11(c). Content of Financial Statements and Related Disclosures
Our comments on quarterly reporting herein have two different purposes. First, we wish to make clear and emphatic our unanimous opposition to recent movements by certain individuals and organizations to abolish mandatory quarterly reporting. Our case takes two forms: (a) substantiating the reasons why quarterly reports are vital to analysts and, perforce, for the efficient functioning of the capital markets; (b) showing why the arguments made for the eradication of mandated quarterly reporting are specious.11 Second, we wish to explicate how quarterly financial reporting needs to and should be improved. [Also included in 11(a)] [AIMR/FAPC92, p. 35]
Auditor Involvement
The shorter the period of time covered by financial statements, the lower is the need for auditor involvement. The need for timeliness is inversely related to the length of the reporting period and short-period measurements, which are relatively imprecise, are difficult to verify. With periods as short as three months, there seems to be little value to be added from auditor involvement with the financial reporting process. In fact, such involvement is likely to diminish timeliness, a primary attribute of interim reports. If external auditors are to be involved, their role should be to assist enterprises to establish procedures and routines that minimize the time taken to get reports prepared and lessen the probability of material errors or misstatements. [Also included in 17(d)] [AIMR/FAPC92, p. 38-39]
In fact, there may be instances in which the auditor's role in annual reporting could be reduced. In companies with strong financial management, effective financial and managerial controls, supplemented by competent internal auditing, a full annual external audit might not be necessary. In those cases, the external auditor would do more systems testing and evaluation than financial statement verification. What might result would be negative assurance on the financial statements in the format referred to in the professional literature as a "limited review." The review work would largely be composed of assessing the effectiveness of financial and managerial control systems and relying on a high-quality internal audit function. [Also included in 17(d)] [AIMR/FAPC92, p. 39]
For enterprises that were to discontinue full annual audits, a time would come when a full external examination of the financial statements would be necessary. This might take place quinquennially. The purpose of that examination would be to provide positive assurance by performing a full audit with emphasis on: (a) complete evaluation of control systems, and (b) a retrospective view of annual income for the five-year period by disclosure of all components of income that make one year not comparable with another. Here is another instance where standards implementing the notion of comprehensive income would be indispensable. We suggest that if and when they are promulgated, the SEC authorize a few selected enterprises to experiment with the changed auditor responsibilities that we suggest. [Also included in 17(d)] [AIMR/FAPC92, p. 39]
__________
[Context] Meeting of the Investor Discussion Group on October 16, 1992. When discussing their objectives and approach to evaluating equity securities, some investors commented on the content of interim financial statements.
Participant I-11
Our clients, most of them with turnovers far over 15-20% a year, asked us about quarterly results and predictions. Our clients are under short-term performance pressure from their customers, the corporate pension managers. We have to recognize that a long-term trend arises from a series of short-term achievements and the early warning system is a function of the careful attention to quarterly numbers. If I have a complaint about financial reporting today, it is that most companies really shortchange the users community in their interim reports. We don't get nearly the detail, the segment breakdowns, the notes and so on that we get in annual reports. The real world of stock investing today is that a year is an awfully long time (one of my colleagues says that long term is after lunch). Because transaction costs have become so trivial, investors are economically able to capitalize on much smaller changes in market value than they could in the past and they do it. [Also included in 11(e)] [TI 10/16, p. 12-13]
__________
Participant I-7
We don't get good FAS 14 disclosure in the annual report and we get less from most of our companies in the quarterly reports. FAS 14 is just an abomination at least in my industry from a quarterly point of view. I also heard the argument about the expense of creating this information. There isn't a reasonable size company that doesn't have internal reporting and the people inside the company get a report card, if not monthly certainly quarterly, and that's the kind of information that is readily available that I would like to see. One of the things that should be discussed somewhere is: what the information that we as outside investors should not be permitted to get from a competitive point of view? They all know internally what their competitors are doing and yet they don't want to provide certain information to us for competitive reasons. It's vital that the accounting profession decide what kinds of information are competitively harmful and others that aren't. [Also included in 1(b), 2(d), 3(a), 3(b), and 3(d)] [TI 10/16, p. 21]
__________
Participant I-7
A couple of simple ones: book value, debt ratios. Trying to do the book value is difficult on a company based on their quarterly numbers. First of all, most companies don't report actual shares outstanding, they give the average for the quarter; that doesn't help you get a book value number. Debt ratios: every company that I follow has its own little twist to it. I think the value that the accounting profession could bring is some standardized ratios that would be reported and audited on an annual or quarterly basis and have very specific definitions for those ratios. [Also included in 1(c), 13, and 17(b)] [TI 10/16, p. 51-52]
[Context] Meeting of the Investor Discussion Group on December 9, 1992. The first part of the meeting was devoted to the topic of disaggregated information. During the discussion, a comment was made on the content of interim financial statements.
Participant I-13
I cover a minuscule industry called the precious metals mining business. I have been on a crusade for some time to get gold mining companies to adopt a standardized quarterly reporting format. That would save a great amount of time to analysts because they would know where to look to find the pieces of information they're interested in. It would be easy to impose a standardized format for an industry like mine because the companies are likely to be more uniform in the nature of the business that they're in. In that standardized format, the companies would give us cost by $ millions and revenue per product. In that way, you can build a quarterly income statement based on production data. [Also included in 3(b) and 3(e)] [TI 12/9, p. 18]
[Context] Meeting of the Investor Discussion Group on January 13, 1993. Part of the meeting was devoted to the topic of display. During the discussion on balance sheet display, a comment was made on the content of interim reports.
Committee/Staff/Observer
How disruptive would it be if you didn't have a balance sheet? [Also included in 5(b) and 5(c)] [TI 1/13, p. 36]
Participant I-8
Very. I can remember when quarterly balance sheets were a rarity. An income statement is worthless without a balance sheet. I would also love to see a quarterly cash flow statement. [Also included in 5(b) and 5(c)] [TI 1/13, p. 36]
[Context] Meeting of the Investor Discussion Group on March 17, 1993. Part of the meeting was devoted to the topic of interim reporting.
Committee/Staff/Observer
Other questions on interim reporting. May we safely conclude that you prefer quarterly reporting as opposed to monthly or semi-annually? Also, may we conclude that you prefer full interim financial statements as opposed to just disclosure of summarized interim data? [Also included in 11(a)] [TI 3/17, p. 36]
Participant I-11
I'd say yes to both. [Participant I-12] touched on a key element. The greatest opportunities for inappropriate valuations to occur in stocks is when there's a change of direction in the company's business. We all spend a lot of our time trying to identify times when a company's business is changing direction. It's a balancing act because there's a lot of static in the data. It seems to me that the quarterly financial report is a pretty good filter for that. If you get much shorter than a quarter, there's too much static. If you get much longer than a quarter, it's too late. Also, we all want full financial statements instead of summary information. [Also included in 11(a)] [TI 3/17, p. 36-37]
__________
Committee/Staff/Observer
The next question relates to the level of detail provided in interim financial statements. Should companies be required to provide more detail than is now typical of the condensed quarterly financial statements that are currently provided? If so, should interim statements provide the same level of detail as annual financial statements? [TI 3/17, p. 40]
Participant I-12
I would like as much detail as I can get my hands on. But I don't know that it has to be as complex as the annual report, although my experience with larger companies has been that they have the ability to produce that information at that level of detail and it would be extremely useful to me to see that information. I would wonder whether the cost-benefit ratio would be overwhelming for smaller companies. But for the most part, for the companies that I cover, I'd like to get the same level of detail as annual statements if I could. [TI 3/17, p. 40]
Participant I-11
I hope management is looking at more detailed statements than those provided quarterly. [TI 3/17, p. 40]
Committee/Staff/Observer
When talking about quarterly statements, we spend 95% of the time focusing on the results of operations, and a little bit on cash flows. Is there a lot of interest in quarterly information that relates to financial position? [TI 3/17, p. 40]
Participant I-11
Sure. [TI 3/17, p. 40]
Participant I-12
You bet. [TI 3/17, p. 41]
Participant I-11
One of my problems with present 10Qs is that they show the period-end balance sheet and the balance sheet for the preceding fiscal year-end instead of the balance sheet for the 12 month earlier. If there is any seasonality, that can be a terribly distorting factor. [Also included in 2(a)] [TI 3/17, p. 41]
Participant I-7
I'd like to make an appeal here that any company that has more than one business and that doesn't produce FAS 14 disclosures should be significantly penalized. [Also included in 3(d)] [TI 3/17, p. 41]
Committee/Staff/Observer
Does the market already penalize those companies? [Also included in 3(d)] [TI 3/17, p. 41]
Participant I-7
I would say that the penalty ends up on the bottom line of the company. In the industry that I follow, one out of 8 companies produces FAS 14 information and it does not get a higher valuation because of a lack of consistency in operating or profit performance, even though they give more information than the other 7 companies. [Also included in 3(d)] [TI 3/17, p. 41]
Participant I-12
In my industries, my observation has been that whenever a company begins to provide segment detail, the valuations do go up after a year and they stay up. I think the reason for that is that it provides clarity of what's going on in the company and consistency between the way management talks about its businesses and run them and what we analysts see and are able to track. [Also included in 3(d)] [TI 3/17, p. 41-42]
Participant I-7
In my industry, clarity without performance doesn't buy anything in terms of incremental value. [Also included in 3(d)] [TI 3/17, p. 42]
Committee/Staff/Observer
[Participant I-12], is that because the companies that are providing such information are the stronger companies? [Also included in 3(d)] [TI 3/17, p. 42]
Participant I-12
Yes, they wouldn't provide it otherwise. [Also included in 3(d)] [TI 3/17, p. 42]
Participant I-7
In my industry, the strongest companies don't provide that information. [Also included in 3(d)] [TI 3/17, p. 42]
Participant I-12
It comes back to the old saying that if you don't provide the information, it means one of two things: either you don't know, which is scary, or you're afraid to, which is even scarier. Both conclusions are negative. [Also included in 3(d)] [TI 3/17, p. 42]
__________
Participant I-12
The big difference between the two is cash versus accrual accounting. If we had quarterly cash flow statements, a lot of these factors would be captured; for example, the compensation example, the advertising example, the repair example. We would know that the particular event happened in a specific quarter but we would also have statements that would allow us to do the trend line analysis that is essential to our work. [Also included in 5(c) and 11(d)] [TI 3/17, p. 45]
__________
Participant I-12
Like [participant I-11], I would tend to lean toward the integral approach [of interim reporting] if I could get quarterly cash flow statements. [Also included in 5(c) and 11(d)] [TI 3/17, p. 47]
Participant I-5
I would be leaning toward the integral approach with greater disclosure, particularly if you can build the disclosure through the cash flow statement. But if you take away the cash flow statement, then I switch and go with the discrete method. [Also included in 5(c) and 11(d)] [TI 3/17, p. 47]
Committee/Staff/Observer
There was some sympathy for full quarterly statements. Given the highly-charged litigation environment, and talking about a multinational company that has to collect all the data around the world and put it together within 45 days, are you suggesting that you really need that and that it should be a requirement for all public companies? Or would you make exceptions when it's not practical or costly? [TI 3/17, p. 47]
Participant I-16
How do you know what your total current liabilities are if you don't know what the components are? [TI 3/17, p. 47]
Committee/Staff/Observer
You can make approximations of these numbers without all the precise details. [TI 3/17, p. 47]
Participant I-16
I think you need to know the components. So why can't you give me the components? If you have a total, you have to have at least an estimate of the components. [TI 3/17, p. 48]
Committee/Staff/Observer
You presume it's there then and we might just as well give it? [TI 3/17, p. 48]
Participant I-16
It's there. [TI 3/17, p. 48]
[Context] Meeting of the Creditor Discussion Group on December 8, 1992. Part of the meeting was devoted to the topic of creditors' objectives and approaches. During the discussion, comments were made on interim reporting.
Participant C-13
I think the pressure from the investment community on disaggregated information has been strong on the business community, and relatively successful, with one glaring exception, and that's interim segment information. And as a result, my answer to [committee/staff/observer]'s question would be that I think that at this point establishing core earning power is maybe more critical. [Also included in 3(d) and 15] [TC 12/8, p. 27]
__________
Committee/Staff/Observer
FASB Statement 14 requires disaggregated information only in annual statements. Should disaggregated information be required in interim statements as well? [Also included in 3(d)] [TC 12/8, p. 37]
Participant C-13
Absolutely yes. I and many users feel quite strongly on this issue. There is significant evidence that there is material information content in quarterly reports. Therefore, if any kind of disaggregated information is important, it's also important in interim statements. And the volatility of results and the practice of companies of buying and selling divisions makes it imperative that on an interim basis you're able to analyze firms on disaggregated basis. [Also included in 3(d)] [TC 12/8, p. 37]
Committee/Staff/Observer
What type of information would you want to see on that? [Also included in 3(c) and 3(d)] [TC 12/8, p. 38]
Participant C-13
Same as annual. [Also included in 3(c) and 3(d)] [TC 12/8, p. 38]
Participant C-12
As strongly as I feel about getting disaggregated information, I think I can live without it on a quarterly basis, unless there is a major change. [Also included in 3(d)] [TC 12/8, p. 38]
Participant C-13
Well, when there's a major change, you need to have had it reported. [Also included in 3(d)] [TC 12/8, p. 38]
Participant C-12
I'm not sure how you enforce that. Otherwise quarterlies are getting bigger and bigger, and I'd just as soon leave something out. [Also included in 3(d)] [TC 12/8, p. 38]
Participant C-15
I'm not even sure if companies would physically be able to compile market shares and so on on a quarterly basis? [Also included in 3(d)] [TC 12/8, p. 38]
Participant C-13
Well, they're not required to present market share information even on an annual basis. But my contention would be that if a company is not reporting to its board of directors at least on a quarterly basis, and I'll bet virtually every major company reports monthly to its board of directors, then it's not being properly managed. So the information is available. [Also included in 3(d)] [TC 12/8, p. 38]
Participant C-12
I would much rather have them do more on an annual basis. Because if I look at [name deleted] today, I'd like them to do a product cut for me, a geographic cut, a legal entity cut. And I don't know that I want all that quarterly, but each of those has some meaning, at least. [Also included in 3(b) and 3(d)] [TC 12/8, p. 38-39]
Participant C-1
Part of that may be a difference, though, between companies that have heavy seasonal emphasis and companies that don't. For companies with seasonal emphasis, which is most industrial or retailers, the ability to get quarterly numbers is very important by segments. I think the rule for non-financial institutions is that quarterly statements are important, and that there is seasonality to them, and there is differences in the way these divisions or business segments report. And I don't know if you need as much detail as you get in the annual, but the ability to at least be able to determine operating income and revenues is important. [Also included in 3(d)] [TC 12/8, p. 39]
Participant C-13
The reason why I say that you should have the same as in the annual reports is that the minimum statutory requirement for annual reporting is not particularly onerous. Now maybe it should be better, but I think on an interim basis we should get at least what's currently required as a minimum for annual statements. [Also included in 3(d)] [TC 12/8, p. 39]
Participant C-11
I was just going to strongly reinforce what [participant C-15] said. I think in every aspect of business, not just seasonal sales, there are so many changes that go on during a year, interest rate trends and so forth, that if you don't know what's going on in different environments, you just don't know anything. [Also included in 3(d)] [TC 12/8, p. 39]
Participant C-4
I think that investors would probably want a lot more frequent information. For creditors, though, their obligations are a lot more long term in nature. And I think the purpose of accounting is to analyze an entity over an operating cycle. And to disclose too much information in an interim period may cause a lot of volatility in the markets, may cause a lot of panic, or discussion that may not be necessary. If we're in touch with our customers and we have open communication, we can get a lot of that information from them I'm all for improving year end segment reporting or operating reporting, and focusing on the full operating cycle rather than quarterly. [Also included in 3(d)] [TC 12/8, p. 39-40]
Participant C-13
Just an observation or rebuttal, if I may. There is academic literature that shows that quarterly reporting reduces volatility. There are fewer year end surprises. [Also included in 3(d)] [TC 12/8, p. 40]
__________
Participant C-4
Backlog is the lifeline of a contractor, obviously. We can use that information to make some pretty accurate projections of where they're heading. We get backlog information on a quarterly basis, and we'll compare the beginning and ending gross margins, do a statistical correlation of those margins. Then when we get a year end financial statement, using percentage of completion basis and we'll adjust that cost to complete number based on historical correlation, and then make a projection of where we think this contractor is headed with the backlog he has on hand. So, it's vital information for us. I would say the accounting profession does not do that detail in general for smaller contractors in any audit work on the cost to complete for contractors. I think they're relying on what management tells them. I don't know how much hindsight review is actually going on in the accounting industry on cost to complete information. [Also included in 1(b), 13, and 17(a)] [TC 12/8, p. 52-53]
[Context] Responses to the postmeeting questionnaire to the December 8, 1992 Creditor Discussion Group meeting.
QUESTION 7
FASB Statement 14 requires disaggregated information only in annual statements. Participants did not seem in agreement on the need for interim disaggregated information. Please consider the following:
If interim disaggregated information was provided:
YES NO
I would use it
i. All the time to update my credit
analysis _ 4 _
ii. All the time, but only to identify
"changes" _ 7 _
iii. Occasionally, but not always _ 3 _
iv. Rarely _ 2 _
v. Never, because interim information
is too volatile _ _
Participant C-12 - Occasionally, but not always because interim information is too volatile.
Participant C-18 - In my view, not cost justified to produce this, given limited value.
Participant C-11 - Only one person said he was overloaded and would be happy with annual. If you analyzed his actual work procedures and the requirements of his job, you'd get a different answer, I suspect.
[PMQC 12/8, p. 17-18]
[Context] Meeting of the Creditor Discussion Group on March 11, 1993. Part of the meeting was devoted to the topic of interim reporting.
Committee/Staff/Observer
Question 11 deals with interim reporting. We presume that currently people prefer quarterly reporting as opposed to a move to more frequent reporting such as monthly. And we also presume that they prefer summarized information than the more detailed information, such as in the annual report. Those are items A and B on page 13 of the meeting materials. If someone has a belief that we have gotten that wrong from previous discussions, this would be a great time to register your complaint. [Also included in 11(a)] [TC 3/11, p. 46]
Participant C-11
I disagree. In many companies I have the same kind of data quarterly than is put in the annual report. And I'm talking about all the stuff in the net interest margin table, all the important detail of loan quality in terms of types of nonperforming loans and all that. The summary of annual data in the quarterly reports can be carried to a point where you're ending up giving no information. A lot of companies still don't give good cash flow information in their quarterlies. There are just many areas that the basic information that you use and need you want quarterly as well as annually. [TC 3/11, p. 46]
Participant C-5
Cash flow is irrelevant at a bank. [TC 3/11, p. 46]
Committee/Staff/Observer
I have misstated B so let me read it out loud so we don't labor under that delusion. May the special committee safely conclude that most investors, creditors and analysts prefer interim financial statements to disclosure of summarized interim financial information . . . ? [TC 3/11, p. 46-47]
[Context] Meeting of the Creditor Discussion Group on March 11, 1993. Part of the meeting was devoted to the topic of priority of improvements needed in external reporting. During the discussion, a comment was made on interim reporting.
Participant C-13
I also picked core earnings as one of my three. I'm not sure that we need specific rule changes but improved disclosure under existing rules would probably be adequate. Secondly, I chose interim reporting because I think a rule change for a reporting segment would be a major step forward. And thirdly, I chose number thirteen, off balance sheet financing and hedge accounting. I think practice is ahead of theory in this sphere and we need some codification. [Also included in 3(d), 15, and 19] [TC 3/11, p. 69]
[Context] Responses to the postmeeting questionnaire to the March 17, 1993 Investor Discussion Group meeting.
QUESTION 14
c. Regarding interim reporting, please indicate your agreement or disagreement with the following:
Agree Disagree
1. Quarterly reporting is more 4 1
valuable than year-to-date
reporting because quarterly
reporting highlights recent changes
in business activities.
2. Moving twelve month information 2 3
is more useful than year-to-date
reporting.
Agree Disagree
3. Current interim reporting for 1 2
public companies should require
moving twelve month information.
Participant I-11: Neutral
4. Current interim reporting for 4 1
public companies should require
separate reporting of fourth
quarter activities.
Participant I-9: Interesting idea.
5. Interim reporting for public 3 2
companies should be expanded from
its current condensed format to a
more detailed presentation but less
than full statements identical to
annual detail.
Participant I-9: It should be as
close to full year reporting as can
be reasonably done on a timely
basis.
6. Interim reporting for public 3 2
companies should be expanded from
its current condensed format to a
more detailed presentation with as
much detail as is given in annual
financial statements.
[PMQI 3/17, p. 26-27]
[Context] Responses to the postmeeting questionnaire of the March 11, 1993 Creditor Discussion Group meeting.
QUESTION 15
c. Regarding interim reporting, please indicate your agreement or disagreement with the following:
Participant C-11: These are not either/or situations.
Agree Disagree
8 4 1. Quarterly reporting is more valuable than year-to-date reporting because quarterly reporting highlights recent changes in business activities.
Participant C-8: Answer depends upon industry. YTD information is very valuable for small construction contractors.
4 8 2. Moving twelve month information is more useful than year-to-date reporting.
Participant C-8: Same as above.
Participant C-21: Depends on industry and operating style.
5 6 3. Current interim reporting for public companies should require moving twelve month information.
Participant C-14: Can do it ourselves, though.
Participant C-21: In addition to quarterly information (?)
13 4. Current interim reporting for public companies should require separate reporting of fourth quarter activities.
Participant C-14: 10Q's are ideal.
10 1 5. Interim reporting for public companies should be expanded from its current condensed format to a more detailed presentation but less than full statements identical to annual detail.
Participant C-11: Depends on what detail.
12 6. Interim reporting for public companies should be expanded from its current condensed format to a more detailed presentation with as much detail as is given in annual financial statements.
Participant C-11: Some detail in the annual is not needed.
7 4 7. Interim reporting accounting rules should emphasize the "integral" approach that determines accruals, deferrals, and estimates by allocating them throughout the year rather than discretely reporting them as they occur.
Participant C-11: Depends on item. Many items such as sales should be discrete.
[PMQC 3/11, p. 23-25]
[Context] The papers are a summary of a committee and staff members' discussions with selected sell-side analysts from Goldman Sachs.
With the exception of disclosure of management's forecasts and projections, the analysts generally confirmed that [the following] list of areas for improvement is both accurate and complete. In particular, most emphasized the importance of disaggregated information. In contrast, most of the analysts were uncertain about management's forecasts and projections. Many were concerned about whether they could ever rely on those forecasts. [Some believe] that analysts [themselves] should develop their own forecasts. [The list recommends:]
1. better disaggregated information.
2. more complete quarterly reporting. That is, interim reporting that more closely resembles annual reporting.
3. better identification and explanation of extraordinary, unusual, and infrequent items.
4. better information about measurement uncertainties, and operating opportunities and risks.
5. improved comparability and consistency in financial reporting methods over two business cycles, including disclosure of ten year summary information.
6. disclosure of the company's goals and objectives
7. better clarity in external reporting without reducing the amount of information.
8. disclosure of management's forecasts and projections.
[Also included in 12 and 15] [GOLDMAN, p. ii-iii]
Every analyst emphasized the critical role in their work of external financial reporting. They also affirmed the importance of audited financial statements.
[Also included in 12 and 15] [GOLDMAN, p. iii]
__________
From what has briefly been described of the [foreign] financial analysts' work, there results a series of requirements with regard to accounting data, which are but insufficiently met at present. We have broken them down into . . . major categories. [Also included in 1(b), 2(c), 2(d), 3(c) 4, 5(a), 5(c), 6, 8(a), 9, 11(b), and 15] [BETRIOU, p. 1]
Semi-annual and quarterly accounts (same observation as for statements of changes). The systematic publication of semi-annual accounts (even if non audited, should that be the requisite condition for rapidity), would be considerable progress. They should include the main items of the balance sheet, of the profit and loss account, of the statement of changes, as well as data per activity. [Also included in 1(b), 11(b), and 15] [BETRIOU, p. 2]
Furthermore, it is important that intermediate accounts be set up according to the same nomenclature as the closing accounts, to which financial analysts compare them. [Also included in 1(b), 11(b), and 15] [BETRIOU, p. 2]