Introduction

Writing an article on Financial Reporting is a daunting task mainly because of the jargon and technical terms involved; they are much heard, seen and used.  Readers as well as the writer are likely to feel bored and withdrawn from the topic for straight forward and delicate expressions of the editorial.  Hardly there is any space to put some reader-enticing humors while filling in the account owing to the fact that an essay on such a topic usually revolves around: real life accounting cases; stigmatizing sandals; squabbling about who is to be ultimately blamed for the protection of investors’ money and for any unfortunate financial debacle; and volumes of related books on rigid rules, regulations and abstract principles of the financial reporting regime.  So the article is destined to be an informative literature with some yawn producing prosaic elements, but on the other hand it is a delight both for me and the readers who are avid learners and who take financial reporting business seriously.  Throughout the article I have used the terms and facts from authoritative sources and footnoted the references on relevant pages.  Needless to say, I had been torn between elaborating the article and keeping it to a precise size to attract readers’ attention.  For making it precise some information might be implicit or isolated; I am responsible for any limitations in this piece of writing on Financial Reporting.

Importance of Financial Reporting

It is an old cliché that ‘Financial Reporting’ (FR) provides useful information to a wide rage of users in making their economic decisions.  Nonetheless, the term, FR, is being uttered too often by the people in economic game.  Following the Enrorn, WorldCom, Sunbeam, Parmalat, Global Crossing, Halliburton, Nicor Energy and many other cases of real life corporate accounting scandals[1] which preceded the ongoing global recession[2]—originated in 2007 in the USA partly from a creative accounting and reporting of notorious sub-prime mortgages known as derivatives— and the recent Stock Market Crash in Bangladesh, market regulators and various users of corporate financial information are now clamoring for quality financial reporting after being badly hurt by the devastating effect of the financial disasters.  Bangladesh Stock Market plunge particularly has caused bewildering financial loss and embarrassed people from all walks of life including the government.  Financial reporting is blamed in those instances as there are ostensible claims that the reported financial information could have saved the damage to some extent, though not entirely.  The cited cases are classic examples of Corporate Crime or White-collar Crime[3] which in its own right entails several misdeeds perpetrated by educated people with responsible duties in business organizations.  And at times financial reporting can be instrumental in committing such a crime as we can now vouch from these remarkable scams where FR had been compromised abusing the loopholes of the financial reporting regulations.

Within the Reporting Framework

“Financial Reporting”, that underpins accountability, is a process to provide information about the financial position, financial performance, and cash flows of an entity through a set of general purpose financial statements that is useful to a wide range of users to make a diversity of investment, credit, and other decisions including tax assessment.  Users, the buyer of the information in the reported financial statements, need to know the status of the business as a result of its past performances to expect and predict current or future capacity of the entity.  They at varying degrees hinge upon the information that the concerned organization supplies to allure them.  Therefore, it is of paramount importance that the information be useful and attributive of qualitative characteristics.

Considering the information need in the market and its role in economic activities, the International Accounting Standard Committee (IASC), the predecessor of the International Accounting Standard Board (IASB) of which the Institute of Chartered Accountants of Bangladesh (ICAB) is a member has issued a FRAMEWORK[4] explaining the purpose of a set of general purpose financial statements, and the concepts that underlie the preparation and presentation of financial statements for external users.  With the fundamental assumptions of Accrual Basis and Going Concern on top, these concepts such as:

• understandability
• relevance
• timeliness
• reliability
• prudence
• comparability
• truthfulness
• fairness
• recognition and measurement of: asset, liability, equity, income, and expenses to maintain capital

are to be adhered to while the preparers of the financial statements apply the relevant Bangladesh Financial Reporting Standards/Bangladesh Accounting Standards (BFRS/BAS) and Bangladesh Financial Reporting Interpretations/ Bangladesh Accounting Standards Interpretations (BFRI/BASI)—all of these together form the BFRS[5].

In addition to the Framework and BFRS, the local regulators like the Registrar of Joint Stock Companies and Firms, the Securities and Exchange Commission, NGO Affairs Bureau, Bangladesh Bank etc. can prescribe industry specific formats of presentation of financial statements.  Thus an applicable Financial Reporting Framework emanates from local statute, and international standards.  The range of regulatory activities typically includes setting minimum standards and requirements for corporate reporting, requiring submission of the financial reports to the oversight body for its review, making regular inspections, and investigating and prosecuting misconduct by the corporate entities for breaching and abusing reporting framework.  Therefore, strongly active Financial Reporting Regulations can encourage and compel standardized financial reporting within applicable framework. 

The Pledge of the Framework

“The application of the principal qualitative characteristics and appropriate accounting standards normally results in financial statements that convey what is generally understood as a true and fair view of, or as presenting fairly such information.”

Our practical work life experiences also confirm that companies sincerely applying and using the reporting framework including BFRS can present the true and fair view of their business status and performances.  Despite the abundance of readymade guidelines for appropriate reporting, entities sometimes willingly or unwillingly (due to lack of resources and indifferent attitude to statutory reporting) tend to show an altered scenario of their business results which is discussed next.

Creativity and Motivations

While supplying information to external parties, the reporting entities may create the figures to their best advantage and report them in the financial statements.  This is called creative accounting—the active manipulation of accounting results for the purpose of creating an altered impression of the underlying financial position or performance (contrary to true and fair view) of an enterprise by using accounting rules and guidance in a spirit other than that which was intended when the rules were written.

This is a potential problem for auditors, and the users of the financial statements.  Recent evidence suggests that it is one of the major issues facing financial reporting.  Chapter 4: Topic 6.2 of Audit and Assurance Study Manual[6] 

Certain provisions under some accounting standards allowing managements’, the responsible parties for financial reporting, judgment and estimates pave the way for willful distortion of reported items.  Such creativity normally falls within permitted regulations and is not therefore illegal.  Eg, hedge accounting to reduce or eliminate the volatility in profit or loss associated with hedging activities, which is a part of the management’s financial risk management process.  Management can deliberately fail the conditions to achieve the best advantageous performance result by not choosing to opt for hedge accounting.  Fortunately hedging activities are not yet widely practiced in Bangladesh.

Warranty provision, and Provisions against numerous lawsuits are illustrative examples in our country.  BAS 37 requires the best estimate of future obligations for those activities in the past, but the process can be sometimes complicated; management can get away with making higher or lower provisions whilst prima facie presence of some warranty provision and disclosures of contingent liabilities may be gratifying for us, the external parties.

Revenue is the most frequently hit item for earnings management via creative accounting, so it tops the list of prone items; there are few other legitimate areas as follows:

• inventory valuations (policy may be abused or erroneous policy may be adopted; NRV test may not be done properly due to product’s uniqueness)

• depreciating asset over useful lives (mainly capital intensive companies may grab the opportunity)

• revaluing the non-current assets while impairment test is rarely performed by the management (in this era of fast pace technological advancement, perhaps Land and some intangible assets such as license, permissions are appreciating in value; most of the other long-lived assets are often impaired at any point in time of a period, however, management overlooks the fact!)

• businesses with related parties within group companies

• prevalence of complicated accounting information processing system (those who use integrated operating systems may not be always able to generate specific reports in line with BFRS; they usually export the data and may manipulate the figures in excel sheet)

• capitalization of intangible assets (mainly companies in IT and telecom sector)

• altering the contractual terms to fail revenue test or lease BAS 17 tests

• impairment of accounts receivables (bad debtors can be shown as collectible per management discretion; but aging analysis may reveals long outstanding receivables)

• deferring income and/or expenditures; and adopting alternative costs capitalizing policy (eg Companies Act 1994 allows certain expenses to be capitalized)

• delaying investment or financing decisions

• absence of clear accounting guidelines (for example we have not yet adopted SIC 21- Income Taxes – Recovery of Revalued Non-Depreciable Assets, so revaluation surplus on land is not shown net of capital gain tax; total comprehensive income is inflated).   

• lenient regulators and NOT SO STRONG financial reporting regulations may instigate an indifference to quality reporting

Motivations

Uncapped profit motives of companies coupled with our avarice for material gains trigger the habit of creative accounting; both the owners and the managers can play role—owners to maximize return by reducing tax burden and to avoid it and other revenue or profit sharing requirements eg BTRC shares revenue with telecom operators, companies also have to share profit with workers under labor code and WPPF—managers to earn desired bonuses or target incentives.

SEC listed ie publicly traded companies are the most vulnerable to income smoothing technique for the reputation and sensitivity issues attached to their reported profit/EPS and share value.  Boosting share price can be their topmost priority.

When companies try to attract new investment or seek finances, they may be inspired to show stronger financial health than the actual fitness.  After obtaining required finances, the companies may be conditioned to maintain a certain liquidity or business status, which can put the management and shareholders under duress.

Intellectually challenging interpretations and mere negligence of law can also be causes of altered reporting.  Reporting entities generally form alliances and trade associations to influence regulators to get favorable requirements which also facilitate careless reporting.

Therefore, it is palpable that business entities always have reasons to look for opportunities to provide misleading financial statements for various motivations of different people engaged and involved in the organizations. 

Red flags and Detections

Professional and educated eyes with considerable knowledge on business, industry sector, and respective country regulations can identify the abnormal areas in the financial statements.  Should they engage themselves in ponderous and careful review and analysis of the reports, they can pin-down the bulged and tilted areas after a scrutiny of the following items:

• cash flows- operating cash flows are out of line (when bank statement collection does not tie with receipt from customers, and non-operating, and financing receipts, there are some explanations)
• reportable income differ with taxable income without adequate explanation
• acquired assets under deal or business acquisitions
• journal entry episodes at year end
• unexplained unusual ratios and trends 
• inadequate policy notes and insufficient disclosures in the financial statements
• actual results significantly differ with estimated figures (budget not achieved or overly achieved)
• management reward is target based and incentives linked to profit or other asset based parameters
• audit qualification and change in auditors (rotation of auditors in listed company is explicable)
• complex business structure– mingled together with group head office, possibility of unrecorded and arbitrary transactions with related party(ies)

This part is exciting; it warrants a separate long discourse.  The pointers as above are merely eye-openers.  Once detected, the items should be normalized by adding and/or removing required and/or undeserving amounts and/or disclosures.    

Streamlining Financial Reporting

Since there can be a relationship between weak financial reporting regulations and shoddy financial reporting, strengthening the regulations should be the most important initiative to regulate Bangladeshi entities’ financial reporting practice.

Continuing the earlier discussion on regulations ie the laws and rules that act as a guardian of financial reporting regime to guide and govern statutory reporting by corporate entities it can be safely said that the range of regulatory activities should entail penalizing and punishing defaulter of standard based reporting practice.  ICAB can lead the movement.  State regulatory agencies at times due to their constraints transfer some of their monitoring duties to autonomous bodies like the professional audit firms operating under the license from the ICAB, who is entrusted with the responsibility of adopting and promulgating International Financial Reporting Standards (IFRS) and International Standards on Auditing (ISA) in Bangladesh.  However, local rules prevail over those adopted requirements.

ICAB and BFRS can guard against ill motive behind financial reporting; fear of non-compliance with ICAB guidelines by auditors and BFRS by reporting entities should be enhanced.

Conclusion

Financial reporting is no more a score keeping job, its importance is much felt now.  New roles are evolving for financial accountants in the economy.  Reporting standards are also being updated to keep pace with the changed economy.  Businesses are becoming more global than ever before; the whole world is a connected global village, and we—Bangladesh— are a part of it.  Good news is that Bangladesh is moving forward, albeit the ongoing global economic turmoil, to join the league of the “Middle Income Countries” in tandem with the target to achieve Millennium Development Goal within the shortest possible time.  These targets have been manifested in global forum; investors from both the developed and the developing countries find interest in Bangladesh for its growth potential.  They are calling for globalized standards under the auspices of the development partners—bilateral and multilateral— and international organizations.  In time, if not sooner, the demand for standardized reporting of financial information will be at its peak.

ICAB and its members—in practice and in employment—are vital for the improvement of standard financial reporting practice in Bangladesh.  We should not stop our pursuit of quality until we reach the prestigious stage where people will accept our reports at face value.    

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[1] http://www.forbes.com/2002/07/25/accountingtracker.html

[2] http://en.wikipedia.org/wiki/Financial_crisis_of_2007%E2%80%932008

[3] Sutherland 1949

[4] IASB Framework

[5] http://www.icab.org.bd/index.php?option=com_content&view=article&id=82&Itemid=116

[6] ICAEW- audit and Assurance Study Manual- ACA advanced Stage

http://www.theguardianbd.com/financial-reporting-in-bangladesh/