Financial Reporting in Corporate Governance

Discuss about the Financial Reporting in Corporate Governance.

Introduction and Purpose

In this report, the key area of discussion is the complexity in financial reporting and its effects. During this report, the analysis is done on the application of the policies and standards set by International Accounting standard Board. Primary focus of the report is made on the financial disclosure standards set by the governing authority. The report aims to identify the major issues that arise due to the high complexity in the application of financial reporting standards and find out some solution to resolve the matter.

At the time of identifying the issues in financial reporting, the report also tries to identify the reasons behind the issues. The report evaluates the accounting theories in order to critically analyze the validity of the accounting or financial reporting standards or policies. At the same time, the report also includes some examples that describe the issues in disclosure initiatives taken by International Accounting Standard Board or IASB. At the end of the report, a conclusion is derived by considering overall result of the discussion.

Disclosure Initiative taken by International Accounting Standard Board

In December 2014, the International Accounting Standard Board has introduced the disclosure initiative in order to enhance the opportunities of previous disclosure initiative provided by International Financial Reporting Standards or IFRS (Gow, Larcker and Reiss 2016). In the new disclosure initiative, IASB has considered all of the national standards set by the governing authorities in different countries. The project was started on 2012 by introducing survey on the disclosure requirements. The disclosure initiative clarifies the difference between the change in accounting estimates and change in accounting policies (Modell 2015). At the same time, the disclosure initiative has also clarified the restrictions on the cash and liquidity. The disclosure initiative includes two types of objectives – general objectives of disclosure considering minimum requirements and additional requirements that a detailed picture of the concerned transactions.

Complexities in financial reporting

The primary objectives of financial reporting are to disclose the current financial position of a company and its’ future expectations. Benzakar (2009) argued that the main aim of financial reporting is to protect the stakeholders of a company from any kind of accounting fraud. Many times it has been identified that the companies have not disclosed the important information or misstated the information in order to gain more advantage (Walker 2016). However, this type of activity affects the interests of the stakeholders. In order to solve this issue, the governing authority IASB came up with the financial reporting standards and disclosure initiative.

However, according to Revsine et al. (2009), the financial reporting standards are much complex and tough to understand. In support of that Benzakar (2009) commented that financial reporting is needed to be done on financial instruments, which are the most complex components of finance. On the contrary, Gow, Larcker and Reiss (2016) argued that financial reporting standards and disclosure initiative are based on accounting principles and if someone has in-depth knowledge of accounting principles, then following the financial reporting standards is not a tough job.

In the words of Kanodia and Sapra (2016), there are mainly two types complexities arise in financial reporting. One is inescapable and the other is avoidable. The first type of complexity arises due to the inherent complexities of the financial transactions like, transactions related to the derivatives, forwards, swaps, future and options. On the other side, the second type of complexity arises due to the introduction of accounting standards. Coad, Jack and Kholeif (2016) noted four reasons behind the avoidable financial reporting complexities. The reasons are as follows:

• Exceptions of the general accounting principles
• In disclosure standards there is a lack of holistic approach
• Use of a mixed model, which includes both historical cost and fair value methods
• Some of the bright lines

Therefore, it can be said that other than the inescapable complexities, the other complexities arise due to some improper guidelines stated under the accounting standards. On the other side, Benson et al. (2015) commented that a rule or standard can be considered as complex if the people face difficulties or issues in implementing the standard in practical field. In the words of Tricker (2015), accountants in different companies face several issues like, confusion while measuring the assets or proper valuation of inventories due to the complexities in accounting standards and disclosure initiative. Hence, the impacts of complex accounting standards are the important matter of discussion in today’s context. The impacts of complexities in accounting standards are analyzed below:

Impacts of complexities in accounting standards

In many surveys it has been identified that at present scenario, the accountants in many small and medium business organizations are not clear about the requirements of accounting standards. At the same time, the accountants are confused while using or following the accounting standards provided by IFRS or IASB (Armstrong et al. 2015). For example, while measuring the assets of the company, the accountant has two options either use of the historical cost or the fair value method. As the accounting standards do not provide any specific guidelines regarding the valuation or measurement of assets, accountants become confused which method would be better.

The companies or the accountants face another issue due to the high complexity in accounting standards; many times the companies misstate the financial transactions. Sometimes, these misstatements are done unintentionally. Due to the lack of proper knowledge in accounting, the accountants fail to understand the requirements stated under the financial reporting standards (Larcker and Tayan 2015). However, these unintentional misstatements affect the interests of the stakeholders. For example, due to the lack of proper understanding of the accounting standards, the accountant overstated the value of assets in the financial statement. This is one kind of financial misstatement. Now, while taking the investment decision, investors will get the wrong information from the financial statement of the company. As a result, the investment decision of the investor will be wrong.  

Due to over complexity in the financial reporting standards and disclosing initiative, the intension of conducting accounting frauds grows in the minds of the accounting or higher level personnel in the companies (Kukah, Amidu and Abor 2016). Sometimes, the auditors also fail to identify the financial or accounting misconducts in the financial reports of the companies. For example, in 2015, it has been identified that Toshiba has conducted the accounting scandal of $1.9 billion. This scandal was not done in one year; the company conducted accounting frauds for several years, which could not be identified by the auditors also. The company did such a scandal by overstating the profit figure in its financial statements. However due to numbers of rules and regulations as well as policies it was very difficult to identify the root of the scandal (Armstrong et al. 2015).

However, Coad, Jack and Kholeif (2016) argued that due to the complexities in the financial reporting standards and the disclosure initiative, the companies become more conscious about their financial reporting. The complex system of financial reporting requires proper knowledge, expertise and intelligence in the field of accounting. On the other side, the failure in meeting financial reporting standard properly causes huge monetary and reputation loss to the company in the form of punishment (Gow, Larcker and Reiss 2016). Therefore, the companies try to involve knowledgeable and expert person in the preparation of financial reports, so that unwanted problems can be avoided. Hence, from this point of view, the complexity in financial reporting standards has brought positive outcome.

Identifying the possible solutions to solve the issues, originated from financial reporting standards’ complexities

In the above discussions and analysis, it has been identified that the companies are facing several issues due to the high complexities in the financial reporting standards and disclosure initiative. However, the companies can solve these issues with the help of the following ways:

Most of the time, the companies face one common problem while preparing the financial report. This is the assets measurement problem. It has been found out before that there is no such strict instruction regarding the assets valuation or measurement methods for the companies and this creates confusion. In order to solve this problem, the companies can apply one particular method for the purpose of measurement and it is better to choose the fair value method (Kanodia and Sapra 2016). If the companies select the fair value method, then the valuation becomes more realistic because fair value method does not consider the historical or past cost. It is calculated on the current market value of the assets. Hence, this method is more realistic. At the same time, Coad, Jack and Kholeif (2016) believed that the fair value method of assets measurement provides relevant information for different types of financial instruments. In support of this, Walker (2016) added that IASB is also working on a project that will introduce some general guidelines or principles to determine the fair value.

At the time of preparing the financial reports, it is mandatory and very important to consider the needs of the users of financial reports. Modell (2015) mentioned that the financial reports are prepared to disclose the financial position of the company to the stakeholders. This indicates that the aim of financial reporting is to mentally satisfy the stakeholders. If the companies consider this particular point as the priority, then they will automatically disclose all the information that is relevant and useful to the stakeholders (Benzakar 2009). Therefore, following the financial reporting standards will be easier.

Proper auditing of the financial reports is very important to resolve the negative impacts of complex financial reporting standards. In many cases, it has been identified that the unintentional accounting misconducts take place due to the negligence of the auditors while auditing the financial reports of the companies (Gow, Larcker and Reiss 2016). This type of casualness must be avoided. Generally, the auditors of the companies are more knowledgeable that the accountants. Hence, the mistakes done by the accountants due to the improper understanding of the complex financial reporting standards can be identified by the auditors. Therefore, critical auditing is essential.

The complexity issue of financial reporting standards can also be solved by another way. For this, the companies only require to follow the basic guidelines of accounting theories. The improvements done by the governing bodies like IASB and FASB, are based on the basic rules and principles of accounting (Armstrong et al. 2015). Therefore, if the accountants have proper grip on the basic accounting theories, then the complexities of the new financial reporting standards can be reduced to some extent.

Therefore, from the above suggestions, it can be clearly understood that avoiding the financial reporting and disclosure initiative complexity issues is not a very tough job. However, the accountants or company’s personnel must have proper knowledge and expertise on the accounting field. At the same time, the sense of responsibility from the auditors’ end is also expected.

Conclusion

The discussion, evaluation and analysis in the report has identified that complexity in financial reporting standards is one of the big issues in present business context. Business world is already very complex and introduction of the new, improved accounting standards has increased the complexity more. The study has identified that the complexities in the financial reporting standards originated due to the lack of holistic approach, excessive bright lines, mixed model and exceptions of general accounting principles. At the same time, the study has also informed that there are mainly two types of complexities in the financial reporting standards and disclosure initiative. One is the inescapable and the other is avoidable.

The study has mentioned that the complexities in disclosure initiating and financial reporting have some negative impacts and positive impact on behaviour of the companies. As the negative impacts, the complexities create the intention of financial frauds in the companies; due to high complexity the accountants cannot clearly understand the financial reporting requirements. However, the complexity has enhanced the consciousness in the minds of the higher authorities of the companies. The negative impacts can be solved by adopting several measures like, selecting of fair value method, while measuring the assets, proper auditing and following basic accounting theories.

Reference list:

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Kanodia, C. and Sapra, H., 2016. A Real Effects Perspective to Accounting Measurement and Disclosure: Implications and Insights for Future Research.Journal of Accounting Research, 54(2), pp.623-676.

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