MORE THAN WORDS
By Ian Fraser
Published: Accountancy Magazine
Date: November 2nd, 2009
Have corporate reports and accounts become useless as a means of communication? Ian Fraser investigates
According to the Institute of Chartered Accountants of Scotland (ICAS), wading one’s way through the 2008 report and accounts of a leading plc has parallels with the 12 labours of Hercules.
The accountancy body earlier this year complained that readers of annual reports, including investors, analysts and professional advisers, are finding them increasingly impenetrable.
ICAS blamed the way in which reports and accounts are put together – with reams of dense verbiage, pretty pictures and corporate governance disclosures often obscuring the important stuff.
Companies once used their annual reports as a means of providing their investors with an accurate description of their business model, a realistic assessment of the risks and rewards facing their business and a realistic picture of their balance sheet.
But some reports and accounts seem designed to do the exact opposite. ICAS said complained that investors are being swamped by too much useless information and too much disclosure.
Details of Sir Fred Goodwin’s pension arrangements are a case in point. These are scrupulously delineated on page 114 of RBS’s epic 248-page 2007 annual report and accounts, which was issued in March 2008, a few months ahead of the bank’s near demise.
Surprisingly, however, the former fund manager Lord Myners failed to spot these references as the government stepped in to bail out the bank a few months later. Who was to blame?
REFORM NEEDED
ICAS’s view is part of its submission to the Financial Crisis Advisory Group, a panel set up by the International Accounting Standards Board and its US counterpart, the Financial Accounting Standards Board. The FCAG – which comprises senior audit professionals and other financial bigwigs – has been asked to consider the standard-setting implications of the global financial crisis.
Hugh Shields, chief economic adviser at ICAS, said it’s wrong to make accounting and audit a scapegoat for the failures in decision-making that led to the banking and financial crisis. He said: “The main role of accounting, and its value to users of financial reporting, is that economic reality is reflected at all times – in this regard the current length and complexity of annual reports is not helpful.
“The corporate report does not tell a clear story about the performance of a business and investors and others face a Herculean task to piece together the information they need to form judgments of corporate performance.”
Complaints about the inadequacy of reports and accounts reached a crescendo with a letter to the Financial Times in May. Philip Whitchelo, a former investment banker with Dresdner Kleinwort, said it is time for serious reform.
MINDLESS BOX-TICKING
He said: “A review of the published annual report and accounts of the banks that have imploded and showered us with their toxic debris shows that the accounting sleights of hand of the 1980s have been replaced by a thick, glossy catalogue of useless puffery, where mindless box-ticking compliance and endless committees stupefy the reader with page after page of irrelevant disclosure and really important information such as the CO2 output of bank branches, and per employee, and details of the water-saving toilet flushing system installed in head office. Of the impending maelstrom, not a whisper.”
“It is time for regulators, auditors and companies to put a halt to this farce and to return the annual report to its rightful place as a source of meaningful information for investors.”
There is little doubt that it suits some corporate boards as well as their auditors to be able to “bury” some of the most pertinent and or potentially harmful and damaging revelations – which by law and accounting practice must be incorporated somewhere – beneath a smokescreen of do-goodery, dense verbiage and in the multiple footnotes which make up the bulk of most corporate annual reports.
Corporate governance requirements, coupled with a legislatively-cowed, tick-boxing mentality amongst audit committees and boards of directors, invariably means there is far more material in an annual report than there would have been a decade ago. It’s also true this gives corporate boards more nooks and crannies in which to bury their bad news, to lose the really unpalatable stuff.
The average fund manager lacks the time to plough their way through the reports and accounts of every company they’re interested in. Many prefer to focus on short-term market movements and RNS announcements on their Bloomberg screens, with some devolving the task of thoroughly reading annual reports to analysts. This, arguably, boosts the chance that the “buried” information goes unnoticed.
A WELCOME READ
Even though there is some resentment that pertinent information is not easier to find, most fund managers still see annual report and accounts as an extremely useful prism through which to gauge a company’s performance and prospects.
The fact that they are, by their very nature, a historical snapshot that is potentially full of spin is taken as read – or “discounted” in fund managers’ parlance.
But one fund manager said: “Much of the evaluation and analysis of annual reports is actually delegated to the analyst community nowadays.
“There is a worry there, given that some of the sell-side analyst firms are over-stretched or have been laying people off and they are also often conflicted, for example if they also work for the same companies on the sell-side. That can mean that some of the more negative information they should be highlighting does not get highlighted.”
Andrew Kelly, co-founder of Edinburgh-based investment boutique Cartesian, said: “It must be remembered that financial statements are required by law to give a true and fair view of the state of affairs of the company. For this reason it can be rewarding to read accounts thoroughly, as unfavourable information may lurk in the detail. We do read report and accounts and focus our attentions on the small detail to seek out hidden anomalies or to assess the financial strength of a particular company.
Graham Campbell, founding partner at Edinburgh Partners, agrees. He said: “It is often best to read annual accounts from back to front.”
“For all their flaws – and I accept that some can be rather colourful – the numbers in report and accounts do give you a good solid picture of how the company has actually performed – the cashflow, the strength of the balance sheet, the level of debt.”
In a recent review of UK annual reports the Financial Reporting Council’s financial reporting review panel said there remains room for improvement.
Having studied the reports of 330 UK companies for the year to March 2009 the panel found that reporting by AIM-listed companies remained inferior to that of their main market-listed counterparts adding that companies should look to improve their disclosure of financial risks, judgments related to the application of accounting policies and sources of estimation uncertainty.
Bill Knight, the panel’s chairman, said: “The panel encourages directors to pay particular attention to the changing risks and uncertainties facing their companies. Disclosure should be full, frank and company-specific and should avoid generic descriptions of the economy which do not help users to understand how the board is responding to the challenges faced by their particular company.”
- Accountancy is the magazine of the Institute of Chartered Accountants of England and Wales. To view the ICAEW website click here
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