Europe Economy

Company Annual Reports Need 'Major Surgery': Analyst

Without "major surgery" on companies' annual reports, investors' trust will continue to diminish, impacting on growth, James Roberts, a partner at accountancy firm BDO, said as his firm released new research showing reports remain a crucial influence when it comes to investment decisions.

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BDO found that only 56 percent of UK-based non-executive directors, 51 percent of finance directors and 56 percent of fund managers trust financial statements published in annual reports, but over 80 percent of them cite annual reports as the biggest factor when it comes to making investment decisions.

The vast majority of fund managers (87 percent) and non-executive directors (84 percent) claimed annual reports were either the most important or a major element when deciding where to invest, despite their skepticism over the data they contain.

But it seems British boardrooms are unaware of the influence their annual reports have, with only 46 percent of finance directors believing they form the basis of most decisions made by investors.

"The divergence in opinion between investors and non-executive directors over what is deemed an appropriate level of assurance is particularly stark, given that investors depend on the annual report and pay serious attention to its contents," Roberts said.

“The risk is that without fuller confidence in how directors are describing their business position, investors will be hamstrung in their decision-making and any growth prompted by the capital markets could suffer," he added.

Over two thirds of fund managers called for more assurance in the narrative information of financial reports and 70 percent were in favor of an extended element of assurance on overall health of a business.

Yet, the need for improvement seems to not be so pressing for companies themselves with 43 percent of non-executive directors opposed including further assurance and half not seeing any need for extended assurance on the business overall.

"The fundamental purpose of the annual report is to act as a guide to the financial position and performance of investee companies – the degree to which it is thought not to achieve that purpose is alarming," Roberts said.

Complicated Accounting

Common complaints from investors included overly complex accounting treatments and insufficient assurances from auditors.

Peter Harris, a Fund Manager at Brooks Macdonald agreed that many company reports are "over complicated", containing superfluous information on the one hand and a lack of extended assurance on the other.

Ross Graham, a Non-Executive Director and Audit Chairman at consumer electronics companies Wolfson Microelectronics and Psion, blamed international accounting standards, rather than individual companies for their complexities.

"Financial statements within annual reports are drawn up under the overly complex rules of International Accounting Standards; it is little wonder that their effectiveness is being questioned," he said.

"Such is their complexity; they almost entirely fail to deliver meaningful information on the run rate of a business or future cash flows."

Harris said reducing the amount of information in annual reports while extending assurances would not be a simple task and it would be difficult to cater for all people who relied on annual reports.

"The challenge is where to cut it without impacting its usefulness for the different range of people using it for their separate means. Any sort of extended assurance can only help but these assurances may be difficult to come by and again what needs bottoming out is how that could be implemented across different industries,” he said.

However, Graham warned that increased assurance could lead to damaging risk aversion among investors.

"A careful balance needs to be struck over the level of assurance provided in annual reports – fund managers should be careful what they wish for," he said.

"Additional assurance, particularly regarding forward-looking information in the narrative section, could lead to overly cautious worst-case-scenario forecasts being provided, which would ultimately undermine the business community's confidence and lead to unhealthy risk aversion," he added.