Wading through the disclosure notes of an entity’s financial statements can often be an arduous task.
Once a year, I set my final-year undergraduate class an assignment that involves the analysis of an entity’s financial performance and position. As part of this, the class must initially obtain the entity’s annual report and come to terms with the details included within. It is often not long before the detail becomes overwhelming, and they struggle to really assess what is important and what is less so.
In general, the feedback is that some of the disclosure notes are really helpful and that others contain so much detail that it’s impossible to step back and see what the major story is.
Some of the areas the class identify as most useful relate to the information provided under segment reporting and, perhaps more surprisingly, leases. The most common areas of confusion surround financial instruments and pensions.
Clearly, these are technical, complex areas, so that is to be expected to a degree. But the feelings of these students probably accurately mirror the difficulties that many find when reading the disclosure notes within financial statements.
The ‘disclosure problem’
The International Accounting Standards Board (IASB) has been wrestling with what is now commonly known as the ‘disclosure problem’ for some time now. This identifies three main concerns about disclosures in financial statements:
- There is not enough relevant information
- There can be too much irrelevant information
- There is ineffective communication.
Entities often view disclosures as a compliance exercise rather than a useful and effective way to communicate
A commonly identified problem relates to the ‘checklist’ approach, where entities view disclosures as a compliance exercise rather than a useful and effective way to communicate with the users of financial statements.
As part of the solution to this, the IASB has issued an exposure draft of new guidance on two existing IFRS Standards: IAS 19, Employee Benefits, and IFRS 13, Fair Value Measurement. I won’t examine the specific proposals here but the general principles underpinning the potential new approach.
Two types of objective
A key proposal is to introduce two types of disclosure objectives: overall and specific.
The overall disclosure objectives would describe the overall information needs of users of financial statements. These would be used to provide a narrower, more standard-specific focus than the current objectives identified in the Conceptual Framework for Financial Reporting and IAS 1, Presentation of Financial Statements. These would provide an overall context for entities when they are applying the specific disclosure objectives in a standard.
It might be hard to prove compliance due to the judgmental nature of selecting the relevant information
The specific disclosure objectives would describe the detailed information needs of users of financial statements. Entities would then be required to identify items of information to meet each specific disclosure objective. These would be accompanied by a separate paragraph explaining what the information provided is intended to help the users do.
The IASB will then include information that the entity may (or potentially is required to) disclose to meet each specific disclosure objective. Each item of information would be linked to one or more of the specific disclosure objectives, and entities would then apply judgment to decide whether the information is material or not.
The aim of the new guidance is to attempt to move entities away from seeing disclosures as a checklist. The language used aims to encourage preparers to think about whether the information required meets the disclosure objectives.
The IASB believes that this change in emphasis will mean that preparers and auditors will need to apply judgment to determine which information is material and whether the information provided satisfies disclosure objectives.
It is not all plain sailing, however, with some problems noted already. There may be difficulty in proving compliance due to the judgmental nature of selecting the relevant information to meet the disclosure needs.
The use of judgment could also lead to a lack of comparability between entities and could actually increase the amount disclosed. Entities may be unwilling to disclose too little so may end up with even more information, just in case it is deemed to be material by some users.
This latest attempt by the IASB is a first real step in solving the ‘disclosure problem’. It is easy to see how increasing judgment could be a move away from the more boilerplate, checklist approach to disclosures.
Unfortunately, it is easy to see how a judgmental approach can bring its own problems. It remains difficult to see a time where users won’t continue to believe that there is either not enough relevant information or too much irrelevant information.
Maybe the disclosure problem is one that simply can’t be fixed by changes to standard-setting and regulation.