• Simplifying Financial Reporting Is Hard

    By | April 20, 2016

    As a concept, business is simple. Someone willing to buy a thing or a service gives you money for that thing or service. If you sell lots of things or services then you've really got something good going. Hooray! You're an entrepreneur.

    In practice, business is not so simple. Sometimes you have to store the things or hire people to help you provide services. Sometimes you need to buy machines to build the things. Sometimes your customers promise to pay you in the future. Sometimes they fail to pay you. You have to pay bills. Sometimes you have to borrow money. When you think you're really doing well, sometimes you ask other people to invest in your business.

    And you can take it from there. A long time ago, some people decided that tracking all these things was a good idea and boom, you've got accounting. Again, as a concept, accounting should be simple. If you make more money than you spend, you have a profit. That's good. If you spend more than you make, you have a loss. That's bad.

    Similarly, you have assets, valuable things, and liabilities, things you owe to others. When assets outnumber your liabilities, that's good. When they don't, that's bad. All this accounting is compiled into financial statements that summarize how a business performed and where it stands. It's all pretty neat, really.

    But in practice, accounting and financial reporting are mind-numbingly complicated. A long time ago, some people decided that there should be standard accounting practices for businesses to follow. You know, so everyone was on the same page. And once again, the concept behind these rules were simple but incredibly complicated in practice.

    At various points throughout history, some businesses decided to break the law or account for things in a misleading way. That resulted in hurt feelings, job losses, lost money and other bad things that make people mad. But mostly the lost money. And when people lose money in America, they sue. In some of these instances, all the lost money and jobs and lawsuits and whatnot results in the government making rules that say that businesses can't do this or that. Or if the business does do this or that, it has to tell the investors or other people who use their financial statements. Sometimes these rules are good, sometimes they are bad, but once in place, they are very hard to get rid of.

    What's interesting about all this is that it was in place before you and I came along. Odds are it will be in place long after we're gone. Business is complicated. Accounting is complicated. Financial reporting is complicated. Governments and laws are complicated. And it doesn't stop there.

    I could've saved you all from this diatribe by sharing this from Wharton professor Wayne Guay:

    [C]ompanies themselves are getting more complicated. Even in the absence of the regulations, they would have to say more to explain that complexity. Then you have the regulations that are being lumped on top of that. Then you have the litigation concerns that are being lumped on top of that. The companies are trying to play a very complex game, and on top of that, they’re trying to provide information to their customers.

    Even when they’re well intentioned, things can get complicated.

    Complicated doesn't work for most people, though. It costs the businesses a lot of money and regular ol' Joes and Janes want to invest in these companies too, and they want useful information to help them make decisions. The problem is finding the real useful stuff among all the less useful stuff. And since it's only going to be more complex in the future, therein lies a pretty serious problem.

    Guay wrote a recent paper along with his Wharton colleague Daniel Taylor and a PhD candidate Delphine Samuels "examin[ing] whether managers use voluntary disclosure to mitigate these negative effects." That's right, more information. And here's how Samuels described the findings:

    Overall in our study, we find that the predominant effect is this positive association between financial statement complexity and voluntary disclosure. In other words, managers are benevolent, so to speak, and are trying to really overall reduce the complexities and the uncertainties related to their finances.

    That is, in Guay's words, "Can they follow up — or pre-empt, perhaps — some of the complexity in the annual reports with additional disclosures like management forecasts or press releases and 8-Ks and those sorts of things?"

    I can say unequivocally that more press releases is NOT the answer. And 8-Ks? I'm struggling with that idea too. Talk about lumping it on. But they may be on to something; that is, there's got to be a way for companies to communicate something concise about in their financial reporting.

    How about a tl;dr? Or an infographic? Or a BuzzFeed quiz? Oh! Or AMAAOFSAD (Ask me anything about our financial statements and disclosures)! Isn't that what earnings calls are? It'd be nice if they started doing those on Reddit. Those are very impulsive, very bad suggestions, but I won't be convinced that more press releases and 8-Ks are the answer. Gag.  

    I kinda mentioned this in regards to PCAOB inspection reports: there's something to be said for packaging and delivery of dense, clinical material. Getting regular people to care about this stuff is not easy, but it's incredibly easy to get them to NOT care about it.

    Financial reporting is complicated. It will get more complicated. Your mission, if you choose to accept it, is to distill it into something simple. But no more press releases. Come on.

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    • People need to make up their mind:

      -Investors are typically sophisticated enough to understand complex disclosure. In fact they want more disclosure to get insight into the company.

      OR

      -Investors are unsophisticated and need things streamlined and simplified to get to the point. More disclosures and information is just paralysis by analysis.

      You can’t have it both ways.

      The truth is that companies and investing IS complicated. I mean we’re talking multinational firms with subsidiaries who use IFRS and need to convert to GAAP. We have complex tax structures in place. There are a myriad of regulatory laws to adhere to. Then you have the PCAOB poking the auditors to do more, More, MORE!

      I mean the complexity of reporting is only a reflection of how complicated it all really is. And if you start simplifying things, then you begin to lose some of the nuance that’s important in fully understanding the situation.

      Here’s some advice to so-called investors: If you don’t want to wade through complicated financial statement then don’t invest. There’s a reason why being a buy-side analyst or successful portfolio manager is such a sought after job. There’s also a reason why there are not a ton of ’em in the first place.

      • Chevy

        Be like Hillary…go long SPY. Park it and forget it. I used to think I was smart and could beat the averages, but alas, my ass was handed to me. Humble pie served HOT

        • I have a mutual fund indexed to the market, and I have just got on with my life.

    • AaronBalake

      “Financial reporting is complicated. It will get more complicated. Your mission, if you choose to accept it, is to distill it into something simple….”

      Instructions are unclear. How am I (an individual) going to simplify financial reporting if all these standardized processes were, as you say:

      “What’s interesting about all this is that it was in place before you and I came along”

      You’re setting me up for failure, Caleb.

      • PWC Prick

        Don’t forget “Best Practices”