Making financial reports. More effective and useful.

• Author: Omberg, Tom
• Position: FINANCIAL REPORTING

In the United States and other major economies, the first decade of the 21st century ended with a global credit crisis and a number of highly stressed or failed financial institutions. A major concern raised by these events was the ability of financial statements to warn users adequately of institutional vulnerability and of risks of failure, even when the statements were prepared according to appropriate financial reporting frameworks.

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As a result there have been calls from a variety of business leaders and reporting professionals for more transparent and complete portrayals of company financial positions and risks--all aimed at strengthening financial reporting for the benefit of investors and other stakeholders.

Such initiatives have actually been around for quite a while. A survey of investors conducted in 2008 by the Office of Investor Education and Advocacy of the U.S. Securities and Exchange Commission indicated that similar needs were surfacing even as the financial crisis was evolving. That study revealed relatively low use of financial reports by investors clue mainly to their perceived lack of relevant, understandable and timely information.

The following explores several financial reporting challenges and trends that have emerged over the past few years. In particular, the focus is on three key qualitative characteristics of useful financial reporting that may contribute to more solid support for financial, investment and other economic decisions, including:

Relevance: Reported information must be relevant to investors and other users as an aid in making decisions based on an entity's financial position, performance, risks and business prospects.

Understandahility: Financial reports must be clear and avoid unnecessary complexity or inconsistency that may limit the ability of users to comprehend the information. Timeliness: In today's fast-moving markets, information must be communicated quickly if it is to be useful in supporting investors' decisions.

Relevance--Addressing the Need for Useful Information

Investors and other stakeholders seek information that is relevant to the decisions they face, including the answers to two key questions they hope to find in financial reports:

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What is the expected return on investment and what is the potential risk associated with that ROI?

Expected ROI. To evaluate the expected return, investors need information that helps them to estimate future earnings and cash flows. A number of challenges may impact the usefulness of financial reporting to investors making those estimates. First, the information in financial reports is principally backward-looking, with few forward-looking elements.

Second, current accounting standards use a mixed-attribute model, with some elements recorded at historical book values and others at fair value.

Regardless of the value recorded, some items are accounted for in ways that may not, in an analyst's opinion, reflect the underlying...