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Debate II Communication within annual reports is NOT satisfactory Christina Leung 50181644 Wayne Yip 50196995 Lynn Yan 50095059.

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Presentation on theme: "Debate II Communication within annual reports is NOT satisfactory Christina Leung 50181644 Wayne Yip 50196995 Lynn Yan 50095059."— Presentation transcript:

1 Debate II Communication within annual reports is NOT satisfactory Christina Leung 50181644 Wayne Yip 50196995 Lynn Yan 50095059

2 Communication is … A process by which information is exchanged between individuals through a common system of symbols, signs, or behavior. A process by which information is exchanged between individuals through a common system of symbols, signs, or behavior.

3 Quality of Information Satisfaction in communication depends on satisfaction of information. Satisfaction in communication depends on satisfaction of information. We divided it into 5 components We divided it into 5 components

4 The components … Sufficiency Sufficiency Readability Readability Understandability Understandability Relevancy Relevancy Reliability Reliability

5 It all begin like this… Oh~! An annual report, let me take a look!

6

7 Hey Darling, it seems that you have a problem, what can I help? The wordings in the annual report is too complicated and too many technical terms.

8 Well, there is a readability problem in this report. Let me take a look at it too.

9 Well, even though I can read the words, but I still cannot understand the details. For example, the implication of the graphs. Hey, what you are talking about is the understandability problem which occur in many annual reports.

10 You uneducated people will not understand the report, give me the report and let me explain it to you~!

11 Although I can read and understand it, but it does not provide me with enough information about the companys operation. You know, you are right~! Sometimes the annual report will not provide enough information for the investor to make decisions, this is a sufficiency problem.

12 Actually, I also got a problem in mind. I wondering who ensure the information in the annual report is reliable. Besides, I also think the annual report is information overloaded, the relevancy is questionable.

13 Thanks for sharing your idea with me guys~! And now we let the presenters to further discuss the issue.

14 Sufficiency This is always a problem in the annual report, since the company want to protect some of its internal information. This is always a problem in the annual report, since the company want to protect some of its internal information. Therefore, investor might not have the information they needed. Therefore, investor might not have the information they needed.

15 Denway Motor Ltd.

16 Source of profit is not clear Source of profit is not clear The figure is such a big amount which we cannot neglect The figure is such a big amount which we cannot neglect Truth and fairness of the financial report might be affected Truth and fairness of the financial report might be affected

17 Enron Case Information about its subsidiaries financial position is not adequate. Information about its subsidiaries financial position is not adequate. The seriousness of sufficiency problem can lead to bankrupt of a big company The seriousness of sufficiency problem can lead to bankrupt of a big company

18 Charts without sufficient details

19

20 Recommendations Disclosure of internal information should be increased Disclosure of internal information should be increased More disclosures of the operation of subsidiaries More disclosures of the operation of subsidiaries

21 Recommendations Standardize the format for the graph used Standardize the format for the graph used What should be included in each type of graph What should be included in each type of graph

22 Readability Annual reports are intended to communicate selected information to a variety of intended audiences. Annual reports are intended to communicate selected information to a variety of intended audiences. One of the tenets of effective communication is that the message received by readers are interpreted in the same way as that intended by the sender--- readability One of the tenets of effective communication is that the message received by readers are interpreted in the same way as that intended by the sender--- readability

23 Readability If the readability level of reports is beyond an intended audiences readability level, the probability of miscommunication or non- communication increases as the gap widens. If the readability level of reports is beyond an intended audiences readability level, the probability of miscommunication or non- communication increases as the gap widens.

24 Overall Analysis of Annual Report Readership Readership PS II % % % % Very thorough 5 26 Thorough 19 60 Less thorough 76 14 100 100 100 100 PS: Private Shareholders II: Institutional Investors Source: Lee. Tweedie (eds.), Shareholder Use and Understanding of Financial Information, Garland

25 Readability Half of the annual reports issued are very difficult to read (i.e. require a college education) and the remainder are difficult to read (i.e. require a high school education). Half of the annual reports issued are very difficult to read (i.e. require a college education) and the remainder are difficult to read (i.e. require a high school education). Studies concluded that annual reports were beyond the comprehension of the general population as well as many stockholders. Studies concluded that annual reports were beyond the comprehension of the general population as well as many stockholders.

26 Readability Which part of the annual report is most difficult to read? Which part of the annual report is most difficult to read? The chairmans statement, auditors report, footnotes to the financial statements, and mgts discussion and analysis statement have been graded to be too difficult to readers. The chairmans statement, auditors report, footnotes to the financial statements, and mgts discussion and analysis statement have been graded to be too difficult to readers.

27 Readability Which factors should be considered when preparing annual reports for readability purpose? Which factors should be considered when preparing annual reports for readability purpose? Word length is related to a readers speed of recognition, while sentence length is related to memory span. Word length is related to a readers speed of recognition, while sentence length is related to memory span.

28 Measurement of Readability Reading Ease (Flesch Formula) Reading Ease (Flesch Formula)=208.835-.846S-1.015W S=no. of syllables per 100 words W=average no. of words per sentence The closer a score is to zero, the more incomprehensible is the writing. The closer a score is to zero, the more incomprehensible is the writing.

29 Extract from Enrons Report 2000 of Independent Public Accountants … projections of any evaluation of the system of internal control to future periods are subject to the risk that the system of internal control may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Our examinations were made in accordance with attestation standards established by the American Institute of Certified Public Accountants and, accordingly, included obtaining an understanding of the system of internal control, testing and evaluating the design and operating effectiveness of the system of internal control and such other procedures as we considered necessary in the circumstances. Our examinations were made in accordance with attestation standards established by the American Institute of Certified Public Accountants and, accordingly, included obtaining an understanding of the system of internal control, testing and evaluating the design and operating effectiveness of the system of internal control and such other procedures as we considered necessary in the circumstances. Arthur Andersen LLP

30 Extract from Enrons Report 2000 of Independent Public Accountants Reading Ease (Flesch Formula) =208.835-.846S-1.015W=208.835-.846*180-1.015*50=3.805 The score is very close to zero which indicates that it is very difficult to read. The score is very close to zero which indicates that it is very difficult to read.

31 Readability Annual reports have become less understandable and readable for the unsophisticated private investors. Annual reports have become less understandable and readable for the unsophisticated private investors. It is because of proliferation of regulatory body pronouncements defining standard formats, terminology, and accounting principles. It is because of proliferation of regulatory body pronouncements defining standard formats, terminology, and accounting principles. In addition, most mgt and the accounting profession believe that the professional investors and financial analysts are the annual reports primary audience, thus less care is taken for unsophisticated private investors. In addition, most mgt and the accounting profession believe that the professional investors and financial analysts are the annual reports primary audience, thus less care is taken for unsophisticated private investors.

32 Recommendations: Annual reports should be written for the sophisticated investor, but in a style such that average reader can understand them. How? Annual reports should be written for the sophisticated investor, but in a style such that average reader can understand them. How? Write shorter sentences, simpler words in place of more complex and longer ones. Write shorter sentences, simpler words in place of more complex and longer ones. Pay attention to layout and format to enhance reader interest: use of personal pronouns and active verbs, better definition of technical terms, and improved use of colorful language to emphasize a point… Pay attention to layout and format to enhance reader interest: use of personal pronouns and active verbs, better definition of technical terms, and improved use of colorful language to emphasize a point…

33 What about graphical communication? Increasingly popular presentation format in annual reports is use of graphs and charts. Increasingly popular presentation format in annual reports is use of graphs and charts. Graphs and charts are supposed to communicate complex & large amounts of information more clearly & quickly. Graphs and charts are supposed to communicate complex & large amounts of information more clearly & quickly. BUT !^-^ BUT !^-^

34 Graphs & Charts Graphical form provides opportunities for preparers to mislead readers through inappropriate construction techniques and misrepresentation of data. Graphical form provides opportunities for preparers to mislead readers through inappropriate construction techniques and misrepresentation of data.

35 See an example: Misleading graphs Whether this area represents Earnings? Or the whole area represents Earnings?

36 Why Sometimes Graphs & Charts are Misleading? Preparers ignorance and carelessness. Preparers ignorance and carelessness. Professional accountancy and mgt organizations do not offer any direction regarding the principles of accurate chart graphics construction. Professional accountancy and mgt organizations do not offer any direction regarding the principles of accurate chart graphics construction.

37 Recommendations: Annual report preparers who use graphs should consciously avoid construction techniques and mislabeling axes which could impair effective communication. Annual report preparers who use graphs should consciously avoid construction techniques and mislabeling axes which could impair effective communication. Accountancy or mgt organizations should prescribe graphical construction techniques as part of a broad annual report disclosure policy. Accountancy or mgt organizations should prescribe graphical construction techniques as part of a broad annual report disclosure policy.

38 Information Redundancy (Advantages) Information Redundancy (Advantages) Repetition of an item can enhance the understandability of particular messages, help to avoid missing key information. Repetition of an item can enhance the understandability of particular messages, help to avoid missing key information. BUT !^-^ BUT !^-^

39 Information Redundancy (Disadvantages) Information Redundancy (Disadvantages) Redundancy can constitute noise in the communication process, contribute to information overload, and diversify a readers attention from more important disclosures. Redundancy can constitute noise in the communication process, contribute to information overload, and diversify a readers attention from more important disclosures.

40 Information Redundancy (Disadvantages) Information Redundancy (Disadvantages) Information overload may lead users (especially individual investors) ignore all information provided including those relevant and important ones according to psychology. Information overload may lead users (especially individual investors) ignore all information provided including those relevant and important ones according to psychology. For example, the book of Accounting Theory: too much information without emphasis. For example, the book of Accounting Theory: too much information without emphasis. Ignore the whole book Ignore the whole book

41 Recommendations: Provide existing information (without further irrelevant information) in a simplified form with emphasis. Provide existing information (without further irrelevant information) in a simplified form with emphasis. Meet users respective needs towards annual report. How? Meet users respective needs towards annual report. How?

42 Individual Investors, Institutional Investors, and Financial Analysts View on the Importance of Annual Report Items ItemsIndividual Income statement 1 Operation Summary 2 Balance sheet 3 Funds flow statement 4 Product line data 5 Mgt analysis 6 Other footnotes 7 Accounting policies 8 Auditors report 9 Presidents letter 10 Institutional1 6 2 3 7 9 4 5 8 10FA1 7 2 3 5 8 6 4 9 10

43 Study indicates that… Income statements, balance sheets and funds flow statements are rated as the most useful items for both individual and professional investors. Income statements, balance sheets and funds flow statements are rated as the most useful items for both individual and professional investors. Professional investors regard accounting policies and other footnotes very important as well, which are rated as not so useful for individual investors. Professional investors regard accounting policies and other footnotes very important as well, which are rated as not so useful for individual investors.

44 Recommendations: Preparers can separate annual reports (on the web) into some sections titled for private investors and for professional investors. Preparers can separate annual reports (on the web) into some sections titled for private investors and for professional investors. Preparers can send only private sections to private investors and professional sections to professional investors. Preparers can send only private sections to private investors and professional sections to professional investors.

45 Recommendations: In the private section, items ranked before 7 (without Other footnotes, Acc policy, Auditors report and Presidents letter) should be attached. In the private section, items ranked before 7 (without Other footnotes, Acc policy, Auditors report and Presidents letter) should be attached. In the professional section, items ranks before 8 (without Mgt analysis, Auditors report and Presidents letter) should be attached. In the professional section, items ranks before 8 (without Mgt analysis, Auditors report and Presidents letter) should be attached. To avoid information asymmetry, all information is available on the web, thus users can get further information if they think essential. To avoid information asymmetry, all information is available on the web, thus users can get further information if they think essential.

46 Reliability Sufficiency Sufficiency Readability Readability Understandability Understandability Relevance Relevance BUT if…….

47 Reliability complied with regulatory complied with regulatory specifics specifics reflects the integrity of reflects the integrity of management in communicating management in communicating objectively & comprehensively objectively & comprehensively

48 Reliability Accurately depict the financial condition Accurately depict the financial condition Free from error Free from error Show a true and fair view Show a true and fair view

49 its content is subject to an its content is subject to an independent check, which has independent check, which has undergone due audit process undergone due audit process Reliability

50 Will the investors rely on the annual report to make investment decision??? Will the investors rely on the annual report to make investment decision??? How can the listed corporations use the stock market to seek the financing??? How can the listed corporations use the stock market to seek the financing??? The bank will be encouraged to limit credit the corporation have difficulties to finance its operation slowing an economic recovery and dampening a rebound in stock prices The bank will be encouraged to limit credit the corporation have difficulties to finance its operation slowing an economic recovery and dampening a rebound in stock prices Reliability

51 In reality…….. In reality…….. Information included in annual Information included in annual account has undergone due audit process the accounts should show a true & fair view this will considerably enhance the reliance people can place on the information account has undergone due audit process the accounts should show a true & fair view this will considerably enhance the reliance people can place on the information Reliability

52 To the Members of Hongkong Land Holdings Limited We have audited the financial statements on pages 14 to 40. These financial statements are the responsibility of the Companys Directors. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with International Standards on Auditing. Those Standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion……. PriceWaterhouseCoopers London, 26 th Februrary 2001 Report of the Auditors

53 HOWEVER… Reliability

54 After the Enron Cases….. After the Enron Cases….. Its bankruptcy has badly damaged the credibility of the accounting industry in general Its bankruptcy has badly damaged the credibility of the accounting industry in general Its bankruptcy has had a strongly negative impact on the image of accounting/auditing firm Its bankruptcy has had a strongly negative impact on the image of accounting/auditing firm Reliability

55 Random sample survey of 100 senior financial executives in Americas 1000 largest companies was conducted by Schulman, Ronca, & Bucuvalas, Inc.(SRBI), a financial strategy consultancy based in New York City. Random sample survey of 100 senior financial executives in Americas 1000 largest companies was conducted by Schulman, Ronca, & Bucuvalas, Inc.(SRBI), a financial strategy consultancy based in New York City. Reliability of auditing Reliability of auditing 27% ~ very confident 27% ~ very confident 73% ~ somewhat confident 73% ~ somewhat confident Credibility of auditing & accounting firm after Enron bankruptcy Credibility of auditing & accounting firm after Enron bankruptcy 83% ~ significant problem 83% ~ significant problem 17% ~ somewhat of a problem 17% ~ somewhat of a problem Reliability

56 Need for new government regulations over accounting firms Need for new government regulations over accounting firms 65% ~ need to better enforce 65% ~ need to better enforce existing regulations existing regulations 25% ~ reject 25% ~ reject 10% ~ need to create new 10% ~ need to create new government regulations government regulations Reliability

57 Based on this statistics, we can conclude that perception of audit integrity is declining Based on this statistics, we can conclude that perception of audit integrity is declining Credibility of auditor report is damaged Credibility of auditor report is damaged Reliability of annual report ??? Reliability

58 Independent auditing Independent auditing clear separation of auditing and consulting function clear separation of auditing and consulting function Government regulation over the accounting/auditing firm Government regulation over the accounting/auditing firm Government regulatory take responsibility to evaluate the auditor report Government regulatory take responsibility to evaluate the auditor report Recommendations


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