Financial statement disclosures
One of the projects that the International Accounting Standards Board (IASB) is currently undertaking is the Disclosure Initiative project, with the aim of improving communication in financial reports.
The IASB has identified three main concerns about disclosures in financial statements, namely: there is not enough relevant information in the notes, there is irrelevant information in the notes, and there is ineffective communication of the information provided.
The IASB released a discussion paper in March 2017, DP 2017/1 ‘Disclosure Initiative – Principles of Disclosure’ and is currently seeking feedback on the disclosure issues identified and on the Board’s preliminary views on how to address them.
You are an investor who, for years, has struggled to work through and understand all of the note disclosures when analysing and comparing the financial reports of companies that you are considering investing in.
You are currently considering investing in either CBA or NAB. After reviewing and comparing the note disclosures provided in their 2017 annual reports, you plan to make a submission in response to the IASB’s discussion paper. In your submission, you plan to provide feedback in response to ‘Section 2 – Principles of Effective Communication’ of the discussion paper, given the difficulties that you have faced due to ineffective communication in financial reports.
In section 2 of the Discussion Paper, the IASB has proposed that a set of principles of effective communication be developed. The seven principles identified in the Discussion Paper are that information in the financial reports should be:
Response to Disclosure Initiative – Principles of Disclosure
The use of Notes to accounts to the financial statements in the Annual Report is to communicate the users of the financial statements the methods in which the values used in the statements is arrived at. There are various methods which can be applied to calculate the figures used in financial statements depending upon the nature of the business and the environment. The notes to accounts are thus very useful in understanding the true impact of the financial values and comparing them with other organizations. They help in understanding the financial health of the organization. However the lack of proper disclosures results in ineffective communication and makes it difficult for the investors to understand the values. This at times leads to suboptimal decision making and even wrong decision making by the investors.
Lacking Principles of effective communication
The review of the notes to financial statements of Central Bank of Australia (CBA) and National Australia Bank Limited (NAB), for the F.Y. ending 30 September 2017 shows that the most lacking principles of effective communication in the note disclosures are:
1) Lack of clear and simple language and
2) Free from unnecessary duplication
It is observed while reading the notes that there is great use of technical words and phrases. The language is not very clear and easy to understand. The statements comprises of a lots of technical references which makes it difficult to compile a statement. The users normally lack the understanding of the technical words and hence end up referring to various other sources to understand the statements. As a result it becomes very time consuming to read and understand the disclosures and also results in misinterpreting the information. The information disclosed in the notes includes a lot of general information from the accounting standards or general information on the nature of the transaction. This information is mostly in the form of accounting definitions and hence do not prove to be of any use to the user of the financial statements. For example the Note 17 on “Provision for Doubtful Debts” in NAB (2017, pg. 90), Includes the information on effect of modification on the provisions of doubtful debts. The information contained is highly technical and shows no connection in the given context. It uses the word loan for debts and explains the impact on impairment of the loan agreement is renewed. The technicality and formal language of the information makes it difficult to correlate it with the organization and with provision for debts in the given situation.
Duplication of data and information is another big concern in the notes and disclosures to financial statements. It has been observed that certain information is repeated at various places which make the disclosures lengthy and bulky to read. The duplication of data and information makes the users disinterested in reading the disclosures carefully and leads to ignoring the important information. The example of duplication and excess information is the first paragraph of the notes to accounts. The disclosure of both the organizations in its first paragraph states that the accounts have been prepared as per the standards issued by AASB and IFRS and the corporations Act, 2001, (CBA, 2017, Pg.93 & NAB, 2017, Pg. 65). The information on compliance of various standards has been iterated in the auditors’ reports as well as the directors’ report. The repetition of the information makes it unnecessarily lengthy and boring to read again and again. Similarly, the disclosure on “Financial Instruments” in NAB (2017, Pg.65) gives information on financial liabilities which are disclosed in Note 19, 20, 21 and 25 respectively. The information is not required to be disclosed here and leads to duplication of information. The disclosure on Derivative Financial instruments include information on what are derivatives and how they are used. The information is not necessary and makes the notes lengthy (CBA, 2017, Pg. 96). The information is copied from the accounting standards and is of no value addition in the disclosure notes of an organization.
Thus it can be concluded that biggest problems in understand the disclosures to the financial statements is the use of technical language copied from the accounting standards and relevant laws. This makes it difficult to correlate the same with the organization and the given accounting reference in the annual report. The above problem simultaneously leads to duplication and redundant information. Since the information given is copied from standards and uses technical language, it is not required as it only makes the disclosures lengthy.
Suggested Changes to improve effectiveness of notes disclosures
The two major changes that can improve the effectiveness of the note disclosures are:
1) Fact Disclosure over form disclosure: The notes normally disclose the nature of the transactions, agreement and the impact of changes in them in legal terms. However, if the information disclosed is about the impact on the financial position of the organization as the result of change in the agreement and transaction, it will more useful for the users in decision making. Thus the direct impact of the transaction on the organization will relate the disclosure with the company.
2) Reduction in redundant information: It has been observed that a lot of information in the notes to disclosure is redundant and helps only in increasing the confusion. Additional information is given on financial terms and transaction even if they are not applicable to the company. For example in place of giving the definitions of operating and financial leases in the disclosure note for ‘Leases’, it will be more useful if the information is given on values of operating and financial leases entered into by the company during the last financial year and till date. As it might be possible that the company has no operating or financial lease, hence the disclosure on the types of leases is redundant information. This can help in even reducing the amount of information presented to the users and increase its utility.
Though the bulky and a large Annual Report may appear attractive in the book form it is very unattractive when it comes to read and understand it for decision making. Thus the biggest change is to reduce the length of the information disclosed and keep it straight and crisp.