the company’s segments and operations on pages 2 – 5.
The traditional view is that annual reports should be prepared on the basis of communicating to shareholders the effectiveness of management’s stewardship (arising from agency theory). In 2010, the IASB changed the conceptual framework to push back stewardship as a main objective, but there was a lot of objection to this decision. As a result, the IASB issued an exposure draft in October 2015, and proposes to give more prominence to the importance of providing information needed to assess management’s stewardship of the entity’s resources. The information required to assess stewardship is historic and backward looking e.g. financial statements, and is also objective and thus arguably more reliable. Similarly, this information will have been audited, giving further credibility to the financial statements in particular.
On the other hand, many argue that as shareholders are investors, they require information that will aid their decision-making. This information should be forward-looking regarding strategy, business models and the company’s ability to create sustainable long-term value and generate cash. Several interviewees in the FRC Cutting Clutter report said that reports are backward looking, too complicated and that main points are poorly connected. This is another reason for reports getting longer, as there is an increasingly greater volume of narrative to compensate for this.
The IASB conceptual framework recognises the primary users of reports as present and potential investors, lenders and other creditors. ICAEW (2011) also agree that reports should focus on shareholders and investors as trying to meet the requirements of ever-wider ranges of users leads to a loss of focus and reports become less effective. This leads to what is referred to as ‘clutter’ in reports. The FRC defines clutter as “both immaterial disclosures that inhibit the ability to identify and understand relevant information, and explanatory information that remains unchanged from year to year”. This definition can be split into two main debates; materiality and standing data.
Currently, the notes include all disclosures, regardless of whether they are unchanged. With clarification on materiality for disclosure purposes, the content and unnecessary clutter currently included may be reduced, although ICAEW believe relevant information may not be disclosed on the grounds of alleged immateriality. Similarly, although IAS 1 only requires disclosures for material items, the FRC study found that a key reason for including unnecessary disclosures was due to a “lack of confidence in making the judgement between disclosures that are material and those that are not”. This perhaps shows a weakness in either the professional training of accountants, or that the consequences of strict regulation and legislation have a negative impact on practice.
To meet the practical consequences of current legal requirements, the annual report is produced as a single volume, and contains both new and unchanged information. As a result, each report contains standing data (identical to previous years) e.g. statement of director’s responsibilities (Britvic 2014 Annual Accounts, p.76) which could be presented separately within the annual report, and with regulatory change it could be possible for it to be included on a website. This has already happened in legislation on the audit report (part of the annual report), as auditors are authorised to provide a link in the ‘audit scope statement’ directing users to a website with the standardised information instead of including the full text in the report.
In conclusion, despite the conceptual framework identifying decision-usefulness as the key element to reporting, the annual report is in conflict between historic and forward-looking information. Therefore, additional narrative and disclosures, including those required by demand from users regarding the wider effect of the company’s activities, is filling out the report whilst clouding the message it aims to convey. This extra information is also contributed to by the confusion as to what constitutes materiality for disclosure purposes, and therefore this issue should be addressed immediately, as it is likely to reduce notes to the accounts.
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