Significance of Financial Reporting

ЎҐSignificance of Financial ReportingÐŽ¦

-An

Essay

Student No. : S00042472

Student Name : Janak Patel

The Collapse of the Corporate Giants like Enron and WorldCom have raised the imminent question, which always remains in the back of an investorÐŽ¦s mind, ÐŽ§Can I trust my hard earned Capital in somebody elseÐŽ¦s hand ?ЎЁ This is not the first time that investors have lost their trust in companies however the fact does not change that the cost of capital from the market has increased significantly for the companies. Investors have started to invest their capital in risk free securities rather than in company stocks.

Investors have also started to look with contempt and doubt at a companyÐŽ¦s financial reports because some of these collapses were preceded by financial frauds cleverly covered by the management of such companies. Investors have arrived to a stage where they no more trust the financial reports provided by the company. However some of the intellectuals believe that financial reporting is of no significance for investment decisions. The reason being the fact that most of the financial reports are historical and they have already been taken into consideration while deciding the price of the stock of the company and it also does not give an idea about the future position of the company.

On the other hand there are also some intellectuals who argue that there are still a lot of investors who still takes their investment decisions on the basis of a companyÐŽ¦s financial reports. Ask investors what kind of financial information they want companies to publish and you'll probably hear two words: more and better. But let's face it, the financial statements of some firms are designed to hide rather than reveal information. So what would ensure investorÐŽ¦s trust in companies and its governance? The answer is a good, future oriented and more transparent financial reporting system.

One cannot deny the importance of a good financial reporting system for ensuring sound corporate governance. There is now a clear need to restore confidence in capital markets and elsewhere by enhancing corporate governance in order to provide financial information of the highest quality.

The lifeblood of markets is information and barriers to the flow of relevant information represent imperfections in the market. The need to sift and correct the information put out by companies adds cost and uncertainty to the marketÐŽ¦s pricing function. The more the activities of companies are transparent, the more accurately will their securities be valued.

A basic weakness in the current system of financial reporting is the possibility of different accounting treatments being applied to, essentially the same facts. The consequence of that would be different results or financial positions each of which would apparently comply with the overriding requirement to show a true and fair view. However the investors might not get the real picture behind the numbers which put them to a disadvantage and they would not be in a position to see through the techniques used by the management to show the results of the company in the most favorable and flattering way.

ThatÐŽ¦s why a stricter and more elaborative financial reporting is very much essential because it discourages managements intentions and besides that there are a lot many advantages to the investors, analysts and other accounts users and ultimately it also benefits the company itself because it limits the scope of uncertainty and manipulation. In addition to that the wider the scope for alternative treatments the less useful financial reports become in terms of comparability thus a uniform set of generally accepted accounting principles and practices is necessary.

What investors look for in an accounting report is a coherent narrative (supported by the figures) of a companyÐŽ¦s performance and prospects. In order to ensure that the responsibility should be placed on the Board of the Directors and they should pay particular attention towards presenting a balance and understandable assessment of their companyÐŽ¦s position.

Furthermore the fundamental principle of financial reporting is that the view presented by the reports should be true and fair. And further principles suggest that board of directors should aim for the highest level of disclosure of the facts which are understandable by avoiding damage to their competitive position. They should also aim to ensure the integrity and consistency of their reports and they should also meet the letter of the reporting standards such as GAAP.

Here the Investors should seek disclosure and simplicity. The more companies say about where they are making money and how they are spending their resources, the more confident investors can be about the companies' fundamentals. It's even better when financial reports provide a line-of-sight view into the company's growth drivers. Transparency makes analysis easier and thus lowers an investor's risk when investing in stocks. That way you, the investor, are less likely to face unpleasant surprises.

As per the views of George Bennet Stewart III of Stern Stewart & Co. the current Accounting Practices are of no use in determining a companyÐŽ¦s current position. In the United States of America, President George Bush has created a new oversight board to regulated accounting standards. But according to Bennet these reforms just solves some of the problems but they do not provide a full fledge solution.

Here the main problem is not with companies like Enron and World Com who broke certain rules the root of the problem is that every company is working on the boundary lines set by the government. The idea is to bend the rules to the maximum and finding a way around the legal requirements. Bennet suggests some extreme measures to reform the accounting practices but that certainly would not cost beneficial to the companies.

On the contrary George J. Benston of Emory University suggests that accounting is not in need of fixing it is just needed to be reinterpreted. Benston agrees with some of the suggestion by Bennet but he totally denies the motion of altering the GAAP from the root. In support to his arguments he describes the importance of traditional accounting system. He explains that the traditional accounting practices did not put an emphasis on measuring and reporting the current market values of balance sheet accounts or changes in these values over the period. Instead the primary aims of the financial reports