How to make accounting standards easier to interpret

By Gary Anders

For accountants, auditors and other finance professionals, accounting standards are the essential technical tools for accurately measuring and disclosing transactions and other events in financial statements.

Yet, how easy are they to interpret, and should standard-setters be working towards making them simpler? The answer, as you might expect, isn’t really that straightforward.

A team of academics from the University of Adelaide recently presented a series of recommendations to the Australian Accounting Standards Board (AASB) in a research report titled Are Accounting Standards Understandable?.

Research conclusions

Report authors, associate professors Bryan Howieson FCPA and Janice Loftus FCPA, and researcher Dr Sabine Schuhrer CPA, analysed 65 accounting standards to measure their overall readability, based on the average length of sentences and the number of syllables per word.

They found the bulk of the standards fell into either the “difficult” or “very difficult” readability score range.

The researchers also conducted detailed interviews with 25 financial statement preparers, auditors and other industry practitioners, including accounting standards drafters.

General observations expressed were that accounting standards were becoming increasingly complex and harder to understand, and making them simpler would be beneficial.

Yet, as Howieson explains, there is a very good reason why accounting standards have become more complex.

“All the low-hanging fruit and easy topics were covered a long time ago,” he says.

“As businesses have become more complex and the type of transactions have become more complex, that’s put a burden on the standard-setters to try and cater for a wider range of transactions and complexity in transactions.

“So, what we’re seeing in more recent years is longer, more involved standards as a response to that complexity in business transactions.”

A technical process

Dr Mark Shying, AASB research director, says the question of how to improve the understandability of accounting standards requires a shared understanding of their nature.

“Simply put, an accounting standard is a technical pronouncement that sets out the required accounting for particular types of transactions and events,” Shying says.

“Howieson notes improving readability scores is not the panacea to improving the understandability of an accounting standard. I hold the same view.

“Some interviewees spoke about the challenge of applying the requirements of the accounting standard to their situation. Within research, this is called actionability.”

Shying says an accounting standard is understandable and actionable when financial statement preparers and auditors can process and explain its messages and can identify what they can do.

“The development of accounting standards, considering the wide impact that they may have, is a deeply technical process. It is also fair to say that the development of standards is an ongoing process, with changes being made as required, as national and international requirements change over time.”

Not so simple

Professor Michael Davern CPA, who holds the position of chair of accounting and business information systems in the Faculty of Business and Economics at the University of Melbourne, believes simplifying standards is somewhat of a losing battle.

“This is one of those debates that you know is never going to go away, because even if you simplify them, people are just going to make them more complex again over time,” Davern says.

 

"I think a technology-driven solution will help... people navigate through the volume of material, and in helping them make connections between relevant standards and to find key definitions that they might need." 

 

“Part of it is the fundamental issue that you can’t really remove some of the complexity, because what we’re trying to describe in the economic activity of a business is complex, so the ways of dealing with that are complex.

“Some of that complexity also comes back to the fundamental debate between a principles-based approach and a rules-based approach. Rules create a lot of complications, and principles are complicated in their application.

“I think the fundamental question is, what’s the necessary amount of complexity given what the transaction might require and you’re trying to account for?

“That’s not an easy question to answer, and you’ll get different perspectives on that depending on the stakeholders you’re dealing with.”

Leveraging technology

Among its key recommendations, the University of Adelaide research team says consideration should be given to improving the way accountants and finance professionals navigate around standards and supporting materials through the use of interactive e-versions of the standards.

A good reference point for this is the “eCode” introduced by the International Ethics Standards Board for Accountants (IESBA) in June 2019, which has leveraged digital technology to help accountants better understand and apply the International Code of Ethics for Professional Accountants.

“At the moment, if you go on the AASB website and want to look at a standard, you get a PDF,” Howieson says.

“You may be able to search within the PDF without too much trouble, but if you’re trying to understand the relationship between that standard and other standards, because there are often cross-cutting issues, you can’t really do that.”

Howieson says that, while hyperlinks to definitions and the background basis for conclusions documents are used a lot, many practitioners don’t know they exist or how to access them.

“I think a technology-driven solution will help a great deal in terms of helping people navigate through the volume of material, and in helping them make connections between relevant standards and to find key definitions that they might need.”

More visual aids

Another recommendation from the research team is to increase the use of flowcharts and other visual aids and templates.

Flowcharts were commonly cited during interviews as a way of helping practitioners to find which standard was relevant and to apply definitions in standards.

“Often people get the principles that are in the standard, but the understandability problem comes when they need to apply it to their particular set of facts,” Howieson says.

“There may be definitions that aren’t quite specific enough, or people may have arrangements that don’t quite fit neatly in the type of language that’s used in the standard.

“We found this in the public sector, for example, where there may be services agreements that just don’t quite fit neatly into the rules.”

There were some concerns expressed during interviews around occasional last-minute changes to standards, with insufficient time for accountants to assess the consequences and provide feedback.

“To be fair to the standard-setters, they do make a lot of materials available,” Howieson says. “But people just don’t seem to know of them, so maybe there are some other ways of promoting greater awareness of the basis for conclusions or where other illustrated examples are that the AASB has produced.”

Getting the best balance

Shying says that simplifying the text in standards could increase readability scores, providing an intuitively simple solution that is not difficult to implement.

“However, there is a very real possibility that, in simplifying technical writing to increase the reading score of the accounting standard, the standard-setters reject messaging that could in fact be effective for understandability and/or actionability.”

Shying says this could have an unintended consequence, where making readability easier actually makes understanding the accounting standard more challenging.

“A multi-modal approach is a better solution – understandability, actionability and readability. And applying caution to the use of readability scores.”

 

"A starting point could be focusing attention on understandability, with an emphasis on actionability by the AASB and other standard-setters, including the IASB." 

 

Broadly speaking, how can standards be made easier to interpret from an accountant’s perspective?

Shying points to the University of Adelaide research group’s finding that those who have a deep understanding of accounting standards and who play a key role in interpreting them are “a very small, select, highly skilled group” – namely technical experts in the big and mid-tier accounting firms, technical staff and auditors.

“So the question could be rephrased as, ‘What would make accounting standards easier to understand for that group?’,” he says.

“A starting point could be focusing attention on understandability, with an emphasis on actionability by the AASB and other standard-setters, including the IASB [International Accounting Standards Board].

“Tools could be developed with predefined goals for enhancing understandability and actionability.”

The role of education

Another key recommendation in the University of Adelaide’s research is that the AASB reconsider its education objective.

Much of this relates to smaller accounting firms, and sole practitioners in particular, having very limited time and resources to keep up-to-date with standards and to interpret how they apply.

“There is stuff out there, but most people are just either too busy to go and find it, or they’re just not aware of it in the first place,” Howieson says.

“A lot of people are already relying on educational materials out of the Big Four or the mid-tier firms.

“In fact, quite a few people that we interviewed were starting with the materials produced by the accounting firms they are audited by, or do consultation with, rather than starting with the standards.”

Davern says keeping up with accounting standards comes down to continuing professional development, with professional bodies such as CPA Australia playing a major role in ongoing education via publications, articles and webinars.

“It’s part of how you build your toolkit of knowledge as an accountant, and it’s not about just understanding the technicalities of the standard, but understanding what it’s trying to do and its broader context.

“Has it got harder in the last 30 years for the small firm practitioner? Absolutely it has, and I think connection to ongoing professional development opportunities has become crucial to that in keeping you in the know. But if you understand the fundamental principles, it’s not like it’s a completely different world. It’s just a different variation, as we’re trying to hone in on trading off that balance between complexity and simplicity.”

Next steps

Striking the right balance between simplicity and meaningful complexity

Any changes to how accounting standards are written, and the standard-setting process itself, will undoubtedly take time.

Howieson notes that Australian standards are often modified versions of international accounting standards.

“I know the AASB is certainly very keen to pick up on a number of the points that we’ve raised. I think the key one, about making standards more interactive and so forth, is a major project,” he says.

“The IASB is also interested in this project, and I think if there’s going to be progress on this, it might be at a more international level than necessarily just in Australia.”

Shying says that, as both the IASB and AASB use an evidence-informed approach to setting standards and guidance, he expects the study findings would be considered as part of the government agency’s working agenda.

How far can accounting standards simplification go?

“There’s a base minimum level of complexity you’ve got to have, and so you want it as simple as it can be, but not too simple,” Davern says.

“If it’s too simple, then the reporting you’re doing based on those standards is not meaningful. It’s about finding that sweet spot.”