Markets value companies on the basis of what they expect them to do in the future; accountants currently only have rules for presenting information about the past.
The gap and the opportunity are explored by the English ICA in Prospective financial information: Challenging the assumptions. The paper was prompted by a simple problem. You can’t set standards for auditors reporting on profit forecasts unless directors have clear principles for reporting on the future. The lack of such principles raises more serious issues.
Directors’ success and failure depend in large part on their ability to meet expectations. Yet they have to shape expectations without violating market disclosure rules and without succumbing to the paranoid fear that anything they say might cost them dear. The only tool for correcting expectations is the bludgeon of the profit warning.
The absence of routine dialogue about the future impairs quoted company accountability and performance. Within all organisations, prospective and historical information complement each other. Budgets are set and people report actual performance against them. Yet this model is rarely deployed for the benefit of outside investors.
The faultlines of current practice are clear in the new economy. Companies with long profit records find themselves staring into an abyss.
Start-ups see great losses paving the way to super profits. Meanwhile it is commonplace to question the relevance of financial statements and the reluctance of standard-setters to recognise a wider range of assets.
Yet there is an alternative. Why not talk about what future financial statements might show?
The paper, which can be viewed at www.icaew.co.uk, sets ground rules to promote openness and restrain excess.
Directors should acknowledge their responsibilities, avoid misleading and accept that comparisons will need to be made with outcomes. The paper redraws the distinction between forecasts and projections and lays down conditions for both. Where these conditions are not met, additional forward-looking disclosures are encouraged.
– Arthur Andersen’s Robert Hodgkinson chairs the English ICA’s Financial Reporting Committee
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