Executive Summary
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There is a debate about the specification of the objective of financial statements.
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Clear specification of this objective is important for the financial reporting standard-setters (so they can produce consistent and coherent standards), users (so they understand the nature and scope of financial reporting), external auditors (so they can say whether the financial statements are “fit for purpose”), and educationalists (so they can teach the next generation).
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The lack of clarity about the objective of the financial statements appears to have created a financial reporting expectations gap.
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Perceived defects in financial statements have resulted in a call for real-time financial reporting, but this may have the effect of creating more volatility in share price movements.
Introduction
The major problem with financial reporting is that people with limited financial knowledge can look at a set of accounts and, by attempting to interpret the numbers, feel that they understand what is happening in an organization. While in simpler times this may have been true, the scale and complexity of modern business, together with the limitations of what can be portrayed in financial statements, means that today’s statements may have the capability to mislead as much as they can inform their users.
A large telecom business may have over two hundred million transactions a day in its accounting records, and such a scale of activity is almost beyond human comprehension. The complexity, and uncertainty, surrounding some transactions and financial instruments make their inclusion in the financial statements problematic to say the least. In the past accounting was defined as “an art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of a financial character, and interpreting the results thereof.”1 The need for financial reporting came about with the development of permanently invested capital (today’s share capital), which required a return to be made to the shareholders for their investment over a period of time (usually annually). The separation of ownership and management, especially in larger organizations, gave rise to the need for the accountability of the managers (agents) to the owners (principals), the financial statements being a convenient basis for this. In some jurisdictions financial statements also form a basis for the calculation of taxation. This subdivision of an organization’s life into artificial accounting periods may not sound exciting, but it is important. It may not cover all aspects of an organization’s activities, but originally this was never intended.
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