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The impact of transparency in accounting

Introduction

According to IAS 1, “An entity whose financial statements comply with IFRSs shall make an explicit and unreserved statement of such compliance in the notes. An entity shall not describe financial statements as complying with IFRSs unless they comply with all the requirements of IFRSs. The application of IFRSs, with additional disclosure when necessary, is presumed to result in financial statements that achieve a fair presentation.” (IASC Foundation Education, 2009)

“Information should be prepared and disclosed in accordance with high quality standards of accounting and financial and non-financial disclosure.” (OECD, 2004). “The application of high quality standards is expected to significantly improve the ability of investors to monitor the company by providing increased reliability and comparability of reporting, and improved insight into company performance.” (OECD, 2004) “The quality of information substantially depends on the standards under which it is compiled and disclosed.” (OECD, 2004) “The Principles support the development of high quality internationally recognized standards, which can serve to improve transparency and the comparability of financial statements and other financial reporting between countries.” (OECD, 2004)

Definition of ‘transparency’ in accounting term

ICAEW defined transparency in accounting term as a “transparency of clear information with which meaningful analysis of a company and its actions can be made. The disclosure of financial and operational information and internal processes of management oversight and control enable outsiders to understand the organization.” (ICAEW, 2010)

“Transparency is a measure of how much information you have about the markets where you invest, the corporations whose stocks or bonds you buy, or the mutual funds or other investments you select.” (Financial Dictionary, 2010) “

“For example, in order to achieve maximum transparency in US markets, the Securities and Exchange Commission (SEC) requires corporations to disclose all information that might have an impact on their financial status so that investors can make fully informed decisions.” (Financial Dictionary, 2010)

“Real-time trading information, increasingly available to individuals as well as institutional investors, and linked pricing systems are other steps toward complete transparency.” (Financial Dictionary, 2010)

Established view

“Transparency in business reporting is significantly constrained by considerations of cost, competition, confidentiality and litigation.” (ICAEW, 2003) “While everyone agrees that transparency is a good thing in principle, there is usually also some recognition that there are practical limits to it.” (ICAEW, 2003) “Against this, some argue that the constraints are generally overstated and are often little more than self-interested excuses for non-disclosure.” (ICAEW, 2003) “On this view, there is no good reason why businesses should not be genuinely transparent.” (ICAEW, 2003)

Enron Scandal

“Enron was formed in 1985 by Kenneth Lay after merging Houston Natural Gas and InterNorth. Several years later, when Jeffrey Skilling was hired, he developed a staff of executives that, through the use of accounting loopholes, special purpose entities, and poor financial reporting, were able to hide billions in debt from failed deals and projects.” (Wikipedia, 2010) “Chief Financial Officer Andrew Fastow and other executives were able to mislead Enron's board of directors and audit committee of high-risk accounting issues as well as pressure Andersen to ignore the issues” (Wikipedia, 2010)

Reformer view

“There should be almost no limits on transparency” (ICAEW, 2003) “Disclosure and transparency are the partners of good governance. They demonstrate the quality and reliability of information, whether is financial and non-financial information that provided by management to lenders, shareholders, and the public.” (ICC, 2010)

“In response to recent corporate governance scandals, governments have responded by adopted a number of regulatory changes. One component of these changes has been increased disclosure requirements.” (Benjamin E. Hermalin, Michael S. Weisbach, 2007). For example, “Sarbanes-Oxley (sox), adopted in response to Enron, Worldcom, and other public governance failures, required detailed reporting of off-balance sheet financing and special purpose entities”. (Benjamin E. Hermalin, Michael S. Weisbach, 2007).

Transparency in a Post-Enron world

“The biggest driver for transparency used to be the European companies’ push to access the US capital markets and the desire to be seen as progressive.” (CIMA, 2002) “However, in the wake of the recent accounting scandals, investors are becoming hypersensitive to the reliability of published accounts and suspicious of the possibility of inflated earnings.” (CIMA, 2002) “The slightest hint of wrongdoing now has the potential to deflate investor confidence and bring share prices down.” (CIMA, 2002)

“In other words, the drive has become more urgent and more desperate as investors steer clear of companies with opaque business reporting systems.” (CIMA, 2002) “Transparency is becoming a matter of survival rather than choice and people are beginning to remember that the rules of financial reporting have never been an exact science immune from interpretation or indeed human error.” (CIMA, 2002)

“Chief executive officers, finance directors and auditors should start to understand that this issue does not just affect their individual operations but capital markets as a whole.” (CIMA, 2002) “If the confidence in markets is missing, capital to finance day-to-day business and longer-term investment funds will be less forthcoming and more expensive as higher rates of return and greater security are sought to offset the perceived risks involved. And that confidence will depend on the quality of reporting by listed companies.” (CIMA, 2002)

Important of transparency

“The world is demanding greater corporate transparency. Investors want access to more accurate and relevant information about companies, transactions, markets and risks. Regulators are moving to exert more control.” (EYG members firm, 2010)

“There’s much debate about how corporate governance should evolve. It’s a debate that’s being held against a background of legislative and regulatory change, the implementation of International Financial Reporting Standards and increased public scrutiny.” (EYG members firm, 2010) EYG believe that “global coordination is a necessity, not a luxury, in today’s interconnected and interdependent markets.” (EYG members firm, 2010) “Regulators and standard-setters need to continue to work together, to promote global consistency.” (EYG members firm, 2010)

“As the worldwide financial crisis continues, calls for greater transparency in financial reporting are increasing.” (Financial Executives International, 2009) “Part of providing greater transparency in financial reporting will entail improvements to the U.S. generally accepted accounting principles reporting model.” (Financial Executives International, 2009)

“Today's company reports and financial statements provide an incomplete story for evaluating past performance and assessing likely future results.” (Financial Executives International, 2009) “Investors need contextual information on important areas impacting performance, such as the competitive environment, strategy and risks, as well as important intangible assets.” (Financial Executives International, 2009) “They are also interested in information on nonfinancial key performance indicators.” (Financial Executives International, 2009)

“Enhanced business reporting is about developing these areas and enabling their sustainable relevance through market collaboration.” (Financial Executives International, 2009)

“Today, corporate reporting is no longer restricted to the financial statements, but encompasses a broad array of additional matters that must also be disclosed.” (Deloitte, 2010) “No longer focused on historic results, it now includes prospective elements, such as guidance on future revenue and earnings targets.” (Deloitte, 2010)

“Transparency enables investors, creditors, and market participants to evaluate the financial condition of an entity.” (Deloitte, 2010) “In addition to helping investors make better decisions, transparency increases confidence in the fairness of the markets.” (Deloitte, 2010) “Further, transparency is important to corporate governance because it enables boards of directors to evaluate management's effectiveness and to take early corrective actions, when necessary, to address deterioration in the financial condition of companies.” (Deloitte, 2010) “Therefore, it is critical that all public companies provide an understandable, comprehensive and reliable portrayal of their financial condition and performance.” (Deloitte, 2010)

Benefits of increased transparency

“For a start, investor confidence will improve with the increase in relevant information. This will in turn lead to more long-term investors. As companies become more open with their strategy, the quality of the management, the value of their assets and the risks they face, they will become a less risky proposition for investors.” (CIMA, 2002) “In this virtuous cycle, they would then have access to cheaper capital.” (CIMA, 2002) “Markets will eventually reward better disclosure and penalize opaque practices.” (CIMA, 2002)

“Despite all the potential benefits, many are still skeptical about the practicality of total transparency.” (CIMA, 2002) “For many companies, especially the first movers, the shift will not be easy.” (CIMA, 2002) “The biggest obstacle is the fear that the companies can end up being held hostage to fortune.” (CIMA, 2002) “In addition, there will be concerns about the reliability of what the companies disclose.” (CIMA, 2002) “As already mentioned, some kind of external verification and/or auditing will be necessary.” (CIMA, 2002) “The cost of providing more information might prove to be a significant barrier, especially for smaller companies.” (CIMA, 2002) “Some may have already developed leading performance indicators for internal use or they may soon be required to do so by either the general trends in the business world or market pressures.” (CIMA, 2002) “Switching to increased disclosure should be the next step.” (CIMA, 2002) “But starting off with a redesign of management accounting information can prove to be a valuable and cost-effective exercise as it will help companies identify the main assets and activities that really drive value in their companies.” (CIMA, 2002)

“Clearly, companies need to make adjustments to deal with sensitive competitive information or unreliable performance measures but these decisions will depend on perceived costs and the benefits of making enhanced information available to investors.” (CIMA, 2002)

Conclusion

“Corporate governance is a key element in enhancing investor confidence, promoting competitiveness, and ultimately improving economic growth.” (ICAEW, 2010) “Much of the recent emphasis on corporate governance has arisen from high-profile corporate scandals. A high profile corporate collapses due to a number of circumstances including financial reporting irregularities leading to a lack of investor confidence and public trust.” (ICAEW, 2010)

“The economic and financial crisis which began in 1998 in certain Asian countries and spread to other regions of the world, as well as recent spectacular bankruptcy cases in the United States, underlined the need for reliable and transparent accounting and financial reporting to support sound decision making by investors, lenders and regulatory authorities.” (ICC, 2010)

“Most corporate governance reforms involve increased transparency. Yet, discussions of disclosure generally focus on issues other than governance, such as the cost of capital and product-market competition. The logic of how transparency potentially affects governance is absent from the academic literature.” (Benjamin E. Hermalin, Michael S. Weisbach, 2007)

In my opinion, corporate governance is elements that can enhance investor confidence, promoting competitiveness, and ultimately improving economic growth. Increasing transparency through enhanced business reporting not only will not affect the corporate governance. Otherwise, it can increase the investor confidence and improve the promoting competitiveness.

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