The 5 R's to Decluttering Your Financial Statements
It is generally accepted that too many sets of financial statements fail in their basic task of informing users, as to the true financial performance and position of the entity.
“The accounts are meaningless”, “The accounts are confusing”, “I don’t have time to read through all of this”, “Where do you start?” “What does this mean?” are very common reactions when users are faced with reading an entity’s financial statements. This is despite the expense the entity has incurred preparing and, where applicable, auditing, and publishing the financial statements.
Many entities preparing general purpose financial statements, may be putting off starting the ‘decluttering’ process because the task seems too daunting. In our December 2015 edition of Accounting Alert we showcased an easy way for all entities to kick start the ‘decluttering’ process simply by critically analysing and culling all unnecessary accounting policies.
Another reason for entities not undertaking the decluttering exercise is the potential time and cost involved, both in preparing them and satisfying the auditors (where applicable) that the revised layout and content of the financial statements is acceptable.
Clearly copying prior year financial statements, which are usually a very standard “safe” copy closely based on a “model” set of financials, is very quick to prepare and has little risk of incurring time costs with the auditor or regulator (where applicable). Putting all possible disclosure in, regardless of whether it is needed or not, is sadly the quickest and cheapest way of preparing financial statements. Unfortunately, the result is not very useful to the users of those financial statements.
When preparing financial statements it pays to consider the 5 R’s to improving disclosure:
Are your accounting policies and disclosures relevant?
Some examples are:
- If you do not have derivatives, why have a derivative note?
- If you do not have revenue, why have a revenue recognition policy and pages dedicated to the impact of introducing NZ IFRS 15 Revenue from Contracts with Customers?
- If all your accounting policy note does is reproduce the basic requirements of the accounting standard, why is it there?
The content of your financial statements should only contain information that is relevant to your operation. Copying and pasting from boiler plate model accounts is only going to bulk up the financial statements and make them difficult to read.
Many entities are also afraid to drop disclosures from financial statements when they are no longer relevant. For example, valuation assumptions for share-based payment calculations are often seen in the notes, even after the options have vested. These can potentially be removed two years after the options were granted, as disclosure is only required in the year of grant, and perhaps as comparatives in the following year.
Many entities tend to include significant disclosures for transactions and balances that are not quantitatively or qualitatively material to the financial statements. These immaterial disclosures may be in the form of accounting policies, other numerical information or narrative that is superfluous to users. These immaterial disclosures should be removed as they draw the users’ attention away from key information.
An example could be an entity including significant disclosure for other assets and prepayments when the balances are trivial.
Is any information repeated?
In reviewing numerous sets of financial statements it becomes very obvious that there is a great deal of unnecessary repetition, with accounting policies being reproduced both in the policies note and under the related note.
An accounting policy only needs to be stated once (if at all), and then most likely within the relevant note.
Another example often occurs where land and buildings are revalued. We often still see NZ IAS 16 Property, Plant and Equipment fair value information disclosed in the property, plant and equipment note, and then being repeated in a separate fair value note with NZ IFRS 13 Fair Value Measurement disclosures.
Should you reorder the contents of your financial report?
The majority of financial reports steadfastly follow the convention - note 1 is accounting policies, note 2 is accounting policies issued not yet effective, and so on. Two questions to ask yourself:
- Does the accounting policy note as presented really reflect the most relevant information contained within the financial report?
- Why do we do it this way?
An easy way to start improving the usefulness of the financial report is to consider reordering. For example, should the impact of NZ IFRS 15 and NZ IFRS 9 Financial Instruments together with some minor annual improvements warrant a prominent positon in note 1 or note 2? Or should this be moved to further on in the report? Also consider:
- Moving performance information near the beginning of the notes.
- Including a ‘highlights’ or ‘key changes during the year’ section after the primary financial statements to give the user a summarised view of major events that impacted the entity during the year.
- Moving the majority of accounting policies to their relevant notes, and merely keeping the ‘Basis of Preparation’ and sundry policies in a separate ‘accounting policies’ note as this will help with understandability of the financial statements.
- Moving key estimates and judgements into the relevant notes in the financial statements to assist understandability of the financial statements.
Should you regroup the content of you financial report?
The majority of current financial statements follow a very rigid format: accounting policies followed by income statement items, followed by balance sheet items. This can usually be clearly seen by looking at the tidy, sequential way in which the balance sheet and income statement are cross referenced to the notes.
Again the question to ask is does this order help the user? Should certain notes be grouped together?
The most common example is all of the disclosures involving financial instruments, such as trade receivables, trade creditors, loans, and cash. Would the accounts be easier to read if all disclosures including accounting policies were grouped together? Should the accounting policies be relocated to the appropriate note?
Are there accounting policies that should be re-emphasised so the user clearly understands the financial report?
The current layout of the financial report results in users “not being able to see the wood for the trees”. Unfortunately too many disclosures are “boiler plated” and do not give sufficient information to the user to understand key accounting estimates and judgments.
While the disclosure initiative does involve reducing unnecessary disclosure where this information is not relevant or is repeated, it does not just stop there.
A key aspect of the initiative is to re-emphasise key judgments and measurement inputs allowing users to properly understand how accounting policies have been selected and how accounting standards have been applied.