Why every picture tells a story in an annual report

The corporate annual report is a kaleidoscopic mosaic: an ever-changing
composite of disparate elements. Once little more than the carrier of a set of
rudimentary financial accounts, these days it provides more complex and ever
more regulated financial and corporate governance statements.

It also contains an accelerating proportion and sophistication of
discretionary presentational words and pictures. From their beginnings as modest
explanations and embellishments within the annual report, presentational aspects
have, in many cases, virtually supplanted the accounting information in the
financial reporting process.

A recent study, Words, pictures and intangibles in the corporate report,
sponsored by the Institute of Chartered Accountants of Scotland, starts to
address the importance of these presentational issues. The research includes all
UK FTSE 100 companies, all the reporting documents they produced for one
reporting year and a detailed examination of their contents, extending to 20,000
observations.

Intangible assets

The need to effectively communicate ‘intangible assets’ means the
presentational aspects of company reports have never been more important.
Intangible assets could include elements such as a company’s products,
management or brand. It is believed by some financial commentators that when
Procter & Gamble acquired Gillette in 2005 for $56bn (£28.4bn), up to 97% of
the price was for Gillette’s intangible assets.

Traditional accounting does not adequately deal with the recognition,
measurement and disclosure of intangible assets. Research suggests that
companies resort to alternative ways of communicating these assets to investors
through the use of discretionary words and pictures.

While words, and especially pictures, have traditionally been regarded by
accountants as lightweight elements of the annual reporting package, it can be
argued that they are heavyweight ingredients, both in the richness and variety
of their messages, and in their potency.

Visual communication

Research in psychology has shown the importance of ‘framing’, and the special
power of visual communication. The corporate world has not been slow to grasp
this. The communicative power of graphical representations in financial
reporting is well recognised. However, discretionary words and pictures now
occupy much greater space than graphs in annual reports, and are arguably more
powerful communication tools, yet their import has been neglected by the
profession.

Discretionary words and pictures in the annual reporting package are here to
stay. The past few years have also witnessed the increasing use of
presentational material in the annual review document. Introduced in response to
surveys of users’ needs and changes in company law in the UK, an increasing
number of large companies now send this document to shareholders and other
interested parties in place of the annual report. The annual review commonly
devotes only a small part of its content to summary accounting statements and
their graphical representation, amid a much greater proportion of narrative
information, photographs and other creative design material than is usually
included in the annual report.

Most strikingly, pictures constitute on average one-quarter of the annual
review. The rapid increase in regulated disclosures has, paradoxically, resulted
in their migration to a less circulated document produced primarily for filing
purposes. Meanwhile, the discretionary material has gained pre-eminence in the
more widely circulated annual review that has developed beyond the original
notion of summary financial statements. Since research has shown that both lay
and expert readers pay attention to this discretionary material, it is an issue
to which accountants should be sensitive.

Presentation is everything

Companies have recognised the importance of communicating, rather than simply
recording, their activities. Media and corporate communications departments
commonly use websites and presentations in addition to annual reports to
communicate with stakeholders. They are telling a story that goes beyond the
bottom line. Accounting practitioners, regulators and researchers have lagged
behind. They are inclined to side-step presentational issues to focus on the
financial statements. Yet accountants should involve themselves in questions of
communication and its potential for perception engineering.

Intangible assets have also become progressively more important to companies.
Our research shows that there is a systematic link between intangible assets and
presentational material. Companies, particularly those with high intangible
values, are using presentational material to promote the intangible aspects of
their business. It is well accepted that accounting for intangibles is cruder
than for other assets, with the result that they are generally excluded from the
accounts. It is also clear that companies are finding alternative ways of
communicating such information to stakeholders.

At present, auditors vary in the degree of responsibility that they accept
for such material in annual reports: while some report that they have reviewed
the ‘other information’ for inconsistencies, others affirm that their opinion
does not extend to ‘any other information’. Our research has not sought to
examine the objectivity of individual cases, but has demonstrated that specific
and systematic use is being made of the discretionary words and pictures. It
should not be ignored any longer.

Fundamentally, these are all issues of communication. Accountants have
traditionally not been eager to involve themselves in communication matters, but
they should be wary of disassociating themselves from customs which are not a
vogue, but an established trend.

Key recommendations

Discretionary words and pictures should be taken as seriously by policy
makers as graphs;l Accountants’ training should include issues of communication
and presentation,and they should be aware of the ways in which narrative and
visual material can enrich the financial statementsl The reporting documents
should clearly separate and identify discretionary and regulatory material.

For an executive summary of the report go to:
http://www.icas.org.uk/site/cms/contentviewarticle.sp?article=5007

 Jane Davison is a senior lecturer in accounting at Royal Holloway College,
London and is one of the authors of the ICAS report