Many recent reports have expressed concern that financial statements have become too complex, to the detriment of users’ understanding. These reports acknowledge that some of this complexity arises because transactions are becoming increasingly complex. However, they also note other possible causes, including the degree of complexity in IFRSs.
Despite this common concern about complexity in financial statements and the criticism of IFRS as being too complex, neither the existing Conceptual Framework nor the IASB’s discussion paper on the review of the Conceptual Framework include or propose much guidance on the issue.
The Bulletin reflects in detail on the causes of complexity in accounting and suggests that additional guidance in the Conceptual Framework could be of help to minimise complexity.
The Final Report of the Advisory Committee on Improvements to Financial Reporting to the United States Securities and Exchange Commission (August 2008) defines complexity as: “The state of being difficult to understand and apply. Complexity in financial reporting refers primarily to the difficulty for:
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Investors to understand the economic substance of a transaction or event and the overall financial position and results of a company;
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Preparers to properly apply generally accepted accounting principles ... and communicate the economic substance of a transaction or event and the overall financial position and results of a company; and
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Other constituents to audit, analyse, and regulate a company’s financial reporting.”
The report notes that complexity can impede effective communication through financial reporting between a company and its stakeholders and that it also creates inefficiencies in the marketplace (e.g. increased investor, preparer, audit, and regulatory costs) and sub-optimal allocation of capital. Hence it is important to minimise complexity whenever possible.
The report also distinguishes between unavoidable complexity, which arises because business transactions are increasingly sophisticated and difficult to understand, and avoidable complexity, which potentially arises from poor standard-setting, regulation, education and information delivery. Similar themes emerge from other reports.
Despite this widespread concern about complexity in financial statements in general, and the common criticism of IFRS as being too complex, the IASB Conceptual Framework does not currently include much discussion of the issue. It touches on the issue of complexity in its discussions of understandability and as part of the balance to be struck between costs and benefits, as follows.
Understandability is an enhancing qualitative characteristic under the Conceptual Framework, i.e. something that should be maximised to the extent possible. In its discussion of understandability, the Conceptual Framework notes, however, that some phenomena are inherently complex and cannot be made easy to understand. Excluding information about such phenomena might make the financial reports easier to understand but they would be incomplete and hence potentially misleading. Furthermore the Conceptual Framework states that financial reports are prepared for users who have a reasonable knowledge of business and economic activities and who review and analyse the information diligently. And even they may need at times to seek the aid of an adviser to understand information about complex economic phenomena.
The Conceptual Framework also notes that a simpler accounting method may be less costly to apply than a more complex method and may result in information that is essentially the same as, but somewhat less precise than, information produced by a more complex method. In that situation, a balance has to be struck between the cost and the possible loss of information.
Press release
Bulletin on complexity
© EFRAG - European Financial Reporting Advisory Group
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