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This report is mainly about the narrative reporting in financial accounting. So, what is a narrative reporting. Narrative reporting is a reporting method that writes in a paragraph rather than the other form which present in form, letter or table. In an annual report, you can find a lot type of reporting methods such as narrative reporting, reporting in numerical form and also information that is present in a table and narrative reporting has play a big role to explain to the user of the annual report what is those figure, table and also other matter that cannot be present in a numerical form about by explaining in a paragraph form that can be easily understand by user that is not familiar with the company or account. In this report, I am going to discuss about the key element of narrative reporting which is the important part that must be fulfill by narrative reporting in annual report. Second I am going to discuss about the part of narrative reporting that has done well and the other narrative reporting information that need to improve under the research of Financial Reporting Council of United Kingdom. Next, I'm going to present the part of narrative reporting's information that attracts the stakeholders and lastly I am going to talk about the benefit plus the limitation or weakness of narrative reporting.
What are the key elements in narrative reporting?
The key elements of the narrative reporting are organization purpose, mission or vision, strategy, goals and performance, risk and opportunities, financial and non-financial highlights, forward looking information, organizational structure and leadership and governance. Organizational purpose is all about the background information that helps the report user to understand the organization environment and how it operates (Anon., 2011). Mission and vision of the company is very important and need to be present so that the user can get the idea of what is the aim of the organization and its future look (Anon., 2011). Next, a good narrative reporting need to present both long-term and short-term strategy of the company that show how is the organization going to achieve their mission (Anon., 2011). Furthermore, goals and performance of the organization need to be express in the report so that the user can get to know what have the organization done in the year and did the organization reach their goals or not (Anon., 2011). Risk and opportunity is the part where the stakeholders have the most interest and also it's the part where the organization feels most uncomfortable with but a good reporting about the risk of the organization will lead to trust between stakeholders and directors (Anon., 2011). Financial and non-financial information play the most important part for narrative reporting because they need to integrate the financial information into organization's story that related to the financial data (Anon., 2011). The other part of report that will attract the stakeholders is forward-looking information. This information that state the organization goals and how the organization going to do in the future to achieve the goals with different business environment will affect the stakeholders decision making towards the organization (Anon., 2011). Organization structure and leadership need to present how the structure of the organization is and how the structure helps the organization to achieve their goals (Anon., 2011). Lastly, governance is all about the organization board of directors (Anon., 2011).
Research from Financial Reporting Council of United Kingdom on the corporate annual report
A review over the narrative reporting 'Rising to the challenge' that has been done to the 50 United Kingdom listed companies by the Financial Reporting Council (FRC) which is the independent regulatory of United Kingdom that responsible in promoting confidence in corporate reporting and governance (Anon., 2009). From their research, they have found out that there is some part that has done well and other parts that still have space to improve in corporate narrative reporting.
Which parts of the narrative reporting has done well?
Narrative reporting on the financial performance and positions.
To have done well in this part, the company needs not only to discuss about the company profit, but at the same time they need to focus on the cash flow and financial position (Anon., 2009). Deep discussion over the financial performance and position is needed to complement the financial statements rather than just repeat the item that shown inside the financial statements. A company also need to look into the area that rarely been describe by the financial statements such as intangible assets because these item in intangible assets is an important part for the financial position. Discussion over the liquidity is also expected by the stakeholders too because of the current fast pace changing business environment. A United Kingdom company has done well in this part by illustrating the liquidity risk of debts through graph which is Great Portland Estates' 2009 annual reports.
Financial Key Performance Indicators (KPIs).
FRC has found out that there is improvement in reporting the financial Key Performance Indicators by the 50 company they done the research. To have a best practice in this area, the company needs to link the Key Performance Indicators to the rest of the report such as the company strategy and plan. An organization has done a great practice in this part which is InterContinental Hotel Groups that have linked the Key Performance Indicators to their company future strategy and plan and provide an explanation on it (Anon., 2009).
For strategy part of narrative reporting, the best narrative report about this part is to discuss about the goal of the company and what strategy they are going to use in order to achieve the goal (Anon., 2009). For example, the goal of the company is to improve popularity of the company but without an additional explanation on how they are going to make it will not be a strategy. They should include the method they are going to use to improve their popularity such as advertise their product and with that that is a whole complete strategy. As an example, you may have a look into the 2008' annual report of Amlin on how the illustrate their strategy (Anon., 2009).
Which parts still have space to improve?
Most company that has been review by the FRC under the 'Rising to the challenge' research has allocated and provides some of their risks. But company should take note and avoid some pitfalls which is there are too many risks to be the principal risk of the company, avoid reporting those general risks such as terrorism and discuss and explain more about the risk they are reporting (Anon., 2009). A good narrative reporting on risk should provide more information about the risk such as is the risk increasing or decreasing (Anon., 2009), will it bring a serious impact on the company.
Trend and factors
Xstrata 2008' annual report have show how they discuss about the trends and factors in a good manner. There is confusion about what is this trend and factors means. For what FRC think, it is about the macro business environment and also the company own factors (Anon., 2009). Narrative reporting on this segment should keep four words in mind which is relevant, future oriented, quantified and evidence if they are going to improve (Anon., 2009).
Contractual and other arrangement
Company always get confuse in this part every time they are going to make a narrative reporting about it. Lord bury had provide an explanation about this in the House of lords 2006. He state that this is not a requirement for the company to state who is their supplier and customer but it is for them to provide the relationship of the company with the supplier or the customer that will affect the business of the company in a directly or indirectly way (Anon., 2009). Director need to make decision on what to report under this segment. An explanation that is enough for understanding on the growth, performance and position is needed (Anon., 2009).
Most of the company only discloses the financial KPIs rather than the non-financial KPIs. A good practice on narrative reporting in this area need to report about the key driver of the company business but because of the Company Act that specifically mention about the employees and environment non-financial KPIs, the company has only choose to disclose the information on these part but forgo the key driver that will affect the company business (Anon., 2009).
What stakeholders want from narrative reporting's information?
Why is the company preparing the annual report? Who are they preparing for? That's the questions. Other than complying with law, an organization is preparing the annual report for the stakeholders. The annual report plays an important role in stakeholders' decision making. So, what is the information that stakeholders want? I will discuss about that.
First of all, it is the forward-looking information. A good reporter will state the company potentials, strategy, business environment, market and more that will affect the company business in the near future and what strategy and action they are going to take to face this different fast pace changing business environment (Anon.). By providing this information, investor will get to know the company analysis ability, competitive ability to take up the challenge in the future.
Second, stakeholders wants to know about the risks that the company facing. Company need to address and identify the key risk they are facing and the method they are going to face the risk. If the company did not have any serious material risk, they also need to state it down in the report so that this can give assurance to the stakeholders that the company is monitoring and assessing risk even there is no a serious matter (Anon.)..
Third, information that the stakeholders' looking for is the Key Performance Indicators (KPIs). There are two types of KPIs which are financial and non-financial KPIs. These KPIs will help the company to determine whether they are reaching their goals or not (Anon.).. Most company fail to state the non-financial KPIs where this is also an important part for the stakeholders. The information that shown by non-financial KPIs will most likely to be like how the company is benefits from hiring a new executive.
Next, business unit of the company is also required by the stakeholders. Stakeholders will be likely to know about the operation and performance, segment or department of the company and more about the business units (Anon.)..
Lastly, stakeholders will also welcome the information about the board operation. Any additional information about the operation of the boards and its committee in deciding their strategy, leading the company, monitoring risk and performance of the company and more is welcome. Stakeholders also wish to see in the report about the activity done by the board and its committee during the year (Anon.).
Limitation or constrains of narrative reporting
So what is the limitation and constrains to narrative reporting? Let get straight to the point.
1st of all, the bad news about the company performance is rarely being reported (Williamson, J.). The bad performance of a company is rarely reported by the company in the annual report and the performance is not just the financial performance but also include the Environment, Social and Governance (ESG) performance too (Williamson, J.). The company also not willing to report about the difficulties they are facing (Williamson, J.)and by doing that the company have devalue narrative reporting to a state that can be said the report is useless because not reporting those part equal to abandon the discussion of risk and opportunities which is the part where the stakeholders has a huge interest in.
2nd limitation that devalues the narrative reporting is forward looking information (Williamson, J.). A company that did not report on that will devalue the narrative reporting because that is the part where the company is going to discuss their strategy in facing the fast pace changing business information or factor that will affect the company. Company usually do not discuss about this part is because of they afraid their competitors will get to know the strategy they are going to use and competitors will find a ways to go against the company strategy. So, if none of their competitors is doing this narrative reporting for forward-looking information, they will not disclose their information in the annual report too.
3rd is the comparability of information. Narrative reporting on comparison between two companies is extremely difficult to be done and don't say about comparing with other company even comparison between their own company past record and current record will be difficult too and this has render the annual report useless (Williamson, J.). Thus, the values of narrative reporting have reduced.
4th is the length of the narrative reporting. A research that has been done by ACCA and Deloitte in 2010 which is Hitting the notes, but what's the tune? Has show that from year 1996 to 2010, the length of narrative reporting has increased by 56% (Sajjad, A.) and that is a big figure. The increase of length of narrative reporting has increase the complexity of the report (Sajjad, A.) for the user to read and has cause value reduction for the narrative reporting. ACCA and Deloitte has make a study on this case and found out that the information that is disclose is to fulfill both the important demand which are from the regulatory and shareholders. Because of this the information that is providing in the annual report has increase to fulfill the demand and has cause information overload (Sajjad, A.).
Lastly, poor quality information has cause the narrative reporting to devalue. So, what is the poor quality information? The 1st to 4th discussion above is the cause that leads to poor quality.
Benefits of good narrative reporting
Now I am going to discuss about what the benefits of narrative reporting.
1st of all, a good performance of narrative reporting will affect the share price performance in medium or long-term (Bruce, K.). A good share price of the company will grant the benefit lots of advantage such as protecting them from being take over by the other company because of high share price, get more capital when issue share and lots more.
2nd is the good practice of narrative reporting will lead to strategy thinking. When the company is doing their narrative reporting, this will lets them to review their goals and reconsider their strategy in meeting the goals (Bruce, K.).
3rd is enhance communication inside the organization. When you prepare a good, appropriate and high quality annual report, it can be use for internal communication that help the staff from different level to have an idea on what the company performance and strategy that will lead them to the objective (Bruce, K.).
4th is that a good reporting will lead to trust between stakeholders and the board of directors or the company. Company that focus on providing a good reporting will lead to the trust of stakeholder that the directors is paying attention and take responsibility to report to the stakeholders what happen inside the company during the years through annual report.
5th is that good narrative reporting will convenient the user in decision making. A poor quality narrative reporting will lead to the confusion of stakeholders and might cause the company to lose potential investors while good practice of narrative reporting will enable the investors to have a clear look at the company potentials and a good narrative reporting will also indirectly help the company to attract investors because it seem to be professional to provide such a good quality report.
And with the 5 point above it conclude my benefit of good narrative reporting part.
As a conclusion, I believe that the current value of narrative reporting in financial accounting is not really favorable. There are still lots of place to improve. Company still has more study that they need to do to improve their narrative reporting and by providing a good practice of narrative reporting, it will bring benefits to the company. Making the information in narrative reporting accessible and understandable will enhance the quality of narrative reporting (Anon., 2011). An effective report is believed to contain a table of contain that convenient the user to use the report and a summary page that about overall message and key information of the report is also a must for user to understand the report as a brief (Anon., 2011). A company that produces a sustainability reporting over their company performance in a good manner will provide an assurance to stakeholders that the company has take responsibility to close attention and monitoring of their company activities. So, by disclosing information that I mention above in 'space to improve' part above and producing information that the stakeholders' wants are key to success in narrative reporting. To improve in narrative reporting, a review on user feedback is important too. If the company is affordable, they may hire an external professional to review and improve the report.
ACCA, 2010. Hitting the note, but what's the tune? United Kingdom: ACCA. Available at: <http://www.accaglobal.com/content/dam/acca/global/PDF-technical/narrative-reporting/hitting_the_notes.pdf>[Assessed 15 November 2012]
Bruce, K., 2010. Narrative reporting in annual report: mind the gap, [e-journal], Available through: <http://www.richardhollins.com/wp-content/uploads/2010/06/MINDTHEGAP_FD.pdf> [Assessed 15 November 2012]
Campbell, D. & Slack, R., (2008) Narrative reporting: Analysts' Perceptions of its Value and Relevance, [e-journal] Available at: <http://www2.accaglobal.com/pubs/economy/analysis/acca/technical_papers/tech_3.pdf>[Assessed 13 November 2012]
Chartered Accountants of Canada, 2011. Improved Annual Report by Not-For-Profit Organizations. Canada: The Canadian Institute of Chartered Accountants. Available at: <http://www.cica.ca/focus-on-practice-areas/reporting-and-capital-markets/item54324.pdf>[Assessed 13 November 2012]
CIMA, 2009. Review puts narrative reporting under the microscope, [online] Available at: <http://www.cimaglobal.com/Thought-leadership/Newsletters/Insight-e-magazine/Insight-Archive/Review-puts-narrative-reporting-under-the-microscope/>[Assessed 17 November 2012]
Financial Reporting Council, 2009. Rising to the challenge. United Kingdom: Financial Reporting Council. Available at: <http://www.frc.org.uk/Our-Work/Publications/ASB/Rising-to-the-Challenge/Rising-to-the-challenge.aspx>[Assessed 17 November 2012]
Sajjad, A. Writing the narrative: the triumphs and tribulations, [e-journal], Available through: <http://www.accaglobal.com/content/dam/acca/global/PDF-technical/narrative-reporting/writing_the_narrative.pdf>[Assessed 17 November 2012]
The Association of British Insurers. Developments in narrative reporting: An Abi Position Paper, [online], Available at: <http://www.ivis.co.uk/NarrativeReporting.aspx>[Assessed 16 November 2012]
Williamson, J., 2010. Consultation response form: The Future of Narrative Reporting, [e-journal], Available through <http://www.tuc.org.uk/tucfiles/333.pdf>[Assessed 15 November 2012]