Home Articles ANALYSIS: FINANCIAL REPORTING DISCLOSURES: CUTTING THE CLUTTER

ANALYSIS: FINANCIAL REPORTING DISCLOSURES: CUTTING THE CLUTTER

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The issue of ‘disclosure overload’ is not new, neither is it an issue for preparers of IFRS financial statements only. In fact, a number of standard-setters and regulators around the world are attempting to find solutions to the issue of disclosure overload. By Mareli Dippenaar

The International Accounting Standards Board (IASB) has found that financial statements contain too much irrelevant and not enough relevant information owing to the poor application of the concept of materiality and the lack of appropriate judgement.

Users of financial statements – including investors and analysts – view the financial disclosures as being too generic (boilerplate) and lacking relevance, making them less useful to their decision-making. Financial disclosures often include too much clutter and this can become confusing or overwhelming for the users. Preparers of financial statements often use International Financial Reporting Standards (IFRS) disclosure requirements as a checklist without considering their relevance, use the wording directly from IFRS, or copy note disclosures from illustrative financial statements but fail to make the information specific to the entity’s specific circumstances.

Possible reasons for disclosure overload include the following:

  • The growth and complexity of financial reporting disclosure, which results in more disclosures, all of which are not necessarily relevant to a specific entity.
  • Risk-aversion. Cautious preparers rather disclose everything required by IFRS, so that they can’t be blamed for omitting important information or misleading their users.
  • Effort. It’s relatively easy to simply use the wording from the IFRS disclosure requirements or illustrative financial disclosures, but it takes effort to consider the relevance and usefulness of the information in an entity’s specific circumstances.
  • Inappropriate application of the concept of materiality and judgement.

The excessive disclosure of immaterial information becomes burdensome to preparers, it obscures the material, useful information (which loses its prominence), and the communicative value of financial statements suffers as the information becomes less relevant, less transparent and less useful.

HOW TO REDUCE THE DISCLOSURE OVERLOAD

It is indeed a challenging task to decide what and how much information to disclose in the financial statements. In order to improve the effectiveness of financial reporting, it is essential to focus on the quality, not quantity, of the disclosures provided. Preparers need the courage to change their mind sets and need to adopt a fresh approach to disclosure: it is essential to move away from a ticking-the-box mentality where IFRS minimum disclosures are treated as a checklist. One should rather take a step back, think about it, consider the relevance and usefulness of the information provided and move away from generic wording and disclosures to entity-specific, useful disclosures. Instead of erring on the side of caution and simply disclosing everything, it should be considered if the information provided is material. International Accounting Standard (IAS) 1, Presentation of Financial Statements, allows non-compliance with specific disclosures required by IFRS, if the information is not material.

GUIDANCE ON MATERIALITY

The Conceptual Framework for Financial Reporting states that information is material if omitting it or misstating it could influence decisions that users make on the basis of financial information about a specific reporting entity. In other words, materiality is an entity-specific aspect of relevance based on the nature or magnitude, or both, of the items to which the information relates in the context of an individual entity’s financial report.’ However, applying this concept of materiality requires judgement and up to now there has been a lack of guidance in this regard.

The IASB is undertaking a broad-based initiative to explore how disclosures in IFRS financial statements can be improved. This disclosure initiative consists of a portfolio of projects, one of which is a research project on materiality, to consider how materiality is applied in practice in IFRS financial statements and disclosures. In order to assist preparers of financial statements to determine whether information is material, the IASB published draft guidance, in the form of an exposure draft of an IFRS Practice Statement, Application of Materiality to Financial Statements (draft practice statement), in October 2015, to obtain feedback from parties with an interest in financial reporting. In developing the guidance, the IASB consulted with the International Auditing and Assurance Standards Board (IAASB) and the International Organisation of Securities Commissions (IOSCO), among others, in response to concerns about uncertainty in applying the concept of materiality, particularly in the notes to financial statements.

A practice statement is not a standard and is therefore not mandatory, but simply includes guidance developed by the IASB. This draft practice statement, once published in its final form, should assist preparers in improving the overall quality and effectiveness of their disclosures, by removing uninformative wording. It does not change the definition of materiality in the framework, nor does it absolve entities from the responsibility to disclose material information. The draft practice statement discusses the characteristics of materiality, provides guidance on applying the concept of materiality to the presentation and disclosure of information, includes guidance to assess whether omissions and misstatements of information are material to the financial statements, and provides limited guidance regarding the application of materiality to the recognition and measurement requirements of standards.

CONCLUSION

Moving away from disclosure overload and removing the clutter in financial reporting disclosures takes courage and effort and requires a change in mind set and a fresh approach to communicating information to the users of financial statements. Judgement is required in order to determine what information is material and an entity’s specific circumstances should be considered. In addition, it is necessary to understand the users of the financial statements and what decisions they make based on the financial statements. Determining what information is material remains a challenge, but guidance is finally on its way!

The deadline to submit comments on the draft practice statement was 26 February 2016.

AUTHOR |Mareli Dippenaar CA(SA) MAcc Taxation (Stellenbosch) is a postgraduate accounting lecturer in the School of Accountancy at the University of Stellenbosch

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