Let’s get back to keeping our eye on the ball…
By Mike Alerding In the spectrum of financial reporting for business entities, the past nine years are generally known as the “Post-Enron” period. The debacle that US businesses have had to endure during this period is not only unprecedented in terms of the number of new financial reporting rules but, more importantly, in terms of the complexity and absurdity of the types of disclosures that are now required. By any definition, it has been a revolution vs an evolution in an area that certainly needed to change, but not without thoughtfulness, application of a cost-benefit analysis and the use of plain old common sense.
What this revolution of insanity has meant to closely held business owners is a substantial increase in the cost of preparing financial statements and a substantial decrease in the usefulness of those statements. A typical annual audited or reviewed financial statement that, ten years ago, may have included four or five pages of Notes, now includes anywhere from seven to ten pages. Each of the new disclosures requires management to gather information, perform research on the disclosure requirements and draft the notes in a manner that meets the requirements of Generally Accepted Accounting Principles in the U.S., better known as GAAP. After drafting is complete, the company’s outside accounting firm then needs to perform testing on the information to ensure that it meets the new requirements, thereby incurring additional outside costs.
Although additional cost is a major consideration, what makes this effort so absurd is that the “value” received by the company is often not only absent, but sometimes is actually negative. If the purpose of providing information in financial statements is to give the reader/user sufficient information to understand the financial position, results of operations and cash flows of the business, it must be set forth in a manner that allows the reader/user the ability to understand what is being communicated AND, to be able to discern important issues from those that are unimportant. In the pre-Enron period, the rule of thumb was to disclose ONLY those matters that were both relevant and material to basic understanding of the financial statements. Now it is often – in fact usually – the case that a reader/user can’t tell important matters from those that are clearly unimportant, thereby substantially decreasing the usefulness of the statements.
Many make the argument that “more information is better information”. I would like to challenge that argument using the basic concept of information overload. Too much information presented in a manner that mixes irrelevant and unimportant information with information that really means something always confuses and frustrates readers/users.
When I was coaching little league baseball many years ago, we had a very talented, strong and athletic young man on our team named Eddie. Eddie had an overall skill set that most kids would die to have – but he couldn’t hit a ball to save his life. As much instruction and information as I gave him, he still continued to miss the ball completely or dribble it in the infield. It was very frustrating to everyone on the team – and to his coach. I would come home at night and tell my wife about how much potential this kid had and how I was frustrated with his inability to make decent contact with the ball.
My wife was a pretty good softball player, but more importantly, had training in psychology and teaching young kids. She watched Eddie in practice one night and, true to form, he missed almost every ball we had thrown to him. When I asked her after practice what she had seen, she said it was very simple – Eddie was suffering from a serious case of information overload – I was giving him far too much information for him to adequately absorb.
She asked me of all the instructions I had given Eddie on how to hit a baseball, which single piece of information was the most important. As she already knew, the most important was simply to watch the ball – very simple, but mandatory if you want to make contact. She recommended that I get rid of all of the other instructions and simply tell Eddie to watch the ball. The next practice and throughout the remainder of the season, Eddie hit the cover off of the ball because I removed all of the interference in my communication and simply focused on the relevant and material bit of information – just watch the ball.
Financial reporting needs to get back to the basic principle of watching the ball when it comes to preparing financial statements and attendant notes. Those who set standards for financial reporting have taken their eye off the ball – too much information has rendered financial information essentially meaningless to almost all readers/users. The standard-setting bodies need to get back to basics give the readers/users what they need – clear and concise information that is both material and relevant to gaining and understanding of the company’s financial statements.
Mike Alerding is a co-founder and Senior Director of Alerding CPA Group, an Indianapolis-based public accounting firm. Visit our website: www.alerdingcpagroup.com.
This post was written by:
Michael Alerding, CPA
Mike has over 40 years of experience in public accounting. He is a prior columnist for The Indianapolis Business Journal and serves on multiple boards throughout Indianapolis. He currently focuses his time on litigation support, business valuations, succession planning consulting and audit and accounting engagements.
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