Despite a global accounting framework, financial reporting needs to become more informative, user-friendly and relevant to satisfy investor demands

Accounting standards across the globe have converged to IFRS (International Financial Reporting Standards) making financial reporting more comparable and credible.

“But with these benefits come more complex, voluminous and theoretical financial reports, a growing requirement to use fair values, increased volatility in results reported and difficulty in understanding the underlying performance of a business” says Jan Gey van Pittius, PricewaterhouseCoopers SA Partner, Advisory – Process Improvement Division. “Despite making great progress, financial reporting needs to become more user-friendly, informative and accessible to investors.”

One initiative that is aimed at improving thinking on narrative and financial reporting is Report Leadership, a partnership between multi-stakeholders comprising the Chartered Institute of Management Accountants, PricewaterhouseCoopers, Radley Yeldar and Tomkins plc.

Report Leadership research indicates that management spends significant time aggregating information, only for it to be deconstructed by investors and analysts. A better blueprint for corporate reporting is required that more closely aligns external reporting with management reporting.

Gey van Pittius says that shareholders need to understand how a business created value in the past and how it might create value in the long term future. “The existing financial reporting model does not provide a good basis for assessing economic value as many assets that generate cash flows remain off the balance sheet. Investors need to understand the drivers of sustainable cash flow so they can form a better view of the value of the business.”

The Report Leadership approach is that present financial reporting is “not broken”, so to speak. “It just needs to evolve to more fully satisfy the needs of users”, says Gey van Pittius. “They want explanations of market trends, prospects, long-term objectives and short-term strategic priorities that help deliver these objectives. Company performance should be placed in context and future strategies and risks to success explained. Investors want to know how management’s views on market trends and prospects compare with reality.”

Report Leadership recommendations are focussed on three areas, the first being on the ability to model the future. Investors typically have insufficient forward-looking contextual and non-financial information to underpin their cash flow projections. A forward-looking orientation should describe external trends likely to affect the business environment and be supported by externally-sourced forecast data, but without management having to disclose competitively sensitive forecasts of performance.

The second focus area of Report Leadership is rethinking selected areas of the financial statements. “These alternative performance measures are a necessity as business becomes more complex. But they must be properly presented and reconciled back to the IFRS numbers. One new non-GAAP disclosure that we recommend is a full net debt analysis, rather than debt disclosures being scattered throughout the report and preventing investors from understanding the full picture of debt risks and servicing plans”, says Gey van Pittius

The third focus is effective communication to ensure that key messages are not lost in voluminous annual reports. “Investors do not read the entire report in sequence. They dip in and out and need to pick up on key points quickly and comprehensively, but still see them within the broad context of overall strategic goals.”

The Report Leadership team is now moving on to consider other reporting areas such as contentious executive remuneration where investors want to see a clear link between remuneration, key performance indicators and the achievement of strategic goals. Another development is electronic shareholder communications such as web-based alternatives that offer logical navigation options, and more use of appropriate formats such as XBRL (Extensible Business Reporting Language).

Report Leadership has also drafted a model annual report of a fictitious company, Generico, based on its framework of recommendations, with innovative disclosures completely compatible with IFRS. Diversified miner BHP Billiton (listed on the JSE, LSE, and NYSE) has been commended by the initiative as being particularly innovative when it comes to disclosing forward looking information. The 2006 annual review identifies seven strategic drivers upfront and relates each one to the group’s strategy.