Financial Disclosure Framework: Devil Is in the Disclosure
Developing a framework for disclosure has been a popular topic lately. There are many efforts underway around the world — by the Financial Accounting Standards Board (FASB), the European Financial Reporting Advisory Group (EFRAG), the United Kingdom Financial Reporting Council (FRC), and others — to establish an overarching framework to make financial statement disclosures more effective, coordinated, and less redundant.
Quality versus Quantity
CFA Institute certainly agrees with the overall objective of these endeavors. However, instead of focusing on raising the quality of disclosures, these efforts have placed their emphasis almost exclusively on reducing the quantity of information. The belief is that excessive disclosure is burdensome and can overwhelm users. This emphasis on reduction is evident in recent publications such as Cutting Clutter: Combating Clutter in Annual Reports and Losing the Excess Baggage – reducing disclosures in financial statements to what’s important.
CFA Institute, on the other hand, contends that there is no such thing as too much useful information for investors. Information overload — or useless information — may come from various sources, such as redundant, boilerplate, and overly condensed information. Improving disclosures shouldn’t just mean cutting them. To improve disclosures we need to ensure that the information is not boilerplate in nature, that it is sufficiently disaggregated, and, most importantly, that it is useful to investors. However, shorter does not automatically translate into greater efficiency. Less isn’t always more; most often it is just less.
The other focus of these efforts has been on materiality. Recommendations have been made to enhance the use of materiality in financial reporting disclosures and deleting disclosure requirements that do not contain material information.
The application of materiality to disclosure requirements per se is hardly a new concept. What has changed is the rather strict application of materiality that leads to limited information being disclosed. In the materiality spectrum, there are certain items that are clearly material and others that are clearly immaterial. However, there is a large grey area in between to which a lot of judgment must be applied in determining which pieces of information should be disclosed. Without such information, investors are ill equipped when making their resource allocation decisions.
These recent proposals also place the onus on users to glean the information they need — such as information on business risks, economic conditions, generally accepted accounting principles (GAAP), and other reporting requirements — from sources other than the financial statements. The FASB has suggested that footnotes not include information readily available from public sources.
This begs a series of questions:
- Do investors really want to look up information that hitherto was included in the footnotes?
- Will disclosures now include hyperlinks to various information sources?
- Isn’t it more efficient for one preparer to collate required information rather than a multitude of investors looking it up from various sources?
- Will these other sources of information be audited or not?
- What will comprise a complete set of financial statements?
Before moving forward these questions must be answered.
Less information may reduce the length of financial statements and the cost to preparers, but that cost will be transferred to shareholders. And they would not be well served by receiving less information.
A major unresolved issue with the work of FASB and EFRAG is the scope of their disclosure framework project. Will the disclosure framework pertain to disclosures within or outside the financial statements? Will it be applicable only to public entities, or all entities? Will it be applicable to interim reporting? A number of questions remain unanswered.
Until such issues are addressed, perhaps as a first step standard setters should consider re-engineering existing disclosures to create efficiencies within the current structure. Such efficiencies can be attained by emphasizing issues important to investors today given the current economic environment, layering of information with summary information upfront and details below, and placing standing information at the end of the report. This would make the reporting package more effective and digestible. After that, the longer term work on the disclosure framework can continue.
What Do You Think?
So what do investors think? Have investors been asked what it is they really want? CFA Institute will be conducting a survey of its membership to ascertain investor perspectives on these disclosure framework issues. That will allow us to best inform the standard setters on how to proceed, and to ultimately ensure that investors are provided with decision-useful information.