Financial Harmony
Have you picked up a set of audited financial statements of a large company at some point in the last five years? If you did, could you understand them and compare the results of that company to the results of another company? Congratulations if you could!
Like many areas in business and commerce that have become exponentially complex over the last twenty years, so too has the ability to prepare, assess and compare a set of financial statements. In a recent Harvard Business Review article, the issue of why this is the case was considered. Here are some of the findings.
Where Financial Reporting Still Falls Short, H. David Sherman and S. David Young. Harvard Business Review, July 2016.
Have you picked up a set of audited financial statements of a large company at some point in the last five years? If you did, could you understand them and compare the results of that company to the results of another company? Congratulations if you could!
Like many areas in business and commerce that have become exponentially complex over the last twenty years, so too has the ability to prepare, assess and compare a set of financial statements. In a recent Harvard Business Review article, the issue of why this is the case was considered. Here are some of the findings.
- The level of accounting compliance and corporate regulation has dramatically increased over the last fifteen years or so thanks to the major corporate collapses early is the 2000s and the GFC only a few years later. More rules creates complexity.
- While the introduction of global accounting standards and practices sought to create uniformity and control, this has not occurred in practice. For example, some countries have not adopted all the global accounting standards but rather ‘carved out / set aside’ some standards while other countries ‘carved in’ other standards.
- Even where a company is subject to certain standards it has used management and executive judgement and interpretation as to how to apply the standards to meet their corporate objectives.
- In some cases, where the application of the standards led to negative financial results, various companies like Facebook and Twitter have undertaken window dressing of the results to make them appear better. For example, in 2015 Twitter reported a net loss of $US521m. But in the same set of financial results it reported adjusted earnings of positive $276m. (“Huh?” I hear you say).
- Remember the days when asset values were reported at cost (less depreciation)? Well now we have fair value accounting which allows companies to value assets at a current sale or realisable fair value. The problem with this is that managerial judgement and interpretation is required to calculate fair value.
- Executives and managers are always going to look for ways to, dare I say ‘manipulate’ financial information so that financial results suit the purposes of the company and themselves. It is unfortunately human nature. Continuing to introduce new reporting standards and requirements can only achieve so much before the burden and complexity start to outweigh any benefits.
- If an outside investor or analyst really wants to understand the finances of a company, then he / she must have some way and time to access and assess information that is not included in the financial statements. They need to be able to “deep dive”.
Where Financial Reporting Still Falls Short, H. David Sherman and S. David Young. Harvard Business Review, July 2016.