Financial reporting needs to adapt to the changing needs of an increasingly diverse set of users.
We may have witnessed more innovation in the last decade than we did in the last half century. Take, for example, the dramatic changes in media, consumer products (and how they are marketed), and the medical field. These changes are often driven by consumer demand. Organizations and industries that are not evolving to meet consumers’ demands are in peril of becoming irrelevant — and possibly extinct.
Financial reports produced by companies are subject to similar innovation pressures. So, the question is: Is there enough being done to evolve financial reporting to meet the demands of consumers, the financial report users1? With respect to the financial information that is included in these reports, regulators such as the Securities Exchange Commission (SEC) and standard setters such as the Financial Accounting Standards Board (FASB), have done well to keep pace with changes in business to ensure that financial reports provide users with a faithful depiction of the economics of the transactions companies’ conduct. Evidence of this is clear in the continued vibrant capital markets we enjoy in the U.S. Currently, based on user and preparer input, there is an increased focus to make the financial disclosures currently required in these reports more effective. The SEC and FASB have projects underway to meet this demand.
But the central question persists: Is there enough being done in the way of innovation to ensure needs of the users of financial reports are being addressed? For example, there has been some evolution in the way financial information is conveyed to users, but when compared to the pace of change in communications in other areas it seems far behind. Relatively, there has been very little innovation in the use of technology in financial reporting. If technology isn’t used to improve the usefulness of financial reports, there is a risk that the value financial reports provide consumers will diminish.
Technology has also increased the user’s capacity to absorb information. As a result, many users now want information that goes well beyond the boundaries of what has traditionally been viewed as information subject to financial reporting. Therefore, it is also important to strive to innovate and expand the type of information encompassed in financial reports.
How digital technologies can make financial reporting more valuable and useful
Technology innovations are constantly redefining how stakeholders view and manage information, raising the bar for financial reporting. Many of today’s financial statement users want customized information, when and how they want it. Some users just want summarized financial information that highlights the most important events of the period; yet, others desire a lot of detail to fuel their sophisticated models and analysis.
Preferences in presentation are also changing. Many users don’t read a financial report like a book, from cover to cover in linear fashion; instead, they bounce from topic to topic looking for related information. Moreover, users don’t just read information – they use information — so they want easy access to advanced features such as search and extraction. They also want the ability to lay pieces of different reports side by side to make comparisons and identify trends. Therefore, users increasingly favor electronic documents over paper reports.
So, then, why not harness the latest digital technologies to satisfy the full range of user needs? For example:
- Replace two-dimensional financial reports on paper (or PDFs) with interactive, multi-dimensional reports that layer information so users can view the specific level of detail they desire.
- Insert hyperlinks and “pop-up” boxes to give users instant access to related information (including information that may be outside the financial report, such as press releases, related research studies, related information on a company’s website) — right where they need it.
- Employ information tags that let users toggle between different views that enable switching between a summarized view and an in-depth view of financial information, as well as allowing for different viewpoints of the same information. For example, embedding technology that can provide a look at revenue and expenses from a functional viewpoint, a nature viewpoint, and a geographical viewpoint — all from the same data set. Technology can also be used to display financial information visually in pictures and other visual formats (instead of just words and numbers) to provide greater insights.
- Use of separate but linked files to isolate current period financial data from information that is relatively unchanged from year to year. For example, separate accounting policies or other background information that, while important to understanding the reporting entity, remains fairly consistent from year to year so users with familiarity with the reporting entity can more easily hone in on more current and changing information. Changes in policies and background can be flagged in the files for easy identification.
Digging even deeper, technology has the potential to produce financial information that is fundamentally more useful. For example, the vast majority of companies today still use only the indirect method for presenting operating cash flows, despite general agreement that the direct method provides more useful information. Why? Because back in the days when the requirement to provide a cash flow statement was initially implemented, it simply wasn’t practical for large conglomerates to produce cash flow statements using the direct method. Today, however, thanks to new technologies such as tagging, companies may now (or soon) be able to efficiently produce cash flow statements using the direct method.
Increasing the scope and value of financial reporting
Many of today’s financial report users are calling for more information than what has traditionally been included in financial reports. They want information that provides a more comprehensive view of the company. To meet this demand, companies have been increasingly providing financial information that goes beyond what is required by the standards, Generally Accepted Accounting Principles (GAAP). Providing non-GAAP information has sometimes been controversial and the SEC has issued rules around providing such information voluntarily in financial filings. However, there is clearly a growing trend to provide information beyond what is required by U.S. GAAP or SEC rules.
Many organizations are considering this issue; however, no one has yet taken the lead to determine what non-GAAP information is useful to investors and how to make providing such information consistent among different entities.
Beyond reporting financial performance, a number of corporate reporting initiatives are suggesting that companies provide additional non-financial information such as environmental, social, and governance (ESG) information. For instance, the Global Reporting Initiative (GRI) provides a framework to guide entities in preparing and disclosing information around their ESG practices and performance – and how those practices drive value for the company and the broader economy. Other groups are seeking to advance and standardize industry-specific sustainability and climate-related disclosures in mainstream reports.
The International Integrated Reporting Council (IIRC) is a global coalition formed around the view that communication about businesses’ value creation should be the next step in the evolution of corporate reporting. The IIRC published the Integrated Reporting Framework to advance communication around holistic corporate performance in language that main stream investors understand; through linking a company’s business strategy, business model, various “capitals,” opportunities, and risks to future economic value over the short, medium and long term. The objective of an integrated report is to show interdependencies and connections between these important elements so that users of the information can see clearly how one impacts another and ultimately affects the value of the organization.
All of these groups recognize that stakeholders are seeking more information about companies than what is currently being captured in traditional financial reporting, and each are advancing frameworks that go beyond traditional financial reporting boundaries. While the Corporate Report Dialogue launched by the IIRC is trying to bring these groups together, for now, each framework is not necessarily coordinated with others and some frameworks may be framed in a language not familiar to mainstream stakeholders. In addition, without clear support from regulatory or governmental authorities the pace of uptake is moderate. Some jurisdictions, such as the U.K., are promoting such innovations and are seeing some changes in reporting. However, there has been very little promotion of these concepts in the U.S., resulting in relatively little innovation.
Making the vision of improved reporting a reality
While the financial reporting regime established in the U.S. has served our markets well, there is no guarantee it will continue to do so without innovation. The SEC and FASB have been working hard to establish guidelines for reporting entities to provide financial statement users with decision-useful financial information. The demand for new modes of communication and information that extends beyond traditional boundaries, however, continues to grow.
To continue to meet user demands and maintain vibrant markets, innovation beyond the areas of current focus is important. This will require active involvement from many constituencies, including investors, preparers, auditors, regulators, and standard setters. Without input from all of these groups, any efforts could easily miss the mark.
In the U.S., the ability to produce financial reporting innovations has been demonstrated in the past. If an earnest and open-minded dialogue about additional improvements can take place, it’s likely that new innovations will be generated that keep financial reports as a hallmark of vibrant markets.
Bob Uhl is a partner in the audit practice of Deloitte & Touche LLP.