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Annual report, a company’s financial statement, plays a vital role in informing stakeholders about the business situation of the most recent financial year (Dick and Missonier-Piera, 2010). Based on an ACCA Members Survey conducted in 2008, the majority of respondents believed that the complexity of annual report had increased in recent year. Rising concerns of growing complexity in the annual reports have been expressed and criticized recently, where many investors claiming that the financial statements are often difficult to understand. Tension between complexity and understandability. This essay aim to investigate the causes of complexity in annual reports, it will firstly define the term ‘complexity’ and explain the purpose of annual reports, followed by analysis the characteristics of information that is presented in financial statements, then determine the causes of increasing complexity and decreasing relevance, last but not least, comment on Sainsbury's annual reports will be provided and recommendation will be included in conclusion section.
In a broad sense, complexity is defined as anything that needlessly makes corporate reporting regulations or the reports themselves unnecessarily thornier to understand, implement or analyses. This includes missing information or irrelevant detail that obscures the overall picture. (Financial Reporting Council, 2009). ACCA(2008) has classified the those complexity by avoidable and unavoidable. FRC’s report (2011) has used the term ‘clutter’ to describe immaterial disclosures and repeated explanatory information.
FRC(2009) suggest that the primary purpose of financial reports is providing information to investors which is useful for them to make their resource allocation decisions and assess management’s stewardship effectively. According to IASB(2015), the objective of financial reporting is to ‘provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity’ (cited in Pacter, 2015, pp171).
As one of the fundamental qualitative characteristics of information that are presented in annual reports set out by IASB Conceptual Framework for Financial Reporting 2010, relevance means that the report is able to meet users’ requirement of information(Elliott and Elliott, 2013). As it is capable of ‘making a difference to the decisions made by users’ (Elliott and Elliott, 2013, pp 241). The value of relevance financial information provides feedback about past evaluations which enable users to make their own predictions. Reports can be difficult to understand or analyse if the information contained is lacks of relevance(Financial Reporting Council, 2009). On the other hand, FRC’s report(2011) also advocate that the lack of relevance is due to immaterial disclosures, as the users have limit time to analysis data, irrelevant disclosures may restrain their ability to identify and understand relevant information. Besides that, there are enhancing qualitative characteristics which takes understandability into account. This characteristics is satisfied when the annual reports is understood by a user with previous knowledge in accounting.
In order to be useful, the financial information should be understandable. According to IASB(2010), when the conflict between relevance and understandability has generated, the understandability is more significant than relevance.
FRC’s report (2011) has clearly identified those drivers of complexity, firstly, behaviour barriers of preparers, their unchallenging way of use illustrative accounts allows them to prepared financial reports with the objective of covering every contingency. Preparers’ behaviour was heavily influenced by existed illustrative accounts or other big firms’ financial reports (such as “Big Four”). As a consequence, these disclosures are reproduced without addressing the relevance of each item to the individual company in order to ensure that the financial statements comply with every disclosure. However, those institutes and auditors who provide persuasive guidance and manuals also play an role in preparers’ behaviour barriers. The report gives ICAEW materiality guidance as an example, since they tend to focuses on inclusion rather than exclude the ‘clutter’ and thin the reports(Financial Reporting Council, 2011).
Secondly, the increasing complexity is also caused by regulation and standard setters are trying to minimise the major change in standards. As it was reported by ACCA(2008), most of the users have faced difficulty in understanding or applying the rules and requirements and believed that the fulfilling of the standard are time-consuming and costly. However, take hedge accounting as an example, under IFRS 9, hedge accounting is associated with an entity’s risk management activities. It is undeniable that the transactions themselves is inherently complex as it plays an significant role in reducing risks by adopting different measurement (Financial Reporting Council, 2011). Apart from its native complexity, the overly complex standard and regulation has just risen the complexity of annual reports (CIMA, 2009). Hence, it is calling for simplifying the standards and regulations.
Moreover, as it was mentioned before, increased disclosures also plays a significant role in greater the complexity in annual reports. Geoff Cooper, Chief Executive of Travis Perkins, express his criticism towards disclosures, and suggest that it was meaningless and impenetrable for most of the businesses (cited in CIMA, 2009). Analogously, some preparers also consider that many of the disclosures are unnecessary or even create confusion (CIMA,2009).
Last but not lease, it is widely acknowledged problem is that annual reports have to meet different users purpose though the level of complexity of annual report can differ person to person. IASB(2010) recognised equity investors( including potential investors), lenders and creditors as primary users group, annual reports should address the needs of other stakeholders. IASB(2010) also believed that financial statements prepared for this purpose meet the common needs of most users since nearly all users are making economic decisions.
An example of complexity is illustrated by investigating J.Sainsbury’s recent annual report (2014). IFRS 7 Financial Instrument: Disclosure was amended for the Sainsbury’s financial statement since 2013, and it was mandatory from 2007. The amendments to IFRS 7 have increased the disclosure requirements of the standard. In Sainsbury’s report, substantial numerical figures were included. However, according to Financial Reporting Council (2011), in order to meet the requirement of law or IFRS, explanatory information such as company’s history and complex notes would still have to be provided and included in the annual report as an appendix. The amount of information that need to provide is excessive.
In conclusion, the criticism of increasing complexity of annual reports is valid. In order to communicate more effectively, it is strongly recommended that standard setters and guidance take simplifying narrative reporting into account and preparers highlighting key information and changes for users to make it clearer and more focused.