Corporate Financial Reporting
Discussion
High quality financial reporting is an issue that affects both individuals interested in investing in the financial markets and ordinary people within an economy. The proposal presented in the discussion paper has especially raised a number of issues with respect to the implication that it has for financial service entities especially banks. The proposal within the discussion paper relating to the classification of assets and liabilities should not be the case for financial service entities for it may cause a clash with the statement on paragraph 2.78 of the discussion paper which asserts that the source of profitability for such entities is management of financial assets and liabilities. The assertion in the discussion paper that the benefits of the proposal outweighs the costs of preparing the suggested information by banks may also not be true if the role played by disclosure is considered. Preparation and presentation of financial statement is a tiring task for financial department. There are numerous requirements that have to be met in disclosure. It is noteworthy that the cost of disclosure may vary considerable depending on the volume of financial transactions, the technology employed by a banking or financial institution and the time allocated for preparation of the financial records. This is an issue that the proposal appears to have ignored in asserting that the cost of preparing and auditing the financial records is universally high.
The discussion paper develops an image that the IASB is developing regulations that are considerate of individual banking institutions financial and time resources. While this may appear to be a positive move that could result in increased profitability, the risk involved in employing approaches that are less restrictive cannot be afforded by the banking sector. Millions have over the years been lost due to accounting practices that were open to manipulation. With this in mind, more emphasis should be placed on ensuring transparency rather than considering the financial and time resource used by financial institutions. Focussing on financial entities expenses in developing the financial statements undermines the role of disclosure and should therefore be reconsidered.
One of the key issues is the assertion that there is a need in change of presentation of financial statement for financial service entities that should result in significant benefits with respect to the cost associated with making the changes. A critical review of reporting and bookkeeping within financial service entities reveals that they currently have numerous guidelines and robust financial algorithms and ratios that are recognised internationally. It is noteworthy that the proposal for change in presentation is being made without tangible evidence of failure of the current ratios. Even though the impact of the global financial crunch has had its way with standards setters resulting in the need for re-examination of some of the existing practices, there is no evidence of a problem that can only be addressed with change in the primary financial statement. The current presentation approach and ratios are appropriate for predicting cash flows among other important financial requirements. The proposed financial statement presentation would results in complication of ratios used in analysing financial results which could potentially result in reduced transparency, comparability and comprehension.
A review of developments and changes made in financial reporting shows that financial crises and hardships have played a significant role. Massive failure of the existing financial systems, infiltrations, unethical practices and failure of the existing practices to shield financial institutions from harsh economic times have historically played a role in changes in financial reporting. The 2008 economic crisis has led to the realisation that the existing financial practices have some leaks that could have global implications. A review of the 2008 economic crisis reveals that the problem originated from issues relating directly to the financial and book keeping approaches adopted by financial institutions and banks. Failure of a system for instance the financial systems could be a result of collapse of a component or poor interaction between components. The assertions that there is no need for change appears to be misguided in that though there is no direct link between the primary financial statement and economic crisis , the financial system were compromised thus calls for change are in order.
Another concern is that there is lack of meaningful definition of the distinction between the business and financing sections. Moreover, categorisation between operating and investing is not clear. The ISAB as a global entity has been developing guidelines used by financial institutions in bookkeeping and accounting. It is noteworthy that a key requirement in developing guidelines is that they should be clear to avoid misunderstanding. Clarity is a requirement that is shared by both guidelines and regulations which serves to assert its importance in financial reporting. Clarity in defining the difference between potentially derogatory financial terms is required for consistent application of management approaches especially for banks. The discussion paper does not clearly define these terms which may result in significant confusion on how common businesses functions of financial institution should be classified. Since the discussion paper does not have a concise classification or categorisation of banking activities it makes such activities arbitrary which reduces comparability across banks. It is noteworthy that the current categorisation of the cash flow items, comprehensive income items and financial positions items into operating, investing and financial activities may not be as helpful in defining practical banking and making decisions. In cases where banks are required to make distinction between the activities, there is likely to be a reduction of comparability of financial information across the banking sector which may result in bookkeeping and accountancy practices that do not meet IASBs cohesiveness objective.
Issues pertaining to clarity have for years considerably impacted on the guidelines developed by the IASB. In fact a number of amendments in the guidelines have been a result of the need to clarify issues. It is noteworthy that amendments are only necessary in a case where the guidelines have been put into action without the detection of unclear issues. However, amending guidelines to ensure clarity before their implementation is a possibility that the IASB could consider before the discussion papers proposals are transformed to requirements that financial institutions have to conform to.
The discussion paper proposes the use of a management approach to categorised assets and liabilities. Even though the approach may be effective in relaying the management intent in financial reporting, the discussion paper lacks sufficient information to assist financial service entities in categorisation. The use of a management approach could result in inconsistency in reporting on a global scale. It is noteworthy that though managers are better placed to translate financial documents, individual investors depend largely on comparability with other institutions. It is noteworthy that comparability of financial statement enhances their characteristics in a qualitative dimension. By reducing comparability of financial statement, the proposed management approach of categorisation would impede individual investors understanding of financial statements by reducing their ability to develop a clear picture of a firms financial performance relative to others and changes in financial positioning.
A review of financial reporting reveals that even though one of the key objectives is management purposes relating to decision making and planning, another role is its importance to individual investors. A financial statement is a document that helps organisations asses their performance within a given period (Stickney, Weil Schipper 2009). Reasons for improved or lacklustre performance are often based upon the financial statements. Like any assessment tool, acceptability of the results is dependent on the usability of the tool by both the management and investors. The use of a management approach which reduces individual investors ability to translate the results could lead to a situation where investors and management teams are at constant disagreement with respect to the financial positioning of firms. This is a key undoing of the proposal for it undermines a goal in financial reporting.
The management approach to categorisation of assets and liabilities could have a negative impact on the already ailing financial markets. Investors confidence in the financial markets has been low due to instabilities and the global financial crisis. In a financial environment where the risk of investment is considerably high, individual investors are less willing to commit their financial resources to ventures that they do not fully comprehend. The management approach to categorisation of assets and liabilities would make every banking and financial institution subject to investors mistrust this would be detrimental considering that most banks need to develop their investment bases owing to the effects of the financial crisis.
Another concern is the need for transparency in presentation of certain important figures. The presentation of realised and unrealised fair values gains and losses should be made more transparent (Basel Committee of Banking Supervision 2009). It is noteworthy that the discussion paper in efforts to improve on transparency proposes that a schedule should be presented in the notes to financial statements. The proposal would reconcile cash flows and disaggregate comprehensive income into four proponents. It is evident that such a presentation would result in additional requirements thus increased complexity of financial statements. As a rule of thumb, transparency has a form of indirect relationship with complexity thus an increase in complexity of the financial statements is likely to lead to a reduction in transparency. This goes against the IASBs efforts to improve on the levels of transparency displayed by financial statement. The proposal to create a complex schedule for financial service entities is basically uncalled for considering that sufficient levels of transparency for realised and unrealised fair value gains and losses can be attained through specific presentation in primary financial documents. Moreover, the proposal in the discussion paper for reconciliation would not be in line with the discussion papers objective of disaggregation. This is an issue that undermines the objective set forth by the discussion paper.
There are a number of objectives set forth in developing accounting and bookkeeping regulations. There are cases where the attainment of an objective may undermine the realisation of another objective. For instance, simple regulation can easily be undone though they allow for usability and transparency. On the other hand, complex regulations may not be easy to forge though they are associated with low levels of usability and transparency. This implies that in setting up regulations there is a need to strike a balance between these factors considering that integrity and transparency of financial statements are equally important. The existence of checks and balances within any amendment is a necessity since perfection is illusive in a practical setting
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