The importance of annual reports for the stewards and its shareholders


According to Derek French 1985 Stewardship is 'The duties and obligations of a person who manages something on behalf of other persons'[Derek French, 1985] The UK Stewardship code was published in 2010, according to the Financial Reporting Council the Stewardship Code aims to enhance the quality of engagement between institutional investors and companies. However earlier this year the Financial Reporting Council have published a report entailing further recommendations on the stewardship function, the FRC encourages in its 2010/11 report the director's sole responsibility to ensure that an annual report provides a true and balanced report on their stewardship business therefore being more transparent in its communication with its shareholders. Lennard also sums up the characteristics of the stewardship function as "…being about information that provides a foundation dialogue between management and investors" [Lennard 2006]. The dialogue described is no other than the company's annual report.

Annual reports are the most thorough and detailed communication method between the stewards and its shareholders. It provides an insight into the financial status of a company by including financial statements such as statement of financial position, statement of comprehensive income etc. It would also include business ventures, information on board of directors including their interests in regards to the future of the company etc. Companies Act 2006 requirements state that the company must give a true and fair view and to make it available to every shareholder. Furthermore the steward must ensure financial statements are in accordance with accounting standards as well as conducting an audit.

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The key recommendation set out by the FRC in its latest published report recommend that directors take full responsibility of ensuring the annual report provides a 'fair and balanced report' on their stewardship of the business. This would allow shareholders to get a non biased review of the company's performance giving the report greater weight, further clarity and greater reliability for shareholders as well as potential investors. A key function of the steward is to be transparent in represented information to shareholders.

"International financial reporting standard" describes the purpose of financial statements as "a structure representation of the financial position and financial performance of an entity" [Alfredson et al., 2009, p 651]. International Accounting Standard 1 requires that a complete set of financial statement must include a statement of financial position, a statement of comprehensive income, a statement of changes in equity and a statement of cash flows all of which are included in the Annual report for the shareholders.

The statement of financial position summarises the organisations financial position, as well as an organisations assets, liabilities and equity. It is widely known as the balance sheet and analyses the company's liquidity, solvency and financial flexibility. Common criticism made by shareholders is that the measurement of certain assets at historical cost or depreciated historical cost rather than current value is not accurate and can be made misleading in the financial statements by stewards [Alfredson et al., 2009, p 670].

The statement of comprehensive income portrays the financial performance of an organization. It analyses the "valuation adjustments affecting net assets during the period. Profit or loss is the most common measure of an entities performance." [Alfredson et al., 2009, p 679]. Dividend is paid depending on profit or loss therefore being of high importance to shareholders. Statement of changes in equity entails new shares issues, the payment of dividends and the effect of any adjustments at the beginning of the period which form the components of equity. Stewards require being reliable when representing this to shareholders as it would entail how much they will be getting as dividends.

IAS7 states that the statement of cash flow is to present information about the historical changes in cash and cash equivalents of an organization during a period of time. The statement of cash flow is important to the steward and equally to the shareholders as it would allow them both to examine and analyze the movement of money, this could be crucial for stewards when reducing costs.

IAS 8, paragraph 5, define accounting policies as 'the specific principle, bases, conventions, rules and practices applied by an entity in preparing and presenting financial statements' IAS1 ensures that the company policies are stated clearly and applied consistently throughout the statements. Accounting policies play a major role in the portrayal of financial accounting as stewards can use it to manipulate information if not applied consistently and in accordance with accounting standards.

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The going concern policy is outlined in IAS 1 which required management to make an assessment of the company's ability to continue as a going concern unless the management intends to liquidate the company. Furthermore if a steward of the business has significant doubt upon the entity's ability to continue as a going concern it must be disclosed under IAS 1. IAS 1 also required financial statements excluding the cash flow to be prepared using the accrual basis of accounting. The framework describes this as "type of information about past transactions and other events that is most useful to users in making economic decisions" [Framework.22] therefore allowing shareholders to recognize assets, Liabilities, equity and expenses. Both the UK body and International Standard outline that Segmental reporting requires information should be disclosed by the type of business it is and its geographical segment according to IAS 14. Disclosure notes allows shareholders as well as potential investors information in regards to the accounting strategies used in the compiling of the financial statements.

Other policies consist of Consistency, Materiality, aggregation and offset. Additionally there are inventory, costing, depreciation and many more policies for stewards to adopt.

Enron is a company known for one of the biggest scandals that led to the bankruptcy of one of the biggest auditing companies in the world Arthur Anderson. Enron is a prime example of a steward in this case Keneth Lay not carrying out his duty towards its shareholders. Enron's financial statements were very unclear about its finances to its shareholders. Furthermore they used the market-to-market policy, this meant that when long term contracts were signed income was estimated at the present value of net future cash flows [Healey, 2003]. This method in contracts is dangerous as the judgments made on potential revenue are inaccurate, as can be seen in the case of Enron and Blockbuster. In another example, Enron entered into a $1.3 billion, 15-year contract to supply electricity to the Indianapolis Company Eli Lilly. Enron was able to show the present value of the contract as revenues initially and later had to report the present value of the costs which resulted in a loss.[Healey, 2003]. These are just some of the problems leading to the downfall of Enron and thus highlighting the importance of regulatory framework.

In the early years there have been many attempts to define accounting and nature, most of the foundations of the accounting standards were from the US and the early writings were done in the 1940's by Paton and Littleton coupled with the American Accounting Association of the nature of accounting. [1] During the 1970's and 80's they were many concerns due to the lack of transparency of financial reports, therefore no clear communication between stewards and shareholders. This led to the harmonization of accounting standards; which than led to a single global set of financial reporting standards as we know them today.

IASC issued a draft which stated that 'conceptual framework that underlies the preparation and presentation of financial statements.'[Bonham et al., 2011, p 46]. The framework defines the objectives of financial statements and identifies and highlights the information which makes the financial statements useful. This allowed shareholders to understand the financial reports which had been very difficult in the past.

IASC was reconstituted as the IASB, the reasons behind this was due to the weak relationship with national standard setters and lack of convergence of IAS and major national GAAP after 25 years of trying. [Bonham et al., 2011,]

IASB describe the framework in short as being able "to provide information about the financial position, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions.'[Framework 1.2] Therefore allowing shareholders to asses if the stewardship function within the organization is functioning the way it should as well as allowing them to make further decisions such as to buy or sell shares.

Additionally the framework states that the 'Financial statements show the results of the stewardship of management, or accountability of management for the resources entrusted to it. Those users who wish to assess the stewardship or accountability or management do so in order that they may make economic decisions; these decisions include, for example, whether to hold or sell the investment in the entity or whether to reappoint or replace the management'.[Framework. 14] the framework goes onto stating that the users of information i.e. the shareholders get an incomplete picture from the statement of comprehensive income if it is not read in conjunction with the statement of cash flow and statement of changes in financial position. [Bonham et al., 2011]

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As the framework is for the users of financial information there are qualities characteristics of financial statement which are understandability, relevance, reliability and comparability. These are the foundations required to combat the clarity issues the accounting regulators have been facing for decades. IASB Paragraph 25 of the framework states "…users are assumed to have reasonable knowledge" therefore meaning that shareholders are not required to know "a complete technical understanding" therefore ensuring further clarity from stewards in financial statements. Paragraph 26 and 27 of the framework states that "Information has the quality of relevance when it influences economic decisions of users" which means that "the predictive value of relevant information is emphasized. Not that financial statements should be prediction in the sense of forecasts, but that information they contain should be relevant to prediction that users might make for themselves about the 'ability of the enterprise to take advantage of opportunities and its ability to react to adverse situation" [Bonham et al., 2011 pg 49]. Reliability would go jointly with relevance, the framework states that the statement should be ' free from material error and bias and can be depended upon by users' this further highlights the importance of the stewards not being misleading to its shareholders in the representation of the financial position of the organization. Lastly a fundamental reason for the framework to be introduces is the comparability problem countries faced with the statements. This was described as "accounting policies employed in the preparation of the financial statements, any changes in those policies and the effects of such changes" [Framework 40] this would further allow shareholders to know what policies are being used and to understand why the particular policy is used.

The harmonisation of the accounting standards coupled with the regulatory framework has made the accounting and financial statement as we know them today. Stewards need to comply with the IFRS as well as GAAP Working in conjunction with one another to deliver understandability, relevance, reliability and comparability. These characteristics are of a steward fulfilling the duty owed to shareholders. Shareholders would need to analyse the financial statements closely in order to make economic decisions as the 'Enron scandal' highlighted that the accounting regulations have flaws and that companies can abuse the IFRS to hide debt in financial statements.