Disclosure and current company practice
In order to produce better quality of disclosure in annual report, some aspects should be given attention. Firstly, it is beneficial to encourage corporate social reporting, as this has been long practicing in the foreign countries such as UK and US. Environmental reporting is such a part of corporate social reporting where we are going to deal in depth in the later part.
Corporate social reporting is defined as the reporting of those costs and benefits, which may or may not be quantifiable in money terms, arising from economic activities ad subsequently borne or received by the community at large or particular groups not holding a direct relationship with the reporting entity. Corporate social reporting in the UK is predominantly the province of the larger companies but, even here, remains largely a marginal activity.
It appears that, on average, the annual report of a company in the top 1000 in the UK would have somewhere between a page and a page and a half of date on matters concerned with employees, the community, customer welfare and the environment. With the exception of the material concerning employees, the vast majority of this would be narrative. Narrative can, again, be usefully distinguished between the
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The considerable majority of UK social reporting would fall into the former category. Apart from these, the corporate should enclose a statement of turnover and profit or loss contribution by the corporate’s subsidiary companies and associated company. In the general practice today, the turnover figure is computed through the sales transactions of the combination of business segment. Therefore, it does not show a complete picture of which subsidiary companies or associated companies are making high or low turnover, profit or loss and etc.
By stating the contribution of each subsidiary and associated companies, we can test the performance measurement of each companies to analyst the potential prospects of each companies. If it is found that those companies are weak which hinder the overall financial performance of the parent company, shareholders can voice out in the AGM to request for the source of such bad performance and implement for improvement. Through this way, the users can gain more advantages as this guarantees for quality financial performance.
In addition, ratio analysis and financial interpretation report should be enclosed in an annual report as well. This is to ease the financial users to make economic decision within a shorter time, as this is a gain of competitive advantage. Different people tend to apply different knowledge of ratios computation as ratios analysis can be categorised into financial accounting and financial management, each of these categories show different method of ratio computation. Therefore, it is ideal for the company itself to prepare the statement of ratios together with the interpretation of these ratios.
Moreover, if users were to calculate the ratios themselves, error or mistake might occur, which the mistake of over-valued and under-valued is likely to cause bad decisions and bad investments. It is believed that smart investors normally apply market hypothesis testing to examine the accuracy of their decisions before making any investment. Therefore, ratio analysis and financial interpretation report should be included to ease the financial users to make economic decision and gain competitive advantage of providing useful and relevant knowledge to users in order to make speed decision.
The sensitivity analysis of “what if” question should be included here as well! This analysis emphasises on the possible outcomes (internal management factors or external environmental factors) of the company performance. For instance, what if the sales grow by 15% instead of 25%? What if cost of sales is 84% instead of 86%? It involves systematically changing one of the assumptions on which the pro forma statements are based and observing how the forecast responds.
All these are the possibility predictions by the company, which can enhance the confidence of the shareholders to a more stable condition as this analysis enable the company to determine which assumptions most strongly affect the forecast and which are secondary, thus chasing for more advantageous target and leading to successful plan. For those companies involved in Research and Development (R&D) activities, a statement of R&D investment expenditure should be included together with the information of new product development data and capital expenditure.
Here, by disclosing this item, financial users can understand to what extent the R&D has developed; and the possibility of success or failure of the R&D to generate a new product has an influential effect to the financial users. By looking at the financial position of the company, smart investors can easily determine the level of successful of the R&D towards generating a new product by looking at the adequate resources exist in the company, the technical feasibility of the product or process that can be demonstrated and marketable.
Besides, it is very important to analyse the investment expenditure vs. the outcomes. The greater the investment expenditure, the higher the risk if the company flunks to generate the marketable product. In 1980s, Rolls-Royce Company, a big, giant company of vehicles manufacturer, applied a great volume of loan to finance its R&D of producing aero-engine. In the level of research stage, it failed to continue the production; while the company capitalise all the R&D costs in the financial statement instead of written off as an expense.
This leads to the company encountering a great hardship of surviving due to the large loss of investment. Indirectly, the share price of the company stock dropped tremendously within a particular moment before recovering. Doesn’t this will de-motivate the investors to further pump in their capital? Therefore, it is ideal to include such a statement and the standard should facilitate this new disclosure requirement so as to view greater transparency to the financial users. Relating to the above, it is ideal to include a sensitivity analysis to the new product development or mega projects.
Sensitivity analysis is one method of analysing the risk surrounding a capital expenditure project and enables an assessment to be made of how responsive the project’s NPV is to changes in the variable that are used to calculate that NPV. The NPV could depend on a number of uncertain independent variables such as selling price, sales volume, cost of capital, initial cost, operating costs, benefits and etc. The basic approach of sensitivity analysis is to calculate the project’s NPV under alternative assumptions to determine how sensitive it is to changing conditions.
An indication is thus provided of those variables to which the NPV is most sensitive (critical variables) and the extent to which those variables may change before the investment results in a negative NPV. By disclosing this analysis, this shows equity to the stakeholders as to whether the projects undertaken will success or not. This analysis is likely to enhance the users’ confidences towards the company, as this is a measure of future projects that can bring the inflow of economic benefits to the company.
When the users are able to determine that the projects undertaken will bring benefits to the company, it hints that the share price of the company will increase as well. Nevertheless, investors will start injecting their risk capital to the company in order to enjoy higher returns in future. Moreover, corporate can practice to include employment report and statement of future prospects. The need for an employment report was founded on the belief that there is a trust relationship between employers and employees and an economic relationship between employment prospects and the welfare of the community.
The intention was that such a report should contain statistical information relating to such matters as numbers, reasons for change, training time and costs, age and sex distribution, and health and safety. The report nevertheless considered it appropriates to publish information of future employment and capital investment levels that could have a direct impact on employees and the local community. Instead of disclosing additional information, we should also look at the current practice of annual report disclosure, as there are still many weaknesses and loopholes, where it really needed further review and improvement.
Note disclosure is considered to be the weakest part in an annual report. Many companies tend not to pay much attention on the disclosure of notes to account in the current practice today. As to whether or not the listed companies have fulfilled and comply with the requirement of MASB disclosure, this is still a questionable area! By comparing the MASB requirement for disclosure and current company practice, there exists a gap of level of compliance. For instance, MASB ED 28 Goodwill requires companies to capitalise and amortise its goodwill with a rebuttable presumption that the useful economic life should not exceed 20 years.
An enterprise can adopt other method of goodwill treatment providing that the other method is much more appropriate in that situation by disclosing the reason for adopting other method. However, there are still many companies select other methods, such as write off goodwill against reserves or permanent capitalise the goodwill, but without disclosing the reason for not adopting the benchmark treatment. Therefore, the accounting profession should emphasise more in the transparent of notes disclosure.