Financial Reporting – Is Simpler Really Better?
Over the last few decades, accounting standards have become increasingly complex. In today’s global economy, new services and products are constantly emerging, and new financial instruments are growing in complexity. At the same time, financial statement users are demanding more data. In turn, standard setters are forced to create new disclosure requirements in order to provide such transparency.
As the list of information on financial statements has continued to grow, “simplicity” has become a common theme for both regulators and standard setters. The SEC, IASB and the FASB are all working on projects related to the reduction of discloser overload and simplification. The FAF’s Private Company Council has also been working on modifying GAAP for private companies to help minimize complexity.
Despite there being a demand for simplicity, there is still much debate over whether or not reducing complexity is truly the best option.
The Argument for Simplicity
Many agree that reducing complexity will be beneficial for the industry as well as businesses and investors. Those in favor of the trend argue that simplification will bring the following benefits:
Reduced Costs for Private Companies
When complexity is reduced and disclosure is more effective, financial reporting is less costly, especially for private companies. The GAAP changes that have already been adopted by the FASB have proven to be beneficial to many private companies.
Before these changes, preparers were required to disclose more information than GAAP requires. Disclosure simplifications for private companies is sensible because private companies are more transparent to the users of their financial statements.
Small businesses stand to gain the most from these changes as they are unnecessarily impacted by overly complex standards.
Increased Effectiveness for Public Company Disclosures
As for public companies, these new initiatives improve the effectiveness of disclosures. Public companies are often challenged to find a balance between what is relevant to users and what is required. Setting global financial reporting standards could eliminate some of the unnecessary complexity that global companies often face.
Improved Reporting Quality and Focus on Making Better Business Decisions
Simplification may reduce reporting costs through the reduction of required personnel and improved efficiencies. In turn, this allows businesses to focus those additional resources on improving reporting quality and making better business decisions.
Once the reporting and the disclosure process has been simplified, accountants and others on the finance staff can focus on analysis and building strategies to improve ROI.
The Challenges Simplification Will Bring
Simplification brings with it many benefits, but it also brings many challenges. Clients and users of financial statements will stand to gain the most benefit.
Auditors will Remain Virtually Untouched
Experts do not believe that auditors will be impacted much by these changes in terms of fees and workload.
Auditors that work with private companies say that many companies were struggling with complicated GAAP in areas like fair value, intangible assets, derivatives and hedging, and impairment of goodwill. As a result, difficult audit issues also arose. Simplification in these key areas should provide some cost and time savings.
The accounting departments in public practice are also in favor of simplification, but the impact it will have on the firm will largely depend on the type of businesses it works with. Private companies will gain the most because they can take advantage of different frameworks.
That being said, the audit workload will remain virtually the same. Accounting firms may see some decrease in the time spent on certain engagements, but these changes will not have an extensive impact on gross revenues.
Most middle-market companies will only see minimal time and cost benefits, so finance staff is unlikely to see any major relief. If small businesses and private companies only account for a small percentage of the accounting firm’s clients, changes in workload are not expected.
As varying frameworks and standards are introduced, firms may need to make adjustments in procedures, training and quality control. For firms that do not have centralized oversight, this can be prove to be challenging.
Clients will also face challenges in keeping up with new standards and frameworks. CPAs will need to improve communication with clients to inform them of their options, explain the differences and why it would be a good fit for their company. Ultimately, small businesses can really only benefit from these changes if they understand them.
What Changes are in the Works?
Standard setters and regulators are working hard to create initiatives that improve financial reporting by simplifying financial statement preparation. These include:
- SEC: The Disclosure Effectiveness project, created by the SEC, is designed to make disclosures more effective by reducing costs for preparers and making them more useful for investors.
- FASB: The aim of the Disclosure Framework Project is also to improve the effectiveness of disclosures. This is achieved through framework development for board’s decision making process. The project will also reevaluate existing disclosure requirements and establish new standards.
- FRF for SMEs: The FRF for SMEs was created by the AICPA and launched in 2013. This special-purpose, non-GAAP reporting framework can be used by eligible private companies who are looking to simplify their reporting and accounting.
- IASB: The IASB launched a rather broad initiative in late 2012 to explore improvements and simplifications of disclosures in IFRS reporting. This initiative includes a number of proposed amendments and projects to current standards.
- PCC: The FAF’s Private Company Council was launched in 2012, and its goal is to determine when GAAP modifications are required to simplify accounting requirements for private companies. The council may also make proposals for GAAP alternatives that private companies can choose to adopt, but these alternatives are subject to FASB approval.
Is Simpler Truly Better?
It’s hard to determine with absolute certainty whether the simplification of financial reporting will be beneficial. On paper, simpler always appears to be better. Smaller businesses and private companies may stand to gain the most from these changes, but public companies will also benefit from more effective disclosures. Many companies will also save on costs and time when it comes to reporting preparation.
Regardless of whether or not simpler is better, standard setters and regulators are moving forward with their pursuit of simplification, which means auditors and preparers will need to be ready to simplify.