Pulling Back The Curtain On Corporate Finance Reports

Corporate accounting standards are changing, with the Financial Accounting Standards Board adopting new standards in ways companies report on leases, hedging and other financial activity. While any change is often disruptive, the FASB and analysts noted that the adjustments ultimately aim to make accounting and reporting easier for finance professional, ad promote transparency.

As Calcbench Co-Founder and CEO Pranav Ghai said of the standard changes late last year, the initiative “will provide a level of visibility into financial statements that previously didn’t exist.”

Accounting strategies can not only boost transparency for regulators and visibility for a firm’s own leadership, but regulators say they can also promote security. Last October, the U.S. Securities and Exchange Commission urged businesses to keep cybersecurity in mind as businesses brace to enact the FASB’s new standards, noting that some companies that are hit by a cyberattack may have been left vulnerable as a result of failing to adequately develop internal accounting controls — particularly among public firms.

Transparency Initiatives Falling Short?

A recent report from CFO.com shed light on another factor driving accounting and financial transparency within corporate America.

According to the publication, a series of corporate scandals from the likes of CBS, Nissan and others has eroded public and investor trust in corporate leadership. Citing analysis from the Edelman Trust Barometer, the report noted that 2018 saw the largest-ever decline in public trust in businesses and government, and it’s causing significant financial losses in the form of stock devaluation, lost business and more.

While transparency can emerge in many forms, CFO.com cited a 2005 report from the University of California, Berkeley’s Haas School of Business that found a link between higher corporate performance and transparent reporting.

Yet the latest research from the University of Alberta suggests organizations continue to find ways to obscure key information about their companies within annual reports in an effort to mask bad news.

According to Alberta School of Business accounting professor Ke Wang, companies’ use of “narrative” in addition to hard data enables firms to limit focus and understanding among investors and the public about poor performance or outlook.

While these narratives are important for firms to explain complex ideas that may not be entirely understood solely through accounting numbers, Wang noted they can promote a lack of transparency, too.

“We found the results to be consistent with the argument that managers can successfully hide adverse information by writing complex financial reports, which leads to stock price crashes when the hidden bad news accumulates and reaches a tipping point,” he said, according to Phys.org reports last week. “The research finds that the relation between annual report readability and future stock price crash risk is more significant when the firm’s CEO holes more stock options of the firm, which props up stock prices.”

Meanwhile, previous research from Audit Analytics has also revealed that the number of accounting errors among the U.S.’s 9,000 publicly listed companies spiked in 2018 after consistent declines since 2006. Many of those mistakes were discovered as corporate accounting teams adjusted reports to comply with revised tax and accounting rules, though some resulted from intentional manipulation.

“Errors can be anything from a misapplication of accounting principles to an error in inputs in accounting software or an error in Excel schedules,” explained UHY LLP partner Michael Burke in an interview with the Wall Street Journal at the time.

In the U.K., some corporate accounting experts have questioned the largest auditing firms’ role in combating accounting errors and fraud after a string of corporate finance scandals. In the U.S., changes in accounting standards, the risk of cyberattacks and pressure from investors to boost transparency may promote trust and clarity in business performance. But researchers warn that corporates continue to find ways to hide the bad news.