What information should companies provide to investors and creditors? To what extent should auditors be associated with that information? The American Institute of Certified Public Accountants formed the Special Committee on Financial Reporting (the Committee) in 1991 to address those questions because of concerns about the relevance and usefulness of business reporting. The Committee's work is part of the AICPA's broad initiative to improve the value of business information and the public's confidence in it. The broad initiative seeks to:
The Committee is not a standard-setting body. It offers its recommendations for the consideration of all those that have an interest in furthering the cost-effective quality of business reporting. If subsequently pursued by standard setters or regulators, the recommendations will be subject to full due process.
People in every walk of life are affected by business reporting, the cornerstone on which our process of capital allocation is built. An effective allocation process is critical to a healthy economy that promotes productivity, encourages innovation, and provides an efficient and liquid market for buying and selling securities and obtaining and granting credit.
Conversely, a flawed allocation process supports unproductive practices, denies cost-effective capital to companies that may offer innovative products and services that add value, and undermines the securities market. Without adequate information, users of business reporting cannot judge properly the opportunities and risks of investment opportunities. To make informed decisions, they need a variety of information, including data about the economy, industries, companies, and securities . Complete information provided by the best sources enhances the probability that the best decisions will be made. And for company- specific information ; which is key because companies are the sources of cash flows that ultimately result in the return on securities or the repayment of
Business Reporting The information a company provides to help users with capital-allocation decisions about a company. It includes a number of different elements, with financial statements as one of those elements. Capital Allocation The process of determining how and at what cost money is allocated among companies.
Users Investors and creditors, including potential investors and creditors, and their advisors that use business reporting as a basis for their capital-allocation decisions.
loans ; management often is the best source. Business reporting packages management's company-specific information and delivers it to users in a meaningful way. Few areas are more central to the national economic interest than the role of business reporting in promoting an effective process of capital allocation. It simply must be made to work as well as possible.
Increased competition and rapid advances in technology are resulting in dramatic changes. To survive and compete, companies are changing everything ; the way they are organized and managed, the way they do work and develop new products, the way they manage risks, and their relationships with other organizations. Winners in the marketplace are the companies that are focusing on the customer, stripping away low-value activity, decentralizing decision making, reducing the time required to perform key activities, and forming new alliances with suppliers and customers ; even competitors.
They are setting the pace for others that must, in turn, reexamine their businesses in light of the increased competition. In response to increased competition and changes in their businesses, companies also are changing their information systems and the types of information they use to manage their businesses. For example, they are developing new performance measures often designed to focus on activities that provide long-term value and competitive advantage, including non-financial measures such as product development lead time and financial measures such as economic value added. Can business reporting be immune from the fundamental changes affecting business?
Can effective business reporting exclude new performance measures on which management is focusing to manage the business? In times of rapid change, the risk increases that business reporting will fall behind the pace of change, failing to provide what users need to know. Today, more than ever, business reporting must keep up with the changing needs of users or it will lose its relevance. Highly relevant business reporting also is important for the long-term vitality of the accounting profession. Accountants ; those in industry, public accounting, education, and research ; are closely associated with the process of business reporting and have an interest in ensuring its relevance.
The Committee's work is analogous to the product and service redesign undertaken by many successful businesses to meet customer needs better. Cost-effective improvements in business reporting will enhance its value both to users and to the profession, just as improvements in products enhance value both to the consumer and to the producers of those products.
Some constituents, including many companies, while acknowledging the importance of highquality business reporting, question the need for a study of business reporting and recommendations to improve it. They ask: Why not let the marketplace for capital determine the nature and quality of business reporting? The marketplace, they argue, already offers powerful incentives for highquality reporting. It rewards higher quality reporting and punishes lower quality reporting by easing or restricting access to capital or raising or lowering the cost of capital.
Additional reporting standards, they argue, would only distort a market mechanism that already works well and would add costs to reporting, with no benefit. They liken reporting standards to costly, inefficient, unnecessary bureaucratic regulations. However, reporting standards play an important role in helping the market mechanism work effectively for the benefit of companies, users, and the public. More specifically, reporting standards are needed because they:
For many years, financial statements and, in the broader arena of business reporting, filings with the Securities and Exchange Commission (SEC) have been prepared following standards, producing highly useful information. Standards in business reporting have proven their worth. The Committee acknowledges that reporting standards could inflict costs on some companies without resulting benefit. That could occur, for example, if a company was required to report information that users do not need. However, reporting standards need not eliminate flexibility in reporting, nor increase costs without benefit. The solution is not to do away with reporting standards but, rather, to design standards flexible enough to be responsive to the costs and benefits companies face in particular circumstances.
Businesses everywhere have renewed their focus on the needs of their customers. Satisfaction surveys, focus groups, and cooperative ventures with customers abound. The insights gained from the renaissance of customerfocused activity are driving critical improvements in the quality, cost, and responsiveness of products and services around the globe. Just as successful businesses align the features of their products and services with the needs of their customers, so, too, should the providers of business reporting. Recognizing this, the Committee concentrated on the information needs of users to help identify and evaluate ideas for improvement.
The Committee undertook a comprehensive study to determine the information needs of users to identify the types of information most useful in predicting earnings and cash flows for the purpose of valuing equity securities and assessing the prospect of repayment of debt securities or loans. The Committee designed the study to ensure that the findings were representative of a broad group of users and to distinguish between the types of information users really need and the types that are interesting but not essential. It also considered how users' needs for information might change over time. To help ensure representative results, the study focused on direct input from users and rejected speculative data. It also involved multiple projects, each of which analyzed information needs from a different view.
Further, the study focused on information from groups in addition to individuals, including a number of surveys and documents from users' associations. To distinguish between needed information and less important information, the Committee developed a framework of information needs based on how investors value companies and how creditors assess the prospect of repayment. It considered information consistent with the framework to be more important and other information less important. It also gathered data about the relative priority users place on different kinds of information, which helped rank potential improvements.
For a longer term view, the Committee gathered information about trends that are shaping business activity and considered the implications of those trends on users' information needs. The Committee's study has been unique and important. Not only has it provided a foundation for the Committee's work but also the Committee hopes it will influence future agendas of standard setters and regulators and the future direction of standardsetting projects. Most important, the study demonstrated the worth of focusing on users as a means to identify and evaluate ways to improve business reporting. Ongoing study is key to keeping pace with evolving needs for information.
Improving business reporting requires considering the relative costs and benefits of various types of information. Just as costs and benefits are key to determining the features included in any product, a practical balance must be struck in weighing the costs and benefits of information. The Committee considered the costs of providing each type of information that its study suggested users need, and it screened from further consideration the types it judged to be too costly in relation to the benefits. The screening process included discussions with financial executives of large public companies, including a working group sponsored by the Financial Executives Institute (FEI). Auditors who serve smaller companies also provided input, as did standard setters, regulators, users, and others.
The screening process produced an information package designed to be both useful and sufficiently costeffective to merit consideration by standard setters and regulators. Weighing the costs and benefits of possible improvements to business reporting is difficult and complex. It is impossible to measure with precision many of the costs and benefits of improved disclosure, such as the cost of disclosing competitively harmful information or the benefits to the economy of another piece of useful information. In addition, the costs and benefits are widely scattered and people are affected to different degrees. While difficult, cost and benefit decisions must be made. On the one hand, business reporting must be enhanced to maintain its relevance, while, on the other hand, undisciplined expansion of mandated reporting could result in large needless costs.
Faced with this dichotomy, the Committee adopted a cautious and practical approach, proposing ideas supported by users that would result in truly useful information while recommending constraints on disclosure to restrict costs in areas where they could be significant. The Committee believes its recommendations are sufficiently costbeneficial to merit consideration by standard setters, which would ; as a matter of course ; perform further cost and benefit analyses as a part of due process.
A lot is right with today's business reporting in the United States. It generally provides users with essential information that heavily influences their decisions. In particular, financial statements are viewed as an excellent framework for capturing and organizing financial information. Users have welcomed improvements in business reporting, but few suggest the current framework should be scrapped and a new one developed. Yet many users are strongly critical of certain aspects of today's reporting. Understanding the reasons for the criticism ; much of it substantive ; has identified highpriority areas for improvement.
Some companies, particularly the larger ones, already provide all the information that users need, but many do not. Those that do, provide it in a variety of ways rather than in a comprehensive, integrated format. Based on the information needs of users as well as the costs and benefits of potential improvements, the Committee developed recommendations to improve business reporting. Key points about those recommendations are:
This report is in three parts. The first, chapters 2 through 4, presents the foundation on which the Committee's work is based. Chapter 2 discusses the Committee's study of users' needs for information. Chapter 3 outlines the central themes underlying the information needs of investors and creditors. Chapter 4 discusses the benefits and costs of business reporting. The second part, chapters 5 through 8, discusses the Committee's recommendations and the bases for those recommendations. Chapter 5 discusses recommendations to improve the types of information included in business reporting and the Committee's comprehensive model. Chapter 6 discusses financial statements and related disclosures. Recommendations about auditor association with business reporting are discussed in chapter 7. Facilitating change is the subject of chapter 8. The third and final part consists of appendices I through V.
Appendix I summarizes the Committee's recommendations. Appendix II presents the Committee's model of business reporting. Appendix III presents a business report illustrating the reporting principles of that model. Appendix IV provides background information about the Committee. Appendix V describes the contents of the Committee's database of materials on users' needs for information, as discussed below.
In addition to this report, the Committee has produced a brochure that summarizes the Committee's work and recommendations. It also has built a substantial (1,600page) database of its research on the information needs of users that includes source information and analysis. Copies of the brochure and the database, as well as additional copies of this report, are available from the AICPA.