Accounting - Instead of praising annual reports, the ASB now wants to bury them

The annual report is dead. Or at least it will be if the Accounting Standards Board (ASB) has its way. The UK’s standard setter has all but washed its hands of this cumbersome and often unread document. After years of attempting to reform it, the latest suggestion is that the whole thing be dropped.

The plan appears to be as sensible as it is radical. Attempts to re-engineer the traditional financial statement put one in mind of the remark from the yokel who is asked for directions from a stranger: “Well if I were you I wouldn’t start from here.” So the ASB has given up.

The problem with trying to drastically alter financial reporting is that it is built on a mixture of company law, stock exchange regulations and accounting standards. But now that the Department of Trade & Industry is coordinating the company law review there is a once-in-a-generation opportunity to clear the decks and start again – and the ASB is determined to seize the opportunity.

The ASB wants a financial statement that will mean something to investors – and that, as a result, might actually be read by them. Over the past few years it has investigated the possibility of reducing the length of financial statements by eliminating certain disclosure requirements. And, back in 1996, it commissioned academics to find out from analysts and other sophisticated users what else could go. Unfortunately, the answer was not a lot. As one ASB insider put it: “When we asked preparers, auditors and users no one could agree about what should be axed.” In the end, 15 items were “candidates for deletion” and a further 58 were “possible deletions”.

But pick up one of the financial reporting tomes from Ernst & Young or Deloitte & Touche and you’ll realise that even 100 deletions would hardly diminish its bulk.

Despite this inability to decide what should go, it is obvious that listed companies would communicate more effectively with their private shareholders if they sent them shorter reports. The law already allows listed companies to send summary financial statements in place of the full set to those shareholders who want them. However, according to the Merchant Handbook 1998, only 30% of FTSE 250 companies offer summary statements (which says something about how seriously they take communicating with shareholders).

To help them do better the ASB has three proposals:
– the law should be re-framed so all listed companies are required to prepare summary financial statements (SFSs), which will become the main report for shareholders;

– the financial content of SFSs could be the same as the content of preliminary announcements;

– full audited financial statements have a vital role in holding companies up to scrutiny, so they would still be available and would be filed at Companies House. This, the ASB believes, would cause annual reports to lose their current glossiness, and evolve into a plain paper format similar to the 10-K documents prepared by US listed companies.

These changes alone may seem radical enough, but the ASB is going even further in its aim of bringing financial reporting to the masses. When Sir Ron, now Lord, Dearing set up the Financial Reporting Council and the ASB in the early 1990s, he got a bee in his bonnet about how non-accountants did not understand profit and loss statements, balance sheets, etc. The example he always used was that most people thought reserves meant cash.

To overcome this problem the ASB is proposing that companies might also offer their shareholders an even simpler narrative review – so far dubbed the “simplified financial review” – which will report and comment on a standardised set of financial highlights in plain language without including confusing tabular profit and loss accounts, balance sheets etc. Shareholders could be sent this review unless they opt to receive financial statements – full or summary – instead. The law would have to be changed to permit companies to provide information in this way.

Although there was a heated debate within the ASB about whether the summary should come out at the same time as the prelims, the proposal is that the timetable would remain as it is. In other words, preliminary announcements would come first, then the full audited report, the SFS, and the simple review would be produced together. In the end, the idea that the City may have been forced to wait for its figures was enough to keep the prelims ahead of the rest.

These are bold proposals, but at this stage proposals are all they are, and the reaction of the DTI will be crucial if they are to get any further.

Its major worry may be that, in pursuit of better communication with private shareholders, the ASB is dumbing financial reporting down too much. If all shareholders get is a cartoon version of company performance, with the directors’ salaries thrown in for good measure, it may save a forest or two, but it won’t improve investor enlightenment.

Peter Williams is a chartered accountant and freelance journalist.