Directors’ reports hardly read by shareholders

Corporate failures in the new millennium sent shock waves across the globe, and investor confidence was an expected casualty. Ever since then global accounting bodies have endeavoured to prioritize investor information and undoubtedly Financial Reporting has assumed greater priority. The Sri Lankan accounting profession too has been in the forefront of this task backed by the regulators. It was in this background that a well known authority on accounting standards, Reyaz Mihular, Partner KPMG, addressed Colombo’s elite corporate leaders at a meeting hosted by the Institute of Chartered Accountants of Sri Lanka in keeping with their continuing policy of being on board with global trends in Financial Reporting.

Mihular was critical on the tradional reporting format and argued that the Balance Sheet is not a guide to value and the P&L based on historical value is not a guide to the future. Quoting examples from Microsoft, he added that value of intangible assets is not visible in the Balance Sheet and IT giant’s high value patents are not seen by the shareholders. Mihular asserted that the “Fair Value” concept is no longer standing on ‘your’ doorstep but has crashed into the domain taking accountants by surprise. Citing danger Mihular warned CFO’s if not prepared to be ready to face trouble.

Stressing the importance of adequate disclosures Mihular added that the directors report is so routine and hardly read by a majority of the shareholders but admitted that the chairman’s review most often highlights future plans of investor interest.

On this point, why are forecasts limited to IPO’s only and not provided annually, do companies play safe and are afraid to provide market relevant information due to liability issues, should not adequate rules be provided to disclose investor useful information without fear of bankruptcy?

Historical Costs (HC) with its 500 year-old mindset is limiting the development and framework of fair value to realize its full potential, resultantly we do not account adequately for goodwill, other intangibles, pensions, share based payment and financial instruments, options are not accounted, some of the adverse effect of these deficiencies are clearly reflected by the many bankruptcies reported in the provident funds particularly in UK. Reporting standards have taken note of these shortcomings and attempts have been made to bridge the gap.

With a gradual change in mindset acceptance of fair values for measurement will increase, and increasing use of NPV computation of fair values (in the absence of active markets) will establish benchmarks for the various risk premiums that need to be factored insto the discount rate. The market will punish companies that move away from the benchmarks enforcing discipline to the process and the emerging technology support in the form of valuation tool kit will drive the development of fair value measurements.

International Accounting standards direct greater use of fair values in measuring transactions, This promotes more disclosure, especially judgements, plans, assumptions and moving off – balance sheet items onto balance sheet. The CFO’s didn’t seem comfortable with Mihular’s assertions and presented dissenting views on the quantum of disclosures and its benefits to the company as well the shareholders.

A thought provoking point was raised on the necessity of making all such disclosures annually in addition to statutory disclosures. Companies are already burdened with requirements of the CSE and the SEC, further compounded by the new Companies Act requirement of holding AGM within six months. It was also pointed out that the new Act places tremendous pressure on Directors with stringent liability.

Some CEO’s felt that certain disclosures may not be in the best interests of the company and may well be used for competitor advantage. Though controversial but an issue with reality was the view that irrespective of standards and modern practices the major stakeholder Inland Revenue will continue to levy taxes on the historical values and it’s a priority that such issues should be settled. Hayleys Director Richard Ebell chairman of the ICASL Financial Reporting Faculty though not disagreeing with Mihular said that shareholder judgement is critical in investor decisions and has no substitute to it.

The fact that markets are integrating worldwide, skill transfers across the borders giving rise to flow of funds more than ever before, differences in accounting methodologies and reporting systems could impose increasing burdens on economic efficiency. Given this background cross border comparisons may well be costly and difficult leading to incorrect market directions and capital allocation. Regulators for this reason will tend to impose global standards. However there needs to be a trade off between needs of companies and investors and the size of the markets is another concern.