“Reducing complexity in financial reporting is desirable, and will allow the exercise of professional judgement. Rules should never take precedence over sound accounting principles”

The word ‘complexity’ is used to describe something intricate to comprehend; putting this

definition in the context of financial reporting complexity; complexity can be described as the

intricacy experience by the investors/audience of financial reporting. There are two causes of

complexity in financial reporting, those caused by the intricacy in commercial transaction,

and those that were initiated through the fault of the financial reporting standards setter, via

regulations (ACCA, 2009). Qualifying the purpose of financial reporting insinuated that the

information in financial reporting must be understood by the targeted audience for the

message to be appreciated (Rutherford, 2013); the lack of understanding of the content of

financial reporting by the investors will inherently have some effect on the accuracy of the

decision being made based on the report. Thus, it aroused the question of how accounting

complexity affect managers financial misreporting; Dechow and Dichev (2002), research

based on the ‘mistakes theory’ argues that complexity causes managers to make more

mistakes and exercise poor judgment. For example, on complex transaction, preparer are

more likely to err when applying standards, thereby increasing the likelihood of misreporting.

As a result of making error, many preparers will instinctually throw everything into the

disclosures (Hoogervorst, 2013), to avoid been caution; consequentially investors now face

with the problem of information overloading. Another theoretical assumption on the issue of

financial reporting complexity is the ‘manipulation theory’, this theory suggests that

managers will manipulate financial information to their advantage when accounting rule is

complex, in so doing, creating uncertainty for the audience of the report usually the investors.

The issues of financial reporting complexity mostly revolves around the rule and compliance

subjectivity; rule such as the one governing revenue recognition varies depending on the

country GAAP standard, even within a country, preparer of financial reporting always find

ways around the set guidelines provided by the standard setter. For example, Tesco revenue

recognition in relation to how it recognised its rebates from suppliers, on this issue Spence

(2014) argues that the manner at which Tesco recorded the rebate revenue is a common

practice in the retail industry, however, Mr. Rogers Sainsbury's finance director cited in the

telegraph (2014) said “accounting for rebates and commercial revenues was ‘very objective’

and ‘clearly defined’ by a set of rules and regulations", dismissing comments that it was a

"subjective process". The two arguments thus bought a spotlight on the complexity of

revenue recognition in financial reporting. The inconsistency in GAAP standard across

countries and the lack of comprehensive guidance combined with the complexity in some

transaction has resulted in a large number of errors in the area of recognition of revenue

(Sondhi and Taub, 2006); on the issue of complexity and the inconsistency in revenue

recognition disclosures, Tanya Branwhite in a press release to the Telegraph stated: “The

veracity of that information cannot be vouched for and what one company says is underlying

profit may not be at all the same in definitional terms as another company’s view of

underlying profits.” . without a consistence means of verification, managers could easily

manipulate financial information at the detriment of the investors; this notion was affirmed in

the study sponsored by FASB in 1981, the research findings concluded that managers

sometimes wittingly try to structure leases differently (as operating lease) to avoid incurring

additional liabilities; in the aftermath of the Enron crises in United State, Sarbanes-Oxley Act

specifically mandate the SEC to review the concept of ‘principle-based’ accounting; after the

review, the SEC rejected the idea of a principles-based only although recommended the

adoption of an objective oriented principles-based approach to promote the exercise of

professional judgement, to minimise complexity and also enhanced the quality/faithful

representation of financial reporting. Addition to SEC proposal, in October 2002 the FASB

delivered a Proposal on the adoption of the Principles-Based Approach to U.S. Standard

Setting.

As noted by many observers, complexity in financial reporting is mostly entrenched on the

approach adopted by the preparer and the GAAP standard in used. According to the FASB,

the demand-driven nature of financial market and the complexity in accounting standards has

resulted in the exclusions to principles in the standards and increases the amount of

explanatory (footnote) and application guidance provided by the FASB and others for

applying the standards, thus making financial reporting cumbersome (FASB, 2002, pp. 2–3).

could lead to situations in which professional judgments, made in good faith, result in different interpretations for similar transactions and events, raising concerns about comparability.

Comparability may be seen as especially important in an international environment, as there is the danger that local accountants and regulators arrive at differing views on the interpretation of contentious accounting issues.

As Schipper (2003) points out, rules are likely to proliferate as accountants ask for guidance that, they hope, will protect them from criticism and lawsuits.Detailed rules and authoritative guidance also serve standard setters’ and regulators’ objective of reducing the opportunities of managers to use judgments to manage earnings (and of auditors to have to accept that practice). Standard setters can be and must show that they are active standard setters. Thus, they may tend to overproduce standards and to write detailed rules covering almost any conceivable situation.

After the aftermath of the Enrol scandal

Enron lied about its profits and stands accused of a range of shady dealings,

including concealing debts so they didn't show up in the company's accounts.

http://news.bbc.co.uk/1/hi/business/1780075.stm

“Financial accounts are supposed to provide investors and stakeholders with an understanding of

the operating performance of the business

This suggests that investors can completely process the pension information that has already

been recognized in income, but fail to fully impound the valuation impact of pension

liabilities disclosed only in footnotes

The Perils of Pensions: Does Pension Accounting Lead Investors and Analysts Astray?

Marc Picconi

The Accounting Review, Vol. 81, No. 4 (Jul., 2006), pp. 925-955

Published by: American Accounting Association

Article Stable URL: http://www.jstor.org/stable/4093156

For example, many preparers will err on the side of caution and throw everything into the

disclosures. They do not want to risk being asked by the regulator to restate their financials.

The risk is that annual reports become simply compliance documents, rather than instruments of communication

underlying profit may not be at all the same in definitional terms as another company’s view of underlying profits.”

Lawrence, A., 2013. Individual investors and financial disclosure. Journal of Accounting and Economics, 56(1), 130 –147.

Rutherford, B. A. (2013). A genre-theoretic approach to financial reporting research. The British Accounting Review, 45(4), 297-310.

Hoogervorst, H. (2013). ‘Breaking the boilerplate. IFRS Conference, Amsterdam.

Sondhi, A. and S. Taub, 2006. Miller Revenue Recognition Guide. CCH Incorporated.

Dechow, P., and Dichev, I., 2002. The quality of accounting and earnings: The role of accrual estimation errors. The Accounting Review 77 (Supplement): 35-59.

ACCA, 2009

http://www.accaglobal.com/content/dam/acca/global/PDF-technical/financial-reporting/tech-ms-com.pdf

Crawford Spence

https://www.accountancylive.com/tesco%E2%80%99s-travails-awkward-revenue-recognition-issue

Mr. Roger.

http://www.telegraph.co.uk/finance/newsbysector/epic/tsco/11132545/Tesco-accounting-questioned-by-Sainsburys.html

Leon Gettler

http://www.charteredaccountants.com.au/News-Media/Charter/Charter-articles/Reporting/2011-08-Call-for-financial-report-overhaul.aspx

Cox, C. 2005. “Remarks Before the 2005 AICPA National Conference on Current SEC and

PCAOB Developments.” Speech given by the SEC Chairman, Washington D.C., Dec 5.

http://www.sec.gov/news/speech/spch120505cc.htm.

Herz, R. 2005. “Remarks Before the 2005 AICPA National Conference on Current SEC and

PCAOB Developments.” Speech given by the FASB Chairman, Washington D.C., Dec 6.

http://www.iasplus.com/usa/0512aicpaherz.pdf.

Peterson, K. 2008. Accounting complexity and misreporting: manipulation or mistake?

Working paper, University of Oregon

Businessweek online herz

http://www.businessweek.com/stories/2002-08-18/its-like-when-someone-robs-a-bank

http://www.charteredaccountants.com.au/News-Media/Charter/Charter-articles/Reporting/2011-08-Call-for-financial-report-overhaul.aspx

http://books.google.co.uk/books?id=uTr1Vh87p6kC&pg=PA69&dq=Financial+reporting+preparer+judgement&hl=en&sa=X&ei=Ils4VJqmEYze7AaKrIHgDg&ved=0CE8Q6AEwBw#v=onepage&q=Financial%20reporting%20preparer%20judgement&f=false

Sondhi and Taub (2006) summarize the problems with revenue recognition when they write:

“The lack of comprehensive guidance, in combination with the variety and complexity of

revenue transactions, has resulted in a large number of financial reporting errors in the area of

revenue recognition.” Revenue recognition can be complex because of uncertainty about both

standards and transactions.