There are none so blind Accounting

Cover one eye with a hand and you see only that which your limited vision allows. Two eyes are inevitably better as they allow you to absorb a greater part of the environment with fewer obstructions. Complete darkness offers no comfort whatsoever.

The corporate governance debate during the past 12 months has focused much on how limited the community's vision is regarding what goes on during the audit process and what checks and balances are in place to ensure the information put out into the marketplace is relevant, reliable and presented in accordance with applicable accounting and other requirements.

What is now consuming the time of many accounting, legal and other professionals is what steps can be taken to improve the quality, clarity and transparency of the information the community receives about the operations and financial performance of companies.

Initiatives floated by various individuals and organisations have included the removal of a boilerplate audit report, replacing it with a more discursive document that describes the risks faced by a company and an assessment of the aggressiveness or otherwise of a method of accounting for a transaction.

Advocates of what is commonly tagged the "plain English audit report" argue the need for a renaissance in the way auditors converse with stakeholders receiving the end product of their work. That - some commentators hope - would lead to users of accounts to attain a better understanding of what a company's performance has been like and the nature of risks a company faces that have been disclosed within the company's financial statements.

The provision of a qualitative assessment of a company's chosen accounting treatments by the external auditor in an audit report is worthy of serious consideration. This recent campaign for the audit report's expansion, however, parallels moves by regulators such as the Securities and Exchange Commission and standard setters such as the International Accounting Standards Board to have more detail on management judgments related to accounting policies.

A recent exposure draft issued mid-May for public comment by the IASB includes a proposed requirement for companies to disclose the reasons for adopting certain accounting policies and their importance. Decisions on when to recognise revenue in financial statements, for example, would fit snugly into the category of an accounting policy that would be significant.

Another type of policy that might be suitable for such disclosure is how a company deals with types of costs incurred during the financial year. A debate last year over the appropriateness of telecommunications companies storing up costs on the statement of financial position - the balance sheet - had as a central issue whether companies really had an asset when they spent money on advertising to get customers or subscribers.

If Australia goes down the IASB route in requiring these disclosures, which will be expected of the AASB if these recommendations are embedded international accounting standards later this year, then companies will need to focus on how best to explain the impacts of chosen methods of accounting on the final reported results.

This will place the onus on all involved in the preparation of financial statements to shed any remaining reliance on technical jargon in order to swing the pendulum towards providing documents that will be better understood by company shareholders and others interested in the way in which a company has progressed during a given year.

This is not to say the responsibility in striving for an understanding of corporate performance rests solely with company management or the board of directors. There is also a profound responsibility on those holding stock in a company to show sufficient interest in exercising their ownership responsibilities by asking more questions about things they don't readily comprehend.

You wouldn't find people ignoring details of water bills, electricity bills, car insurance and other things that pass across their kitchen tables each day. There are responsibilities associated with running a household and ignoring those issues risks having certain services or benefits discontinued.

Similar care needs to be paid to the task of holding stock in a company and, while there is an obligation on the part of companies to provide information that is clear and unambiguous, an equally important obligation exists for those holding shares in an entity to make an effort to understand the material provided.

This is where the use of a concise financial report as the primary communication between a company and its shareholders needs to be questioned. There is sufficient anecdotal evidence about the inadequacy of these documents from auditors and others that should give our corporate regulator, the Australian Securities and Investments Commission, and the Federal Government cause for concern.

It is probably time to consider returning to the practice of sending out the full set of financial statements to shareholders and emphasising the need for them to read the numbers rather than just looking at the mercurial rises and falls of the share price on a daily basis. This is the only complete source of information for shareholders and, while the concise financial statements seemed like a good idea at the time, it is necessary to reconsider the merits of issuing those documents following the collapses of entities such as HIH, One.Tel and Enron.

Concise financial statements are precisely that. They do not contain all of the disclosures prepared by a company. Auditors will tell war stories of annual meetings where shareholders ask questions about the financial statements and refer to issues that have been addressed in the full-blown set of accounts.

Those shareholders have been the recipients of the concise set of financial statements that do not contain all of the notes prepared for compliance with accounting standards and the Corporations Act.

During an interview earlier this year John Shanahan, a partner at Spencer & Co, pointed to the need for investors to go beyond the concise reports if they find a qualification or an emphasis of matter in the audit report signed off by the external auditor.

Shanahan rightly pointed out that not all of the matters subject to the audit qualification will be contained in the abbreviated document and it made it all that much more difficult for people wanting access to the information that could help them unlock what is to them a mystery or black hole.

A further concern spoken about in accounting and investor circles for some time now is that absence of prominent "health warnings" in concise financial statements to indicate that the full set of accounts may be obtained from the company. The importance of prominent warnings of this sort cannot be underestimated because while the product might comply with legal requirements set down in the accounting standard covering concise financial statements it is inferior by comparison to the full financial statements.

Even if the communication is shorter and might be sufficient for some, there is still a grave danger that important information that investors need access to will be missed if all they are getting is the concise set of financial statements. This points to at least two significant problems regarding accessibility. Material written in the jargon of regulation has less of a chance of being understood by shareholders, but shareholders that do not receive all of the relevant facts as prepared by the company for regulators are in danger of not seeing the complete picture.

It seems a fairly complicated way to deal with what is a very basic and fundamental concept about communication. Done well, it enhances trust between a company, its shareholders and the market generally. Poor communication leaves the way open for distrust, confusion, accusations a lack of transparency and a lack of accountability.

Allowing people the opportunity to better understand the state of play with a company or even a government means there is every chance of those individuals developing a trust in what they're being told by the entity concerned and, most probably, less chance of them feeling as if they've been left in the dark.

Each of us is blind until somebody takes the time to give the gift of sight.

Disclaimer

The purpose of this database is to provide a full-text record of all articles that have appeared in the CDJ since February 1997. It is aimed to assist in the research and reference process. The database has a full-text index and will enable articles to be easily retrieved.It should be noted that information contained in this database is in pre-publication format only - IT IS NOT THE FINAL PRINTED VERSION OF THE CDJ - therefore there might be slight discrepancies between the contents of this database and the printed CDJ.