Academic journal article Review of Business

Corporate Financial Reporting Complexity: Recommendations for Improvement

Academic journal article Review of Business

Corporate Financial Reporting Complexity: Recommendations for Improvement

Article excerpt

Executive Summary

Despite the improvements in financial reporting stemming from SarbanesOxley, the U.S. financial reporting system continues to face a number of challenges. Conceivably the most urgent is the need to reduce complexity, and thereby improving transparency and increasing the usefulness of reported financial information to constituents. This paper examines the Final report of the Advisory Report of the Advisory Committee on Improvements to Financial Reporting, and offers recommendations to progressively redress the existing complex system of standards, rules, and regulations that fail to provide relevant and transparent financial information. This complexity has been mounting for many years as a result of different forces; structural, institutional, cultural, behavioral, and political. It is believed that these recommendations, if implemented, would achieve measurable improvements to the current financial reporting system. The paper concentrates on the sources that create substantive complexity and provides an analytical insight of the recommendations. This paper also provides implications for accounting educators and practicing professionals.

Introduction

The impact of market financial innovation and regulation: Financial innovation is fundamentally market driven, and generally more complex and less understood at inception. In conjunction with it, corporate financial reporting is becoming as complex as the U.S. tax system. In general, complexity may effectively impede communication through the feed of financial information between a company and its stakeholders by creating inefficiencies in the marketplace (e.g., increased investor, preparer, audit, and regulatory costs) and producing suboptimal allocation of capital. Over the past two decades, the U.S. experienced several major financial crises. These include the S&L crisis, the reporting scandals, (1) the dot.com bubble, and more recently the ongoing global problems in the credit and financial markets. (2)

Formulating a proper regulatory response to financial innovations is a challenging task for the standard setters (SEC, FASB, AICPA, EITF, ISAB and others). Many have argued that the U.S. should strive to implement a regulatory regime that is principles-based, risk-focused, and consistently applied that can provide needed transparency and safe haven from legal and regulatory risks. Rules should implement principles rather than develop in an ad hoc manner, and financial globalization and financial innovations are closely tied. Thus global regulatory collaboration and coordination are now more vital than ever. (3)

The issue of complexity is one of the most important aspects in financial reporting, and financial instruments are among the most complex on which to report clearly. For example, the concept of fair value, which was intended to help bring transparency, was scorned by some as a "villain", exacerbating the current turmoil, and heralded by others as a savior in revealing the problems on a timely basis. Financial market consequences are of particular relevance to accounting regulators; many empirical studies have investigated the market's response to the deliberations surrounding and enactments of specific kinds of regulation, and to the information content of data that companies were to disclose as a result of enacted regulation. (4) Given the complexities of pronouncements by accounting standard-setters, research on the consequences of regulation is expected to be long-drawn-out.

The purpose of this paper is to examine the issue of complexity in the SEC Advisory Committee on Improvements to Financial Reporting (better known by its acronym, CIFiR). (5) While the proposed recommendations will remain relevant for both international and U.S. financial reporting, the discussion here will primarily be conducted in the context of current U.S. environment. The remaining sections of the paper start with evaluation of CIFiR proposed recommendations that have attracted relatively concerted attention and challenges. …

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