The narrative reporting debate: everyone is concerned about it, but concerted efforts to initiate better global practices remain challenging.

Non-financial disclosures and other elements of narrative reporting provide important information to stakeholders, and are often key to value creation in growing industries. Despite this, or perhaps because of this, narrative reports are sometimes misleading. Accounting organizations around the globe are addressing this issue in a variety of ways, looking for best practices or legislation that will effectively stem misrepresentation in narrative reporting.

The International Federation of Accountants (IFAC) is taking a keen interest in these international developments and is looking for ways that all of its members can share the information they are collecting on the subject. Armed with that, IFAC hopes to develop an updated series of best practices for improved narrative reporting globally.

Differing perspectives

There is no standard definition of narrative reporting, but it can include the Chairman's statement, the directors' report, the management discussion and analysis (MD & A), remuneration, corporate governance and environmental reports.

The challenge IFAC immediately came up against when it began discussing this idea among 22 representatives of international accounting bodies (including CMA Canada) was the varied nature of everyone's research on the subject.

"Although many organizations are working on the topic of narrative reporting, they are not necessarily working on the same areas or within the same scope," notes William Connell, chairman of IFAC's Professional Accountants in Business (PAIB) Committee. "If you consider enhanced business reporting, the topic is quite broad. If you just consider the U.K.'s Operating and Financial Review (OFR), that's very specific. We didn't want to tackle something that was too broad."

Nor does IFAC want to reinvent the wheel. The American Institute of Certified Public Accountants (AICPA) is currently working on a study of enhanced business reporting--to further advance or change existing business reporting practices, going beyond current best practices in narrative reporting.

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The International Accounting Standards Board (IASB) has also started to look at management commentary issues, and had aimed at releasing a draft report by the end of September, with a plan to finalize the material for public comment by December 2004. At the same time, with the Financial Accounting Standards Board, and the U.K. Accounting Standards Board, it has invited nominations for an International Advisory Group to analyze reporting financial performance/comprehensive income issues. IFAC hopes to encourage, support and comment on the IASB consultations.

The British government has also published its draft regulation for implementing a mandatory Operating and Financial Review (OFR), and has released guidance for directors. This will create another set of international best practices from which to consider a comprehensive examination of narrative reporting.

Here in Canada, the Canadian Institute of Chartered Accountants (CICA) has recently revised its MD & A guidance, and also offers 20 Questions Directors Should Ask About Management's Discussion and Analysis on the Institute's Web site.

Stakeholder needs

The fact that 22 international representatives flew to New York on short notice this summer to discuss this issue suggests how critical it has become. The recent problems at Bennett Environmental, a Canadian company that cleans up contaminated soil, provides an excellent example of how poor reporting can negatively affect shareholders. As reported in The Globe and Mail ("Possible clues to implosion of Bennett were largely ignored," August 5, 2004, by Eric Reguly), in June 2003, the company announced that it had won a $200 million clean-up contract in New Jersey. It knew the deal was faltering as early as August 2003 but did not report that the project had fallen through until July 22, 2004.

This is by no means an isolated case of poor disclosure. It may be an extreme example, but it underlines the importance of reviewing the problem.

The IASB has outlined a number of basic principles of good management commentary. The commentary should:

* provide information on the principal business factors and strategic and operating decision processes at the heart of the outcomes in the financial statements;

* supplement and complement financial statement information by providing management's analysis of the financial position of the company and its performance; and

* include forward-looking information that focuses on generating value for investors.

Connell considers the real challenge, however, is to find out what information investors really want--and whether good information standards will indeed improve reporting practices.

"What we would like to do is to conduct research with investors to create a clear direction for best practices," he says. "We do have a series of selected investor groups that we know about within a number of different geographies with unique cultural voices. For instance, if we compare Japan, the U.K. and the U.S., investor needs are going to be very different in those three countries. The U.S. is generally more volatile than the U.K.--investing styles are different and expectations are different. At the moment, there is an inordinate amount of interest in remuneration in the U.K.. This may be different elsewhere and may also gradually change in the U.K. as well."

IFAC is planning to distribute a series of questionnaires and also conduct a number of face-to-face interviews or focus groups to study the needs and wants of stakeholders, to determine where the gaps are in narrative reporting practice--and whether the gaps can be filled with revamped international best practices.

Connell does believe that there will be certain elements in a report that all investors will want to see and that industry-specific concerns will be determined within industry segments.

The IFAC exploration of this topic is still in its early stages and it's hard to say how well it will fare. It will depend on member organizations and their will to share information and ideas, and the will of the public to embrace the practices that come out of those discussions.

"It comes back to the same basic point--good information is what companies, boards and investors all need," Connell says.

Robert Colman is editor-in-chief of CMA Management.