Financial accounting:
FIRST STEP TOWARDS
REDUCTION OF DISCLOSURE
OVERLOAD
The significant growth of Annual Financial Statements (‘AFS’) concerns many
commentators. They find AFS just too long and, as a result, less effective as a tool
to communicate between their preparers and their users. Ultimately, this reduced
utility of AFS could put the societal benefits attached to standardized and mandatory disclosure via AFS at risk. This article aspires to identify a robust and plausible first step towards improving this situation.
Ir. Paul Vos MBA RC: Annual Financial Statements (‘AFS’) have grown considerably over the years.
For instance, over the last 5 years companies listed at
the London Stock Exchange have seen their AFS grow
by roughly 50% (Deloitte, 2010). Many commentators
across the globe have raised their concerns regarding
this growth. They find AFS just too long and, as a result, less effective as a tool to communicate between
their preparers and their users. Users cannot see the
wood for the trees. This reduces the utility of AFS not
only for users but subsequently also for preparers. Preparers, while facing undue cost, could lose a channel
to inform users and thus lose a way to attract capital.
‘Let me start with the issue of disclosure
overload, which is one of the most common
concerns that I hear from all types of stakeholders, from investors to auditors of microcompanies all the way up to the C-suite at
major companies. Many of those stakeholders tell me that financial reports are just
too long – and, as a result, that they have
become much less effective tools for communicating with investors. Yet investors continue to say they want more information, particularly when there is a business downturn
or failure. Often the information that these investors want is available in the financial
statements – but it is hidden in plain sight.’
(Leslie F. Seidman; Chairman of the Financial
Accounting Standards Board (FASB) in her
address to Compliance Week Annual Conference on the 4th of June 2012 in Washington DC, USA)
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Ultimately, this reduced utility of AFS could even put
the societal benefits attached to standardized and
mandatory disclosure via AFS at risk. Despite a longstanding and global discussion among all involved,
concerns around this growth of AFS only intensify. A
‘silver bullet’ does not seem to be easily available.
The term ‘disclosure overload’ is used by many
to address immaterial disclosures via the statements and the notes of AFS that inhibit the ability
to identify and understand relevant information.
For instance, the accounting policies section can
easily run to eight or more pages, yet regularly
contains wording that is directly copied from
the related International Financial Reporting
Standards (‘IFRS’). Another example is disclosure
around financial instruments. Even in a company
where financial instruments are not core to the
business strategy the related disclosures could
stretch to more than 15 pages. These immaterial
disclosures are seen as the key cause for the growth
of AFS and thus disclosure overload (ICAS, 2011).
This article aspires to identify a robust and
plausible first step towards a reduction in disclosure overload in AFS prepared under IFRS. This
requires answering three questions which I will
cover in this article: ‘Why is disclosure overload an
issue?’, ‘What is fuelling disclosure overload?’ and
‘How could disclosure overload be reduced?’ But
before providing the answers to these three questions, it is worthwhile to provide an introduction to
the underlying research.
Research centered around three discussion papers
My understanding has been established based upon
the responses to three discussion papers issued
by the International Auditing and Assurance
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1) WHY IS DISCLOSURE OVERLOAD AN ISSUE?
Over the last decade the number of disclosures
in IFRS¹ AFS has been growing to such extent
that ... Example: Major pharmaceutical company²
Number of financial data
in annual report
3500
... societal benefits attached to standardized
and mandatory disclosure via AFS are put at
risk
More detailed financial
review & notes
3408
Impact of disclosure overload³:
Confuse rather than inform users
Obscure relevant information
Result in undue cost for preparers
Details to operating costs, risk
management, remuneration
3000
2500
‘It is a shame that while annual reports have doubled in size,
the number of shareholders requesting a copy has halved’
More detailed notes
2000
Hundred Group of Finance Directors4
Further details financial results
1500
Provisions
EPS
Based on IAS
1000
Operating Profit
EBITDA per division
1st consolidated financial
statements
500
0
72
75
78
81
84
87
90
96
99
02
05
07
08
‘Annual reports are increasingly becoming a secondary
source of investor information’
Ernst & Young and Barclays4
1
2
3
4
IFRS = International Financial Reporting Standards.
EFRAG, ANC & FRC (July 2012), ‘Discussion Paper Towards a disclosure framework for the notes’.
FRC (2009), ‘Louder than Words’; ICAS & NZICA (2011), ‘Losing the excess baggage’.
Hundred Group, Ernst & Young and Barclays (September 2011) ‘Response to FRC’s discussion paper Cutting Clutter’, three letters.
Figure 1. Why is disclosure overload an issue?
Standards Board (IAASB, 2011), the UK Financial
Reporting Council (FRC, 2011) and the European
Securities and Markets Authority (ESMA, 2011).
These papers have triggered 120 stakeholders to
submit extensive and thoughtful responses covering
over 1,000 pages. All types of stakeholders are
represented in these responses ranging from preparers, users and auditors of AFS to regulators and
standard setters. This research is novel in its rigorous and integrated review of all these responses.
This has revealed not only what the beliefs are
among stakeholders, but also attempts to explain
why stakeholders have these beliefs.
Why is disclosure overload an issue?
The graph shown in figure 1 provides a further illustration of the significant growth of AFS over the
years. This graph depicts the number of quantitative
data points in the annual report of a major pharmaceutical company. In 1994, the year in which this
company adopted IFRS, its AFS contained 500
financial data points. By 2008 this number has
grown to over 3400 data points. This equates to
almost a factor of 7 or a compounded annual
growth rate of 15%.
Several studies (FRC, 2009; ICAS & NZICA,
2011; KPMG, 2011) have concluded that this grow-
‘Its sheer volume is
confusing the
users of AFS rather
than informing
them’
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2) WHAT IS FUELLING DISCLOSURE OVERLOAD?
Standard setter
Disclosure
requirement
derived from anti
abuse view point
Disclosure
requirement driven
by verifiability:
enough detail to
reperform
calculation
Regulator
Auditor
Focus on inclusion
rather than exclusion
Rely on ‘Manuals of
Accounting’ produced
by ‘Big Four’
Build on previous
year’s disclosure
Reviews may give an
appearance of seeking
‘tick-box’ compliance
with disclosure
requirements
Illustrative accounts
and GAAP checklists
produced by
accounting firms
address all disclosure
eventualities
Focus on what to put
in not what to take
out in order to ensure
compliance
(regardless of
materiality)
‘Tick-box’ compliance
approach
Prospect of external
review by auditor and
potentially regulator
reinforces ‘tick-box’
approach
Influenced by what
everyone else is doing
Standard setter keen to
be seen as effective
Preparer
Regulator wants to
minimize risk of
adverse comment
Auditor keen to avoid
challenge and adverse
publicity
Fear - err on side of
caution
Source: Synthesis of behavioural model as sketched in the discussion paper ‘Cutting clutter’ published by FRC in April 2011.
Figure 2. What is fuelling disclosure overload?
ing volume of disclosures has added to the complexity of the AFS. This increased complexity is creating several negative effects. First of all its sheer
volume is confusing the users of AFS rather than
informing them. Secondly, the disclosure overload
caused by extensive immaterial disclosures is obscuring the relevant information as users cannot
see the wood for the trees. Thirdly, especially as
various disclosures go beyond management’s needs
to run their business, preparers have to spend considerable time, effort and thus cost in preparing all
these disclosures.
My research confirms that the vast majority of
each type of stakeholders frequently encounters
cases of immaterial disclosures in AFS. To even
larger extent all types of stakeholders assess this
issue as very significant indicating that the impact
of immaterial disclosures is experienced as negative.
Why is this causing a problem? Let’s start with
the users of AFS. Disclosure overload hurts the
ability of AFS to support these users for instance
around their investment and credit decisions. This
reduced utility could result in users relying less
upon AFS as also illustrated by the response of the
‘This preference for verifiability
transpires from some distrust of the
standard setter towards preparers,
auditors and regulators’
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‘It has become increasingly clear that we are suffering from disclosure overload. This is not entirely due to financial
reporting. The plain fact is that businesses have become more complex. However, it is the job of financial reporting
to describe this complexity, not to mask it.
Not all disclosures provide useful information to investors. Standard boilerplate responses are more about ticking
boxes than helping investors really understand what is going on under the hood of the business. This is an issue
that preparers, auditors, regulators and standard setters will have to tackle together.
For our part, we need to make sure that disclosure requirements are appropriate. Bottom-up, each disclosure requirement may have made sense when the standard was first introduced. However, from a top-down perspective do
the disclosures in totality improve the clarity of financial reporting, or do they make it more difficult to really see
what is going on?’
(Hans Hoogervorst; Chairman of the International Accounting Standard Board (IASB) in his address to the Consejo Mexicano de Normas de Información Financiera on the 7th of March 2012 in Mexico City, Mexico)
Hundred Group of Finance Directors1 depicted on
the right side of figure 1. This could potentially
result in less informed and thus less optimal investment and credit decisions. This not only hurts individual investors and creditors, but could ultimately
also affect the optimal employment of financial
capital in our economy.
To make things worse, this reduced reliance
upon AFS has a negative knock-on effect on the
companies that prepare these AFS. These preparers
could lose a channel to inform the users and thus
lose a way to attract capital. The responses of Ernst
& Young and Barclays shown in figure 1 illustrate
that this could cause companies to have to rely
more upon other channels like investor relations
presentations. In addition several preparers indicate
having to spend ample time and effort in preparing
the immaterial disclosures. Thus, disclosure overload causes that AFS not only offer a reduced utility
to their users but also to their preparers.
This reduced utility even threatens the raison
d’être of AFS. Standardized and mandatory disclosures via AFS are generally believed to generate societal benefits: so called positive externalities (Hirsleifer, 1971; Verrecchia, 2001; Bushee & Leuz, 2003). For
instance they commit firms to disclose in a truthful
and non-selective manner. This prevents investors
only receiving the good news. However, realizing these
positive externalities does require that AFS are actually used. In fact, if mandatory AFS are not being used,
they will represent a deadweight loss for society. This
is why disclosure overload is also concerning the custodians of these externalities, like policy makers,
standard setters and regulators, greatly. This explains
the statements made by the chairs of the two leading
accounting standard setters at the boxes in this article.
What is fuelling disclosure overload?
The previous section revealed an intriguing notion:
all types of stakeholders around AFS, from standard
setters to users, acknowledge suffering from disclosure overload. Yet, as illustrated by the continuous growth of immaterial disclosures, these stakeholders do not seem to be able to solve it. This
brings us to the second question to be answered:
What is fuelling disclosure overload?
The discussion paper ‘Cutting Clutter’ of the UK
Financial Reporting Council sketches a charmingly
simple and powerful behavioural model that could
explain this paradox. Figure 2 aims to capture the
core of this model in a structured fashion. The
model explains how the behaviour of each type of
stakeholders is influencing the behaviour of another
type. Key is that a certain order has been assumed:
it starts off with the standard setter influencing the
regulators who in turn influence the auditors who
ultimately influence the preparers.
The disclosure requirements set by the standard
setter seem to originate from an anti-abuse viewpoint. Hence, the standard setter seems to fear that
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27
‘Preparers prefer
to be safe rather
than sorry’
without listing potential specific disclosures preparers will violate the overriding principle that all
material information needs to be disclosed. One
way of preventing such abuse is to aim for verifiability, meaning that third parties need to be able to
(re)perform materiality assessments. It goes without
saying that this requires additional disclosures. It
must be noted that this preference for verifiability
transpires from some distrust of the standard setter
towards preparers (who need to execute these assessments adequately), auditors (who are expected
to convince themselves that these assessments are
executed adequately) and even regulators (who act
as a disciplinary force on both preparers and auditors). All of this seems to be driven by an underlying
desire of the standard setter to be seen as effective.
In return the regulators, due to behaviours and
actions of the standard setters, are tempted to focus
on inclusion rather than exclusion. Keen to prevent
anything falling between the cracks it is no surprise
that during reviews one is keen to tick off all potential disclosures. This may appear as ‘tick-box’ compliance. Like the standard setter is keen to be seen
effective, the core driver of the regulators is minimizing the risk of adverse comments.
The posture of the regulators affects the behaviour of the auditors. Ultimately, auditors are very
keen to avoid adverse publicity and therefore are
avoiding regulators’ challenge. This core driver
translates in a similar ‘tick-box’ compliance approach as displayed by the regulators. Furthermore, such approach fuels the existence of and reliance upon ‘Manuals of Accounting’ as produced
by each of the ‘Big Four’ firms2 , illustrative ac-
3) HOW COULD DISCLOSURE OVERLOAD BE REDUCED?
IASB’s¹ endorsement of ‘Losing the excess
baggage’² would provide the strong and
public support required
Proposals of ‘Losing the excess baggage’
Reduce and amend disclosure requirements in individual IFRS
Disconnect inclusion of line items from
inclusion of information
Among all stakeholders, IASB is
uniquely well placed to demonstrate
leadership
No dilution to existing IASB’s guidance
Positive effect via sequential behaviors of
all other stakeholder groups
Characteristics of both proposals
Fully in line with existing IASB guidance
In theory irrelevant: only material
disclosures are required
In practice potent: removing source for
automatic inclusion
Inevitable various critiques: less positive
voices may be motivated by reluctance
and potentially even anxiety to exercise
more judgment around materiality
IASB’s endorsement would not only provide a robust first step towards reduced levels of
disclosure overload in AFS, IASB’s endorsement also seems plausible
¹ IASB: International Accounting Standards Board.
² ICAS & NZICA (2011), ‘Losing the excess baggage’.
Figure 3. How could disclosure overload be reduced?
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counts and disclosure check-lists covering all disclosure eventualities. Finally, the auditors are influenced by the AFS signed off by their peers.
Hence, there is an element of herd-instinct here.
This will complicate the envisioned reduction of
disclosure overload as it is hard for a first mover to
break out of the pack.
All three types of stakeholders discussed so far
affect the companies preparing AFS. Ultimately,
these preparers are accountable for disclosing all
material information. Preparers can be expected to
sense the core drivers of these three types of stakeholders. These drivers can be summarized around
minimizing the risk of adverse comments resulting
in behaviours that centre around putting the
monkey on the back of the successive type of stakeholders. In this light it is no surprise that the core
driver of a preparer is fear, with the consequence
that a preparer errs on the side of caution. All of
this instates the same ‘tick-box’ approach seen before and an associated focus on what to put in and
not on what to take out. This triggers an approach
in which one keeps on adding upon previous year’s
disclosure, without much consideration to take out
information that has become immaterial.
This behavioural model provides an explanation as to how all types of stakeholders contribute to disclosure overload. Each stakeholder wants
to be seen as effective and therefore is keen to
minimize adverse comments: this is shaping their
behaviours. However, behaviour of each stakeholder influence behaviours of the stakeholders
further downstream. Preparers, being first in line,
are risk-averse. As a result, preparers prefer to be
safe rather than sorry. Because regulators are not
seen to challenge immaterial disclosures, preparers and their auditors strongly believe that they
are best off by: a) simply adding all disclosures as
listed in IFRS regardless their level of materiality
and b) provide a note to each line item listed in the
primary statements even if such note does not provide additional material information.
My research reveals that all types of stakeholders recognize this behavioural model to a large
extent. Most acknowledge both the role of other
types and their own role. However, on their own
role, auditors are collectively slightly less firm and
less united in their views. Especially the references
to their accounting manuals, disclosure check-lists
and illustrative accounts seem to have ruffled a few
feathers. Yet others accept the behavioural model
and already moved on contemplating what its consequences should be.
Here the responses of stakeholders to the discussion paper ‘Cutting Clutter’ also offer insights.
Based upon my review of all this commentary I conclude that it cannot realistically be expected that
preparers and their auditors will spontaneously and
independently reduce the level of disclosure overload. Making preparers and auditors change requires public and strong support upstream. Regulators and thus standard setters need to provide
such support. This support should be public because preparers and their auditors need to notice it.
The support should also be strong, as just paying lip
service will not be perceived as credible backing.
How could disclosure overload be
reduced?
This brings us to the third and final question: how
could disclosure overload in AFS prepared under
IFRS be reduced? The behavioural model discussed
in the previous section suggests that any robust
first step towards less disclosure overload requires
the International Accounting Standards Board
(IASB) providing public and strong support. I argue that endorsement of the proposals made by
the Institute of Chartered Accountants of Scotland (ICAS) and the New Zealand Institute of
Chartered Accountants (NZICA) in their report
‘Losing the excess baggage’ 3 would represent such
support. Furthermore, such step seems plausible
as IASB is uniquely well placed to demonstrate
leadership in this area.
ICAS’s and NZICA’s proposals in ‘Losing the excess baggage’ boil down to two approaches. First, it
proposes a reduction of disclosure requirements in
individual IFRS. Being listed in an IFRS does not
automatically make something material. Second, it
suggests disconnecting the decision to include a
specific line item in the primary statements from
the decision to provide information in the notes. It
is not a given that a material line item always comes
with material information and vice versa.
My research confirms that the majority within
practically all types of stakeholders acknowledge
that both proposals are fully in line with IASB’s
current guidance. In fact, in theory they should be
irrelevant as, due to the materiality override, only
material disclosures are obligatory. Nonetheless, as
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29
explained by the behavioural model, in practice endorsement of these approaches to disclosures will
remove key sources for automatic inclusion of immaterial disclosures resulting in overload. This
makes IASB’s endorsement a robust first step.
IASB is uniquely well placed to demonstrate
leadership. While endorsement will not dilute
their existing guidance, it will positively influence
all other stakeholders. Certainly endorsement will
not only trigger positive critiques. However it is
important to realize that less positive voices may
be motivated by reluctance and potentially even
anxiety to exercise more judgment around materiality. As reducing disclosure overload requires
more judgment, these sentiments actually argue
in favour of IASB embracing a more selective approach towards disclosure requirements. Furthermore, via endorsing this proposal IASB could create a stepping stone towards a disclosure regime
based upon a single principles-based disclosure
framework or based solely on disclosure principles
in individual standards.
All of this makes that IASB’s endorsement of the
proposals as provided by ICAS and NZICA ‘Losing
the excess baggage’ would not only provide a robust
first step towards reduced levels of disclosure overload, IASB’s endorsement seems also plausible.
and NZICA issued their final report called ‘Losing the excess baggage – reducing disclosures in financial statements to what is important’.
Literature
~ Bushee, B. & C. Leuz (2003), Economic Consequences of SEC Disclosure Regulation, article 02-24-B published by The Wharton Financial Institutions Center.
~ Deloitte (October 2010), Swimming in words: surveying narrative reporting in
annual reports and Deloitte (November 2010), Drowning by numbers: surveying
financial statements in annual reports.
~ ESMA, European Securities and Markets Authority (November 2011), Consultation Paper: Considerations of materiality in financial reporting.
~ FRC, Financial Reporting Council (June 2009), Louder than words, discussion
paper.
~ FRC, Financial Reporting Council (April 2011), Cutting Clutter, discussion
paper.
~ Hirsleifer, J. (1971), ‘The Private and Social Value of Information and the
Reward to Incentive Activity’, The American Economic Review, 61, 561-574.
~ IAASB, International Auditing and Assurance Standards Board (January 2011),
The evolving nature of financial reporting: disclosure and its audit implications,
discussion paper.
~ ICAS, Institute of Chartered Accountants Scotland, (June 2011), Response to
IAASB’s discussion paper The evolving nature of financial reporting: disclosure
and its audit implications, letter to International Auditing and Assurance
Standards Board.
~ ICAS, Institute of Chartered Accountants of Scotland & NZICA, New Zealand
Institute of Chartered Accountants (July 2011), Losing the excess baggage – reducing disclosures in financial statements to what is important, discussion paper.
~ KPMG (2011), Disclosure overload and complexity: hidden in plain sight.
Notes
~ Verrecchia, R. (2001), ‘Essays on disclosure’, Journal of Accounting and Econ-
1 The Hundred Group of Finance Directors represents the Finance Directors of
omics, 32, 91-180.
the UK’s largest companies, with memberships drawn mainly from boardrooms
This article is based upon the final thesis written within the in-
of the FTSE 100.
2 Auditing Firms KPMG, PWC, Deloitte and Ernst & Young are collectively ad-
ternational Executive Master of Finance & Control (iEMFC) program under the aegis of Maastricht University. Dr. Peter Sampers
dressed as the Big Four.
3 In October 2010 IASB asked the Institute of Chartered Accountants of Scotland
RA, Professor of Financial Accounting has acted as the academic
and the New Zealand Institute of Chartered Accountants to undertake a project
supervisor. This thesis is available via the iEMFC section at the
to review the levels of disclosure requirements in existing IFRS and to rec-
website of Maastricht University. The author is employed as
ommend deletions and changes to disclosure requirements. In July 2011 ICAS
Finance Manager within Royal Dutch Shell.
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