No closure on disclosures

(Conclusion)

Risk-aversion as one of the main culprits

“Many preparers will err on the side of caution and throw everything into the disclosures. They do not want to risk being asked by the regulator to restate their financials….”-Hans Hoogervorst

They say the first step to solving a problem is to understand the problem.  In an effort to further understand the “disclosure problem,” IASB organized a Discussion Forum on Financial Reporting Disclosures which was participated by regulators, standard-setters, auditors, preparers and users of financial statements.  While there were different perspectives from the participants, a common conclusion, according to Hoogervorst, was that many aspects of the disclosure problem have to do with behavioral factors, referring specifically to risk-aversion. 

The following texts taken from The Feedback Statement on the Discussion Forum on Financial Reporting Disclosures released by IASB in May 2013 paint an even more detailed picture of how risk aversion contributes to the problem.

• Some preparers treat financial statements as compliance rather than communication documents. The result is an excessive use of boilerplate text. In their own defense, some preparers said that the cost of failing to disclose what later proved to be relevant information was high.

• Auditors and securities regulators had focused on compliance at the expense of communication, leading to a ‘tick the box’ approach to disclosure.

• Regulatory enforcement using a ‘comply or explain approach,’ whereby preparers are called to explain why a particular disclosure is not material, leads to a ‘better safe than sorry’ attitude. Preparers, and auditors, claim that this leads them to err on the side of caution so preparers include disclosures even if they do not consider the information to be material.

I do not know if there were participants to the Discussion Forum coming from the Philippines but I wouldn’t be surprised if the same views will be heard if a similar forum is held locally.

What can be done?

When the standard-setters prescribed what disclosures should appear in the financial statements at a minimum, surely they didn’t imagine it will result in “excessive disclosures.”  Preparers complain about the increasing disclosure requirements in the standards. Users complain that they are not getting the information that they need. The Discussion Forum demonstrated that there was no clear agreement on the problem definition among the participants.  But they all accept that they contributed in a way to the problem and that there are no quick fixes for the problem. 

They also agreed on another thing – that IASB should take the lead in addressing the issue.

In response, Hoogervorst set out in his speech a 10-point plan for the IASB to deliver tangible improvements to disclosures in financial reporting which includes among others:

• Clarifying that the materiality principles does not only mean that material items should be included, but also that it can be better to exclude non-material disclosures.

• Clarifying that if a Standard is relevant to the financial statements of an entity, it does not automatically follow that every disclosure requirement in that Standard will provide material information.

• Making sure that the Standards, particularly IAS 1 – Presentation of Financial Statements, give companies flexibility on the order of the notes and where  they disclose accounting policies, allowing companies to communicate their information in a more logical and holistic fashion and  to give greater prominence to important accounting policies.

• Seeking to use less prescriptive wordings for disclosure requirements when developing new Standards, creating more explicit room for judgment on materiality.

• Reviewing the Standards, starting with IAS 1, IAS 7 – Statement of Cash Flows and IAS 8 – Accounting Policies, Changes in Accounting Estimates and Errors, with the goal of creating a new disclosure framework, to be followed by a general review of disclosure requirements in the other existing Standards.

It might take more than a change in the standards to change the current culture of boilerplate disclosures and checklist mentality but Hoogervorst and the IASB hopes that the above measures will “help to ignite the much-needed change in mindset of preparers, auditors and regulators that is so sorely needed.”  Well, I too hope so.

Oliver C. Bucao is a Risk Management Partner of Manabat Sanagutin & Co. (MS&Co.), the Philippine member firm of KPMG International.

This article is for general information purposes only and should not be considered as professional advice to a specific issue or entity.

The view and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG International or MS&Co. For comments or inquiries, please e-mail manila@kpmg.com or rgmanabat@kpmg.com