"arguaby the annual general report is a poor aid to economic decision making" Discuss.
ELEMI ATIGOLO-0325936
FINANCIAL ACCOUNTING
Financial Accounting: First assignment, Kingston University
"ARGUABY THE ANNUAL GENERAL REPORT IS A POOR AID TO ECONOMIC DECISION MAKING". DISCUSS.
HOW USEFUL ARE ANNUAL GENERAL REPORTS FOR ECONOMIC DECISION MAKING. DO THEY POSE ANY WEIGHT WITH THE OVERALL DECISIONS OF A BUSINESS OR ORGANISATION? DISCUSS
CONTENTS PAGES
Abstract 3
Introduction 4
Discussion, Annual General Report as an aid to economic decisions 4
Conclusion 9
References 10
Bibiography 13
"ARGUABLY THE ANNUAL GENERAL REPORT IS A POOR AID TO ECONOMIC DECISION MAKING". DISCUSS.
HOW USEFUL ARE ANNUAL GENERAL REPORTS FOR ECONOMIC DECISION MAKING. DO THEY POSE ANY WEIGHT WITH THE OVERALL DECISIONS OF A BUSINESS OR ORGANISATION?
ABSTRACT
The following essay focuses on the Annual General Reports, and their usefulness in helping to make economic decisions. Companies and businesses, use Annual General Reports to help communicate their financial affairs to interested parties. The statements in these reports often hold valuable information for many parties; but how useful are they as aids to economic decision making. Some have argued that they are essential, while others have maintained that they are of no real benefit. This essay discusses some of the issues surrounding the apparent usefulness of the Annual General Report to economic decision making.
INTRODUCTION
The issue surrounding the usefulness of Annual General Reports1 as aids to economic decision making has been a widely debated topic (Most and Chang, 1979; Best, 2003; Hassink, 1998). It is an important issue because it concerns those decisions, which hold economic weight for businesses and individuals; and can have dramatic effects if made wrongly. (Kurson, 2002) It has been maintained in many textbooks and academic literature that a company's Annual Report is a useful aid when making economic decisions. However it is my contention that a company's Annual Report is a poor aid to economic decision-making, and in some circumstances could be considered as a misleading document. This essay will consider arguments concerning the usefulness of Annual Reports as aids to economic decision-making; and highlight some of the problems associated with these documents. It will then put forward reasons for the introduction of new accounting standards and practices, to take into consideration some of the issues with which Annual Reports fail to address, but which can be considered as being of relevance to economic decision making.
DISCUSSION, ANNUAL GENERAL REPORT AS AN AID TO ECONOMIC DECISIONS
The need for information for economic decision making is ever apparent, many users use financial information for decision making, (Schredelseker, 1999) meaning that the information gathered needs to be of a useful nature to be of any benefit. An Annual Report has been defined as a "document containing a set of financial statements, which help to convey the financial situation of an organisation or business for the current year" (Porter and Norton, 1995). At a minimum it consists of, an income statement, a balance sheet, a statement of cash flows and accompanying notes (Emery and Finnerty, 1997).
These financial statements arguably contain useful information, which help to communicate the financial affairs of a company2 to interested parties. In terms of economic decisions, a subset of this group namely investors3 or potential investors and creditors will normally be most at risk from the implications of these published reports. Each financial statement contains different information about the affairs of a company. It has been asserted that these statements hold useful information needed to make rational investment, and creditor decisions (Rolo, no date; FASB4, 1978; Porter and Norton, 1995:54). The balance sheet reports the financial position of a company at a particular point in time. It shows the assets of the company which are the productive resources used in its operations, and it also shows the liabilities and stockholders' equity of the company which are the total claims of creditors and owners against the asset. The statement of cash flows indicates how the cash position of the company has changed during the period covered by the income statement; it breaks down the sources and uses of cash into three components; operating, investing and financial activities. The accompanying notes, disclose the accounting policies used to prepare the financial statements, and can also provide additional detail, concerning items found in the accounting statements, such as a break down of income, interests and other financial charges (Emery and Finnerty, 1997:27-31). As these statements are the predominate means by which external users (those not involved in the detailed daily operations of the business) can gain a perceived insight into the financial affairs and stewardship of those in charge. These statements and their contents have been maintained as being of extreme importance.
However these statements although holding financial information about a company, may actually be of limited use for economic decision making, due mainly to their subjective nature (Lerach, 2001).
"Virtually every number in a company's annual report is created by judgements and estimates made by company insiders, whose cash bonuses depend upon meeting pre set earning targets"(Lerach, 2001:3).
The contents of these statements are all effected by subjective judgements. A question such as when is revenue actually recognised? Is answered in truth with, when managers decide that a sale or earnings process is complete. A ...
This is a preview of the whole essay
However these statements although holding financial information about a company, may actually be of limited use for economic decision making, due mainly to their subjective nature (Lerach, 2001).
"Virtually every number in a company's annual report is created by judgements and estimates made by company insiders, whose cash bonuses depend upon meeting pre set earning targets"(Lerach, 2001:3).
The contents of these statements are all effected by subjective judgements. A question such as when is revenue actually recognised? Is answered in truth with, when managers decide that a sale or earnings process is complete. A decision such as this is fraught with subjective determinations regarding future obligations to customers; easily corrupted by side agreements for rights to return, re-stocking and other contingencies affecting the obligation to pay. The same could be said about assets liabilities and expenses. All these are based on significant estimates that involve unusually subjective judgements or uncertainties, or that are subject to potential significant change in the near future, all in manners that may have financially disruptive effects on the business and lead to misconceptions to investors. Ultimate collectable status of receivables, timing of revenue recognition, realisation of financial instruments (based on the highly subjective evaluation of collateral) or difficult-to-assess repayment sources, and significant deferral of costs are all factors which relate to problems associated with Annual Reports (AICPA, 1997).
However it could be argued that due to the disclosure requirement of financial reporting, according to the (FRS) Financial Reporting Standards' FRS3 (1992), that these problems can be minimised by companies and businesses disclosing additional information. This information arguably helps users acquire a more complete picture of gains and losses arising during the year. However the concept of "Full" disclosure although a requirement can also be effected by subjective judgement. There have been many cases in articles and reports regarding companies failing to disclose fully, vital financial information relevant to economic decision making. Companies such as Waste Management, Cendant, Xerox Comroad and Enron, have all been fraudulent in disclosing vital financial information, and in their Annual Reports (Shutiak, 2002; Fry, 2003; Marr 2003; SmartPros 2002; Chartier 2002; Gambal 1998) these events have led investors to become suspicious of all accounts.
Although it could be argued that these isolated events do not distract from the "apparent" importance of Annual Reports, they do highlight the fact that there is a lot of subjective conception about Annual Reports and their aid to economic decisions. Moreover it has been asserted that for financial information to be considered, as an aid to economic decision making, it must be useful. (ASB, 1999a). The ASB outlined a set of qualitative characteristics with which financial information should possess to be considered as useful. Firstly Understandability, the need for information to be understood by the user (with a reasonable knowledge of accounting). Relevance the ability to influence economic decision (disclosing relevant information). Reliability, free from error, (the extent to which users can depend on the information to represent the economic conditions or events it purports to represent). Comparability, the quality of accounting information that allows comparisons to be made between or among companies (ibid.). These characteristics help to identify useful information for the making of economic decisions by investors. However unless the financial statements are constructed in a way in which they contain these qualities, they can not be considered as useful aids.
Although it has been maintained, that Annual Reports are supposedly meant to contain these qualities, in reality the financial information in many Annual Reports is confusing and ambiguous. According to a study conducted by professors at the University of Michigan (lee et al., no date) many companies are using visual aesthetics to sway investors when the fiscal data is lacking or vague. The usefulness of these reports are becoming less apparent to investors, the study concluded that "when no financial information was included, Annual Reports containing aesthetics created by low-performing firms attracted more than twice as much average investment, compared to firms with aesthetics from high performers" (ibid.). This leads to the notion that Annual Reports are of no real benefit or aid to economic decisions as many companies attempt to mislead users by their contents.
"Given the pervasive doubts about the accuracy of publicly available financial information today, people may be sceptical of reports of high financial performance and thus feel uncertain about the organisation" (ibid.).
Moreover this can be seen in the issues surrounding "Window dressing", a term used when companies attempt to enhance their palatability and make their Annual Reports seem more favourable (Rahman, 2002). Although not illegal (in most cases), window dressing is misleading, in essence, window dressing entails abusing the flexibility embedded in the application of the Generally Accepted Accounting Principles (GAAP) for the sole purpose of improving the "bottom line" (AIMR, 2000). Although there are many forms, the most common practices of window dressing are frequent changes in the method of valuation of assets, creation of different reserve funds, under-or-over valuation of goodwill, showing of fictitious transactions, and understating expenses (ibid.). Window dressing is widely practiced (O'Brien, 2001) and greatly undermines the integrity and usefulness of Annual Reports, as it hinders the true and fair view concept of financial reporting.
The many problems and issues surrounding Annual Reports and their apparent inability to act as useful aids to economic decision making, leads way to the re-occurring topic of the introductions of new and improved accounting standards and practices, in an attempt to increase their usefulness. (Bies, 2002; Taylor, 2002; FASB, 2002). Many companies have started to produce more frequent financial reports (semi-annually, quarterly and monthly) in an attempt to increase the frequency of disclosures, thereby enhancing the value of financial information to investors. Moreover other attempts have been made to respond to some of the problems found with the method of valuation of intangible assets, and the move away from the historical nature of accounting to more current values. Consideration for the inclusion of environmental issues such as, wars, competitor actions and factors of market demand have also been debated as all these ultimately can have an effect on a company. (ASB, 1999b)
CONCLUSION
In conclusion, although Annual Reports do contain important financial information, they are poor aids to economic decision making, due to their array of problems and subjective nature. While companies continue to mislead and misdirect investors and associated parties in order to improve their "bottom line"; the ability for the Annual Report to be considered as a useful aid to economic decision making will always remain as null. Until financial reporting and ethical standards and practices are improved, the distraught and unlucky investors and associated parties of the once great but now collapse Enron Company will not be alone.
REFERENCES
* (AICPA) American Institute of Certified Public Accountants, (1997). 'Consideration of fraud in a Financial Statement on Audit', Statement on Auditing Standards 82
* (AIMR) Association for Investment Management and Research. (2000),'Meeting the Earning Numbers'. [WWW]. Available from http://www.aimrpubs.org/adv/issues/v5n5/full/a0050015a.pr.html [Accessed 23 October 2003]
* (ASB) Accounting Standards Board,(1999a) 'Statement of Principles for Financial Reporting'
* (ASB) Accounting Standards Board, (1999b) 'Current ASB projects' [WWW]. Available from http://www.asb.org.uk/technical/current.cfm [Accessed 23 October 2003]
* Best, Ben (2003), 'The Uses of Financial Statements'
* Bies S. Susan, (2002), Remarks 'Effective Accounting and Disclosure for Financial Transactions and Financial Institutions' [WWW]. Available from http://www.Federalrerve.gov/boarddocs/speeches/2002/20021107/default.htm [Accessed 21 October 2003]
* Chartier, John, (2002) 'Enron is simply the latest case as accountants face increasing client pressure' [WWW]. Available from http://money.cnn.com/2002/01/11/companies/acct_scandals/ [Accessed 19 October 2003]
* Emery, Douglas R. & Finnerty, John D. (1997), 'Corporate Financial Management', New Jersey, Prentice-Hall, Inc.
* Financial Accounting Standards Board (FASB), (November, 1978),' Statement of Financial Accounting Concepts No. 1'
* Financial Accounting Standards Board (FASB), (2002), 'FASB Adds Revenue Recognition Project to Its Agenda' [WWW]. Available from http://www.fasb.org/news/nr052002.shtml [Accessed 24 October 2003]
* (FRS) Financial Reporting Standards,(1992) FRS3 'Reporting Financial Performance'
* Fry, Melissa Crytzer (2003),'Reaping What Is Sown' [WWW]. Available from http://www.t-bird.edu/about_us/lib_research/tbird_mag/vol55_no_3/ [Accessed 20 October 2003]
* Gambal, John F. (1998),'Cendant's Demise -Fraud? No! Ignoring Strategic Thinking? Yes.' [WWW]. Available from http://www.Gambal.com/aboutGambalanditsnewconcept/articles/cendantsdemise.html [Accessed 22 October 2003]
* Hassink, Harold (April 1998.), 'On the Usefulness of Corporate Annual Reports to Trade Union Bargainer'
* Kurson, Ken (2002) 'A fool, his money and Enron' [WWW]. Available from http://money.cnn.com/2002/01/29/401k/kurson/ [Accessed 20 October 2003]
* Lee, Fiona; Worline, Monica; Rafaeli, Anat, (no date),' Attractive Annual Reports may help Struggling Companies Lure Investors'. University of Michigan Business School [WWW]. Available from http://www.bus.umich.edu/FacultyResearch/Research/AttractiveAnnualReportsMayHelpStruggling.htm [Accessed 21 October 2003]
* Lerach, William S. (2001). 'The Alarming decline in the quality of Financial Reporting and upsurge in securities fraud' pp. 1-23
* Marr, Steve, (August 2003). 'Big Banks: Enron's Helpers in Fraud?' [WWW]. Available from http://businessproverbs.com/articles/article.asp?art_id=1085 [Accessed 20 October 2003]
* Most, Kenneth S. and Chang, Lucia S. (September 1979), 'How Useful are Annual Reports to Investors?' The Journal of Accountancy p.111-113
* O'Brien Peter .Y, (2001). 'Its that time of the year for investment window dressing' [WWW]. Available from http://www.sharechay.co.nz/features/nbr/article.php/b4fcab26 [Accessed 22 October 2003]
* Porter, Gary .A & Norton, Curtis L. (1995), 'Financial Accounting: The impact on decision makers' Orlando, The Dryden Press Harcourt Brace College Publishers.
* Rahman, Khondaker. Mizanur (2002). 'WindowDressing of Financial Statements and Auditor liability in Bangladesh: Focus on Convention, Law, Ethics, and Professional practices' [WWW]. Available from http://jaias19.hp.inforseek.co.jp/rahman_doc.htm [Accessed 23 October 2003]
* Rolo, Joe (no date). 'The Usefulness of Financial Statements' [WWW]. Available from http://www.collegetermpapers.com/termpapers/business/the_usefulness_of_financial_statements.shtml [Accessed 22, October 2003]
* Schredelseker, Klaus (1999). 'On the Value of Information in Financial Decisions, A Simulation approach' University of Innsbruck
* Shutiak, James (2002). 'Cooking the Books'. [WWW]. Available from http://www.eca.ca/articles/june_newsletter.htm [Accessed 20 October 2003]
* SmartPros Editorial Staff, (2002), 'SEC Accuses Xerox of Financial Fraud' [WWW]. Available from http://www.smartpros.com/x33675.xml [Accessed 19 October 2003]
* Taylor, Jeffrey. (2002). 'IASB and the Future'. [WWW]. Available from http://executivecaliber.ws/sys-tmp1/iasbandthefutre/ [Accessed 23 October 2003]
BIBIOGRAPHY
* ACCA, (2003), 'Paper 1.1 Preparing Financial Statements' Middlesex, Foulks Lynch ltd.
* (AICPA) American Institute of Certified Public Accountants, (1997). 'Consideration of fraud in a Financial Statement on Audit', Statement on Auditing Standards 82
* (AIMR) Association for Investment Management and Research. (2000),'Meeting the Earning Numbers'. [WWW]. Available from http://www.aimrpubs.org/adv/issues/v5n5/full/a0050015a.pr.html [Accessed 23 October 2003]
* (ASB) Accounting Standards Board,(1999a) 'Statement of Principles for Financial Reporting'
* (ASB) Accounting Standards Board, (1999b) 'Current ASB projects' [WWW]. Available from http://www.asb.org.uk/technical/current.cfm [Accessed 23 October 2003]
* Best, Ben (2003), 'The Uses of Financial Statements'
* Bies S. Susan, (2002), Remarks 'Effective Accounting and Disclosure for Financial Transactions and Financial Institutions' [WWW]. Available from http://www.Federalrerve.gov/boarddocs/speeches/2002/20021107/default.htm [Accessed 21 October 2003]
* Chartier, John, (2002) 'Enron is simply the latest case as accountants face increasing client pressure' [WWW]. Available from http://money.cnn.com/2002/01/11/companies/acct_scandals/ [Accessed 19 October 2003]
* Edwards, J.R & Mellett H.J (1995), 'Introduction to Accounting', 2nd edition, London, Paul Chapman Publishing Ltd.
* Elliott, Barry & Elliot, Jamie (2003/2004), 'Financial Accounting and Reporting', 8th edition, England, Prentice Hall International UK limited,
* Emery, Douglas R. & Finnerty, John D. (1997), 'Corporate Financial Management', New Jersey, Prentice-Hall, Inc.
* Financial Accounting Standards Board (FASB), (November, 1978),' Statement of Financial Accounting Concepts No. 1'
* Financial Accounting Standards Board (FASB), (2002), 'FASB Adds Revenue Recognition Project to Its Agenda' [WWW]. Available from http://www.fasb.org/news/nr052002.shtml [Accessed 24 October 2003]
* (FRS) Financial Reporting Standards,(1992) FRS3 'Reporting Financial Performance'
* Fry, Melissa Crytzer (2003),'Reaping What Is Sown' [WWW]. Available from http://www.t-bird.edu/about_us/lib_research/tbird_mag/vol55_no_3/ [Accessed 20 October 2003]
* Gambal, John F. (1998),'Cendant's Demise -Fraud? No! Ignoring Strategic Thinking? Yes.' [WWW]. Available from http://www.Gambal.com/aboutGambalanditsnewconcept/articles/cendantsdemise.html [Accessed 22 October 2003]
* Hassink, Harold (April 1998.), 'On the Usefulness of Corporate Annual Reports to Trade Union Bargainer'
* Kurson, Ken (2002) 'A fool, his money and Enron' [WWW]. Available from http://money.cnn.com/2002/01/29/401k/kurson/ [Accessed 20 October 2003]
* Lee, Fiona; Worline, Monica; Rafaeli, Anat, (no date),' Attractive Annual Reports may help Struggling Companies Lure Investors'. University of Michigan Business School [WWW]. Available from http://www.bus.umich.edu/FacultyResearch/Research/AttractiveAnnualReportsMayHelpStruggling.htm [Accessed 21 October 2003]
* Lerach, William S. (2001). 'The Alarming decline in the quality of Financial Reporting and upsurge in securities fraud' pp. 1-23
* Marr, Steve, (August 2003). 'Big Banks: Enron's Helpers in Fraud?' [WWW]. Available from http://businessproverbs.com/articles/article.asp?art_id=1085 [Accessed 20 October 2003]
* Most, Kenneth S. and Chang, Lucia S. (September 1979), 'How Useful are Annual Reports to Investors?' The Journal of Accountancy p.111-113
* O'Brien Peter .Y, (2001). 'Its that time of the year for investment window dressing' [WWW]. Available from http://www.sharechay.co.nz/features/nbr/article.php/b4fcab26 [Accessed 22 October 2003]
* Porter, Gary .A & Norton, Curtis L. (1995), 'Financial Accounting: The impact on decision makers' Orlando, The Dryden Press Harcourt Brace College Publishers.
* Rahman, Khondaker. Mizanur (2002). 'WindowDressing of Financial Statements and Auditor liability in Bangladesh: Focus on Convention, Law, Ethics, and Professional practices' [WWW]. Available from http://jaias19.hp.inforseek.co.jp/rahman_doc.htm [Accessed 23 October 2003]
* Rolo, Joe (no date). 'The Usefulness of Financial Statements' [WWW]. Available from http://www.collegetermpapers.com/termpapers/business/the_usefulness_of_financial_statements.shtml [Accessed 22, October 2003]
* Schredelseker, Klaus (1999). 'On the Value of Information in Financial Decisions, A Simulation approach' University of Innsbruck
* Shutiak, James (2002). 'Cooking the Books'. [WWW]. Available from http://www.eca.ca/articles/june_newsletter.htm [Accessed 20 October 2003]
* SmartPros Editorial Staff, (2002), 'SEC Accuses Xerox of Financial Fraud' [WWW]. Available from http://www.smartpros.com/x33675.xml [Accessed 19 October 2003]
* Taylor, Jeffrey. (2002). 'IASB and the Future'. [WWW]. Available from http://executivecaliber.ws/sys-tmp1/iasbandthefutre/ [Accessed 23 October 2003]
Annual General Report and Annual Report will be used interchangeably
2 Companies and business is used interchangeably
3 In the context of this essay investors will be perceived to include potential investors and credits unless stated otherwise
4 Financial Accounting Standards Board
(footnote continued)
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