25 January 2013

FEE: Comment letter on EFRAG-ANC-FRC discussion paper towards a disclosure framework for the notes

FEE supports the work that EFRAG has performed to date in trying to develop a disclosure framework aimed at setting a number of principles to increase the relevance of the notes to the financial statements.

Disclosures in the financial statements are an integral part of the corporate financial reporting made by entities. FEE believes that it would be difficult to find remedies to the shortcomings of financial reporting by addressing disclosures in financial statements in isolation. Therefore, FEE recommends that EFRAG takes a broader perspective and considers the development of a coherent disclosure framework that is applicable to all the different elements of the annual financial report including management commentary, corporate governance and financial statements (not solely financial performance but also of the challenges faced by the entity more broadly).

Developments over the years have significantly increased the level and complexity of the disclosure requirements. This evolution has intended and unintended consequences on the readability and understandability, as well as the auditability of the financial statements as a whole.

The increasing volume of information has not always enhanced the accessibility and usefulness of the information presented in the financial statements as the length and complexity of the annual reports may obscure important and key disclosures relating to the performance of a company.

There is increasing criticism that financial statements may not appropriately respond to users' needs. Those who mandate the disclosures of the annual reports need to think of financial reporting not as a compliance exercise but rather as a critical component of the financial reporting. Having a clear understanding of the users’ needs before proceeding to mandate disclosures is more likely to result in effective, practical financial communication.

There is a tendency for preparers to include all disclosures required in the financial statements to ensure compliance with the relevant standards because they fear the negative consequences of non compliance if scrutinised by regulators and/or auditors for omissions. Therefore, in the application of standards, it would be appropriate to move away from an approach based on compliance checklist to an approach based more on judgement.

At the same time, users are expressing frustration that financial statements include boilerplate information instead of the relevant information they need. Hence there appears to be a real need to refocus the purpose of financial reporting by establishing what information is essential as part of general purpose financial statements.

Against the trend of ever more disclosures, there have been several attempts to reduce the length and the complexity of the disclosures whilst increasing the quality and focus of the information they provide.

Despite all the achievements of these many projects, FEE believes that changes are not only needed in the area of financial statements disclosures, but also to corporate reporting as a whole to further increase its relevance and usefulness. To achieve these goals, the debate should take a broader perspective focusing on both the financial statements and the narrative section of the annual report.

The scope of information currently included in financial statements may not be sufficient any longer to enable users to make informed decisions. A growing number of investors increasingly seek to understand the overall performance of the company and the link between corporate financial information and the company’s strategy, business risks and governance. They are gradually extending their focus beyond financial information to key non-financial information included in the narrative section of the annual report. Therefore, FEE believes a holistic approach needs to be taken to effectively tackle current issues in financial reporting and improve corporate reporting as a whole.

Improving financial reporting is a shared responsibility and, while FEE believes that the role of the standard-setters and supporting organisations is paramount, FEE would encourage them to engage more broadly in this area.

As part of this holistic approach to improving financial reporting, FEE supports the development of a disclosure framework and the efforts of EFRAG in this respect.

However, in FEE´s view, EFRAG should take a broader perspective when thinking about disclosures. For instance, the FRC 'Thinking about disclosures in a broader context' paper provides some ideas about how to draw the boundaries between different elements of the annual financial report and how to develop placement criteria for disclosures. Therefore, FEE would recommend EFRAG to consider these ideas while further developing the disclosure framework.

Before a final conclusion can be drawn on where the disclosures need to be placed in different elements of the annual financial report, it would be necessary to identify some placement criteria. The development of such criteria would provide a structure for a financial report. It may even be a significant way forward to eliminate the existing inconsistencies and duplications within the financial reports. A coherent disclosure framework for this purpose would ultimately improve the quality of the information provided to users.

It is also important for EFRAG to continue with its efforts to undertake proper field testing such that the future development of the disclosure framework can be based upon an assessment of what information users are looking for in the notes and which information can be justified for presentation from a cost-benefit point of view.

Although it is not addressed in the Discussion Paper, there are aspects related to the auditability of financial statement disclosures which should also be taken into account while developing a disclosure framework.

To respond to stakeholders' demands for assurance and to audit requirements imposed by regulators, it is important that management, who remains responsible for preparing information, ensures that disclosed information is supported by sufficient and appropriate evidence.

This may not be possible where the information in disclosures is derived from systems which are separate from the main accounting systems and thus might not be subject to the same internal controls. This might mean that they are more challenging to audit.

It should also be noted that the increasing amount of qualitative and forward-looking information in financial reporting, which require management’s judgement and estimation, also increases the level of judgement that auditors need to exercise.

Therefore, the "auditability" of such disclosures is also an element that should be considered when developing a disclosure framework, as is also the case for financial reporting standards.

Comment letter

© FEE