Reliability of disclosures

The general perception is that the threshold of reliability of information provided as disclosure in footnotes is lower than the reliability of information provided through measurement of assets and liabilities in the balance sheet and incomes and expenses in the profit and loss account.

In earlier years, in the absence any significant presence of financial analysts and due to scanty disclosures, investors did not attach importance to information provided in footnotes; and consequently auditors were not very diligent in verifying the reliability of those information.

In recent years, the auditing environment has changed significantly.

With the increasing presence of institutional investors in the capital market, the profession of analysts is growing fast. Analysts pay equal attention to all the information, including disclosures in financial statements.

 

Therefore, the auditor's evaluation covers all those information. Standard on Auditing (SA) 700 (Revised)- Forming an Opinion and Reporting on Financial Statements, stipulates that the auditor's evaluation as to whether the financial statements achieve fair presentation shall include consideration of the overall presentation, structure and content of the financial statements; and whether the financial statements, including the related notes (emphasis added), represent the underlying transactions and events in a manner that achieves fair presentation.

It further stipulates that an audit involves performing procedures to obtain audit evidence about the amounts and disclosures (emphasis added) in the financial statements. Therefore, in the present day context, it is inappropriate to assume that the information presented in footnotes is less reliable.

Accounting rules formulated in the last decade focus more on relevance than reliability. The position is now well accepted. It is evident in softening of the opposition against the fair value accounting. Therefore, to assume that the threshold of reliability of information on footnotes is lower than those provided on the face of financial statements is to assume that information provided in footnotes is unreliable.

This is not true. Increasing trend towards voluntary disclosures provides evidence that analysts and investors consider, even unaudited information as reliable. More and more companies are providing, voluntarily, more information than the minimum required by accounting rules or other laws.

Good companies understand that investors use information provided through voluntary disclosures in decision-making. Therefore, they take due care to ensure that the information is reliable. Empirical researches show that voluntary disclosure of the relevant information attracts more investors and indirectly reduces the cost of capital.

In other words, investors rely on information that is not audited, provided the company could establish the credibility and integrity of the information provided by it. This is clearly evident from the observable market response to performance guidance issued by leading companies while releasing quarterly financial statements.

In view of the above, it can be argued that the objective of providing relevant information to investors and creditors is achieved even by disclosing that information in footnotes. It is not necessary to provide the same only through recognition and measurement of asset, liabilities, incomes and expenses in the financial statements.

If, we accept this argument, an entity should formulate the accounting policy based on the assumption that the perceived level of reliability of information, which is presented as disclosure, is the same as that of information provided on the face of financial statements. For example, there is no need for using the fair value model for the measurement of items of property, plant and equipment (PP&E).

If, the fair value of land, which can be sold without discontinuing the business, is relevant in decision-making by investors, it can be disclosed in the footnotes, rather than carrying it in the balance sheet at fair value. There is an advantage.

Accounting rules require that if, fair value model is used for measuring an item in a particular class of assets, then all assets in the same class are to be carried at fair value in the balance sheet. On the other hand, if the entity uses the cost model, it has the discretion to disclose the fair value of selected items.

For example, it may decide to disclose fair value of the land, whose value is high and is growing fast (e.g. land located in South Mumbai). This will help to avoid costs (e.g., costs to value pieces of factory land located in remote areas) that do not benefit investors.

Affiliation: Director, International Management Institute - Kolkata E-mail: asish.bhattacharyya@gmail.com