The annual report: is shorter better?

Corporate reporting season is in full swing and while the market will be closely analysing key numbers around earnings, the annual reports to be published soon afterwards may not always attract the same levels of scrutiny.

For many people, the critical information has already been released to the market. What is the point then in wading through a document of more than 100 pages, the vast majority of which, according to Henry Botha, is “marketing spin.”

“If you went through it, the chairman’s report and the chief executive’s report are just waffle,” says Botha, a program director at the Melbourne Business School with a focus on financial literacy.

“Then you have the section on divisional operations where senior executives give their feedback, and if you were totally rational you wouldn’t believe that either.”

What to read in the annual report

The only important parts of an annual report, says Botha, are the directors’ declaration where the company says it can pay its debts, the audit report and the numbers around profit and loss, and the balance sheet and cash flow.

At the University of Melbourne, Professor of Accounting Michael Davern has led research funded by CPA Australia, which included interviewing professional investors on how they use annual reports.

Davern says this research, published in a report “Decision Usefulness in Financial Reports”, found that the audited financial statements were still “go to” documents when investors started to build company valuations.

“These audited numbers really are the starting point, they are the necessary but not sufficient first point in understanding the value of the company,” he says.

“We were pleasantly surprised how important it was because it is the one piece of information which is audited and they know is reliable.”

Other parts of the annual report, says Davern, can be largely “window dressing” from management but even though investors recognise this, many of them still find it useful in forming their view about the company and its performance.

Auckland University’s Tom Scott CPA agrees with Henry Botha that annual reports are too long but says that making them shorter and more concise also has its issues.

Scott, associate professor of accounting at AUT, has studied annual reports published by New Zealand’s local government sector.

New Zealand councils have begun publishing concise versions of their annual reports, which are on average 10 per cent of the full version. These are prepared in accordance with the equivalent of the AASB 1039 accounting standard for concise reporting.

Auckland council’s standard report is over 800 pages, so anyone reading the shorter version still has 80 pages to get through.

“It is a definite win that the summary annual reports are shorter,” says Scott. “But they weren’t necessarily any more readable.”

Shorter annual reports are still complex

Scott and his colleagues analysed the readability levels of both full reports and summaries and found that there was no difference.

“So, while they are shorter they aren’t any easier to understand, and part of the reason for that could be that accounting is complex.”

Melbourne Business School’s Henry Botha says the answer lies not in “dumbing down” reports, but in improving the financial literacy of those who read them.

 

“So, while they are shorter they aren’t any easier to understand, and part of the reason for that could be that accounting is complex.”

 

If “mum and dad” investors are serious about their involvement in the share market, he says, it is up to them to acquire the necessary skills to read financial statements.

“You read lots of articles saying no one reads these things because they are so complicated, but the fact is they should be complicated,” says Botha.

“For someone to become a fully qualified accountant takes approximately six years. To suggest that reporting should be simplified is like saying that engineering drawings should be simplified so that everyone can read them, but that is a joke because it probably means the building will fall down.”

More readable annual reports

Some companies, however, may have their own reasons for keeping their annual reports opaque.

UNSW Business School academic Mark Humphery-Jenner looked at the readability of US corporates’ 10-K annual report filings and found that companies facing litigation produced “foggier” annual reports.

Humphery-Jenner found that annual reports from companies facing litigation were 8.8 per cent “foggier” than peers with less risk, while companies that had been sued in the last four years also produced less readable reports.

Stephen Varady, who chairs the Australasian Reporting Awards, says a more innocent reason is that the annual report has become a “repository for bits and pieces of information which don’t fit anywhere else”.

“Regulators think everyone should know about something and because the annual report comes around once a year, people think ‘let’s chuck it in there’,” says Varady.

He believes that many organisations have forgotten the function of their annual report, which is “to tell the performance story of your organisation and its strategic objectives”.

There is also confusion, he says, about who the annual report is written for. Is it shareholders, regulators or, in the case of government organisations, other stakeholders?

After 10 years of judging awards, Varady says that change has been incremental. 

Initiatives such as the Global Reporting Initiative have had a positive influence, but too many companies are still disengaged. 

A downturn in the number of private sector entries in the awards is a worrying indicator of the low level of interest in improving reports.

“I’m also surprised that organisations as a whole haven’t taken advantage of electronic publishing,” says Varady.

“Distributing the report on the web isn’t the same as publishing a web-based report, and there are some opportunities in terms of where that can develop.

“Web publishing opens up opportunities for videos and graphics, and for people to click and read specific pieces of information relevant to them, but the transition has been a little slower than I would have expected.”