Introduction
Over the years, regulatory bodies have been developing multiple strategies to harmonize accounting standards across the international market to enhance financial reporting among organizations. Therefore, several changes have been made in the existing standards to develop guidelines that capture financial and non-financial elements that ought to be accounted for in annual reports. In addition to changes in standards, stakeholders are also showing great interest in forward-looking information issued by companies. While the change in standards is essential for leveling the global financial market, reducing subjectivity, and enabling stakeholders make informed decisions, the practice also imposes additional costs required to adjust existing IT systems and train employees.
Changes in Accounting Standards
IFRS, which is the dominant accounting standard for the UK publicly traded companies, has undergone several changes in recent times. An example of such changes is the introduction of IFRS 16, which appears to be an enhancement of IAS 17 on aspects of lease accounting. Initially, standards that governed leases required lessors and lessees to distinguish between operating and finance lease (Segal and Naik 1). Unlike operating leases, finance leases are eventually transferred fully as properties or rights of the lessee; thus, they are accounted for in the balance sheet. Under IAS 17 standards, operating leases were mainly omitted from a company’s financial statements (Segal and Naik 2; Magli et al. 77). Hence, it was easy for organizations to control accounting for specific ratios in the balance sheet.
With the introduction and implementation of IFRS 16, leases in UK companies are accounted for differently. Unlike before, entities are required to recognize the right-of-use as an asset and debt as a liability in the balance sheet, regardless of an operating or financial lease (Morales-Diaz and Zamora-Ramirez 109). In light of this, the aggregate amount of lease payments made to the lessor and the hire purchase value in the instance of a finance lease are recorded as liabilities to the venture. However, few exceptions are available under the new standard, including lease accounting for short-term leases of less than one year and those with low value of below $5,000 (Morales-Diaz and Zamora-Ramirez 109). Changes in such a standard have a significant implication on the firms’ balance sheet as it may be difficult for the management to maintain a consistent debt to equity ratios.
Significant changes in accounting standards have also been established through the introduction of IFRS 15 by both IASB and FASB, which governs revenue from contracts with customers. Under the new standard, publicly traded companies are required to account for revenues from contracts with customers by recording an estimated amount, which is determined by taking into account various factors that may affect the transaction, including nature, amount, timing, and uncertainty of cash flows (Mattei and Paoloni 171). IFRS 15 appears to be an improved way of accounting for revenue, especially when it arises from contracts. As observed by Mattei and Paoloni, unlike IAS 41, which is activity-based income reporting, IFRS 15 promotes contract-based revenue reporting (172). IFRS 15 is undeniably a remarkable way of improving quality financial reporting among organizations.
Importance of Changing Standards
The above transition in accounting standards is of significance in the current financial market. Notably, the changes have created a levelled playing field for companies in the financial sector. As observed by Segal and Naik, the previous IAS 17 standard created varying comparability of financial statements among firms operating in the same industry (8). The authors give a scenario of two ventures, where one omits while the other includes lease accounting in the financial statement. According to Segal and Naik, a lending institution that relies on provisions in the financial statement is more likely to perceive the former as being creditworthy and grant new loans although both companies incur lease liabilities (9). However, with the promulgation of the latest changes in lease accounting standards, all entities that rely on leases are more likely to have comparable financial statements and an equal chance of objective credit rating in the financial market, which may, in turn, boost fair competition in the global arena.
In addition, changing standards has been an ideal way of reducing subjectivity in accounting. One of the factors that facilitate subjectivity is the level of discretion awarded on the management of various organizations. For instance, under IAS 17, preparers of financial statements can easily determine whether to include operating leases on the balance sheet because there lacks a standard definition of the term. As noted by Segal and Naik, operating lease is basically recognized as “a lease other than a finance lease” (2). However, the current changes have reduced the level of discretion available to companies with regard to leases and accounting for revenue from contracts with customers. In the presence of the established standards, firms are likely to be more transparent to regulatory bodies and shareholders about their financial position.
Apart from reducing subjectivity, changes in standards have also been an effective way of enabling stakeholders to make informed decisions. As mentioned earlier, the introduction of new standards, such as IFRS 16, has led to significant alterations of the balance sheet ratios developed by companies (Morales-Diaz and Zamora-Ramirez 106). Unlike before, firms are required to include certain assets and liabilities, which were initially omitted in their financial statements. Arguably, some of the off-balance sheet cashflows have significant effect on the evaluation of a venture’s financial position. Besides, Segal and Naik observe that stakeholders rely on financial ratios to analyze the operational effectiveness and liquidity of an entity and make strategic decisions (7). In an attempt to eradicate subjective accounting, the changes in standards may also play an essential role in facilitating transparent financial reporting, inclusive of detailed assets and liabilities, which may help stakeholders make informed decisions.
While the change in standards is vital in enhancing the quality of financial reporting among firms in the international market, scholars have observed multiple adversities that face organizations as they transition to the new guidelines. According to Segal and Naik, the majority of the companies have to incur additional costs associated with upgrading their IT systems to integrate new standards and train their employees how to implement them in financial accounting and reporting (6). The researchers also add that the cost of gathering and analyzing existing contracts based on current standards, such as lease accounting, may be higher than the benefits derived from the practice (Segal and Naik 6). Based on the above information, it is evident that changes in standards have both positive and adverse effects on companies.
Forward-Looking Statements
In addition to changes in standards, there has also been a significant shift in financial interest among stakeholders. As noted by the chief financial officer of BMW AG, “public interest is increasingly focused on forward-looking statements” (“Speech: Relevance of financial reporting”). Waweru et al. describe forward-looking information as financial statements that capture current plans and future organizational forecasts and which enable users of financial reports to assess the future economic position of a company (657). Apart from taking an interest in financial statements issued at the end of each fiscal year, stakeholders are also being vigilant about the future prospects of their organizations and measures that the management is taking to attain the projected goals. The increasing focus on forward-looking statements is likely to have an implication on financial reporting among companies.
The implication of Increasing Focus on Forward-Looking Statements on Financial Reporting
The current trend of forward-looking statements is likely to challenge companies to shift to an integrated form of financial reporting. According to Kilic and Kuzey, integrated reporting entails incorporating economic, social, and environmental issues in financial analysis in an attempt to develop a holistic view of an organization (3). In order to provide a clear picture of a firm’s future financial position, preparers of financial reports will need to have comprehensive knowledge of the dynamic economic factors that may affect financial performance and include such details in their annual reports. As such, financial reporting among corporations may evolve from mere records of what has occurred in the past to detailed accounts of future financial and non-financial performance.
Furthermore, an increasing focus on forward-looking statements may deem it necessary for firms to maintain multiple separate financial reports, which may subject them to additional operating costs. According to Kilic and Kuzey, the law requires listed companies to publish annual and corporate governance reports at the end of each financial year for purposes of transparency of their economic situation to the regulatory bodies, shareholders, and other stakeholders (1). The authors also add that firms can maintain voluntary sustainability and social reports, which are often published on their websites (Kilic and Kuzey 1). With the growing public interest in forward-looking statements, ventures may deem it necessary to enhance their approach of financial reporting to incorporate their future financial prospects. As such, additional resources may be required to maintain distinct reports required by stakeholders for strategic decision making.
Although forward-looking financial disclosure (FLFD) is a prominent trend in the contemporary business environment, some of its objectives may be off-set by multiple uncertainties. As observed by Asay and Hales, the above form of information may be uncertain and unverifiable despite being made in good faith (10). In light of this, some of the reported future prospects may not be attained as depicted in the reports. Therefore, this explains why majority of the companies that issue FLFD include cautionary disclaimers as a method of protecting themselves against potential legal suits. In the presence of economic disparities, future organizational financial projections may not be achieved.
Conclusion
Several significant changes have occurred in financial accounting standards. The changes have not only levelled the global financial market and reduced subjectivity but have also enhanced the ability of stakeholders to make informed decisions. However, these changes also impose additional operating costs on publicly listed companies. Public interest has also shifted to forward-looking statements, a practice that has prominently influenced financial reporting among business organizations.
Works Cited
“Speech: Relevance of Financial Reporting in Today’s Global Environment.” IFRS. (2019, July 5). www.ifrs.org/news-and-events/2019/07/trustee-speech-relevance-of-financial-reporting/. Accessed 29 November 2019.
Asay, Scott, and Hales, Jeffrey. “Building a Safe Harbor for Whom? A Look at Cautionary Disclaimers and Investors’ Reactions to Forward-Looking Statements.” SSRN Electronic Journal, vol.1, no.1, 2015, pp. 1-39.
Kilic, Merve, and Kuzey, Cemil. “Determinants of Forward-Looking Disclosures in Integrated Reporting.” Managerial Auditing Journal, vol. 33, no. 1, 2018, pp. 115-144.
Magli, Francesca et al. “The Effects on Financial Leverage and Performance: The IFRS 16.” International Business Research, vol. 11, no. 8, 2018, pp. 76-89.
Mattei, Giorgia, and Paoloni, Niccolo. “Understanding the Potential Impact of IFRS 15 on the Telecommunication Listed Companies, by the Disclosures’ Study.” International Journal of Business and Management, vol. 14, no. 1, 2019, pp. 169-179.
Morales-Diaz, Jose, and Zamora-Ramirez, Constancio. “The Impact of IFRS 16 on Key Financial Ratios: A New Methodological Approach.” Accounting in Europe, vol. 15, no. 1, 2018, pp. 105-133.
Segal, Milton, and Naik, Genevieve. “The Expected Impact of the Implementation of International Financial Reporting Standard (IFRS) 16- Leases.” Journal of Economic and Financial Sciences, vol. 12, no. 1, 2019, pp. 1-12.
Waweru, Fredrick et al. “Relationship between Forward-Looking Information Disclosure and Financial Performance of Non-Financial Firms Listed in Nairobi Securities Exchange, Kenya.” International Journal of Academic Research in Business and Social Sciences, vol. 6, no. 11, 2016, pp.654-669.
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