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The changing significance of financial statements.


Financial statement users are turning to other information sources to meet their needs. How should the profession respond?

Financial statement users are turning increasingly to other sources to meet needs which are not being met by the information such statements contain. As more and more other data and analyses become available, the relative importance of financial statements decreases within the context of the total range of available information. Because of the growing disparity between users' needs and what statements provide, CPAs may find their role diminishing since it is related to information that is of declining importance.

The American Institute of CPAs future issues committee has prepared an issues paper on the changing significance of financial statements. The paper has been submitted to the Institute's strategic planning committee, which will use it as input in its planning process. This article describes the future issues committee's findings, the implications for the profession and the options available to CPAs.


A number of factors have contributed to the changing perception of financial statements' relative importance. Key among them is the radical change in the general business environment since the generally accepted accounting principles model was developed.

Today there are both new levels of enterprise risk and uncertainties and unprecedented volatility in the capacity of certain assets to provide economic benefits. For example, when oil drilling rigs and tankers are idled as a consequence of falling oil prices, such fluctuations raise the questions of whether historical cost is the most useful measure of the value of various assets and whether users need additional information on asset measurements. There also has been an increase in the sources of future economic benefits not measured and reported under the current GAAP model.

Companies face tremendous volatility in foreign currency values, commodity prices and interest rates. Meanwhile, the pace of technological development increases the risk that products and production facilities will become obsolete as well as the possibility that competitors will produce more efficiently and cut into a company's market share or profit margins. Complex financial transactions and instruments are more and more common in today's economy. All of these factors have created concern about whether financial statements provide users with sufficient information for decision making.

In addition, the GAAP model does not include many nonmonetary assets. For example, when goodwill is recognized in a business combination, the future economic benefits it encompasses, such as customer base, managerial skills, research capability and future prospects, are not separately measured and reported. And they are not reflected at all in financial statements that do not include goodwill arising from a purchase. But these intangible, unmeasured assets have great importance in an economy increasingly dependent on expertise, data and technology, an economy in which an expanding service sector does not rely on fixed assets as the primary generator of revenue.

As a result of all these factors, users often make investment and lending decisions based in large part on data that are not included in GAAP financial statements and that have not been attested to by an independent outside party. They study companies' public reports, 10-K filings and sections of annual reports other than the financial statements. They search for current-value financial data, financial forecasts and other information contained in companies' business and strategic plans. To acquire this information, they turn to sources other than CPAs, such as investment bankers, financial analysts and the companies themselves. Yet, the raison d'etre for an independent CPA profession is to attest to information useful in making investment and credit decisions.


Just as the economic climate has grown more complex, the population that uses financial statements has changed significantly since the GAAP model was developed. There is now a much larger proportion of sophisticated users, from knowledgeable individuals to fund managers, including professional analysts whose reports are available to less sophisticated users. The active and informed users' awareness of their own needs creates a growing demand for additional, more relevant financial and nonfinancial information.

Rapid advances in information technology hold out new possibilities for providing more relevant financial reports to users. On-line, real-time data collection facilitates the preparation of timely financial reports and other information. Advances in telecommunications allow immediate dissemination of this information to users. These changes put the concept of timely financial reporting in a new perspective and create new opportunities to meet user needs.

Timeliness in financial reporting is one of the characteristics discussed in Financial Accounting Standards Board Concepts Statement no. 2, Qualitative Characteristics of Accounting Information. Other characteristics described in that statement also are affected by the changes in the business environment. Completeness, for example, is affected by the increased need for information on risks and uncertainties. These relationships are not being studied now on a broad scale. The AICPA has made a contribution in this area (see, for example, the Report of the Task Force on Risks and Uncertainties, published in 1987), but no AICPA committee is charged explicitly and exclusively with assessing the effect of rapid economic change on financial reporting or with the linked tasks of determining implications for the profession and formulating appropriate responses.

Similarly, the AICPA does not aggressively introduce its interests into the standard-setting process. Since the FASB's creation, the Institute has been less vocal in the accounting debate because it is no longer the standard setter and because it is only one of several constituencies interested in financial reporting. Ironically, even though the FASB has existed for almost 20 years, much of the general public still believes the profession is fully responsible for GAAP and for perceived shortcomings in the GAAP model.


If these conditions continue without an adequate response, there are likely to be undesirable consequences:

* Independent accountants' contribution to the effective operations of capital and financial markets could drop if the value of financial statements CPAs examine, review or compile continues to decline in relation to other available information and if these statements are not perceived as responsive to users' needs.

* Firms in public practice could face competitive disadvantages if users increasingly rely on others for information not contained in financial reporting. For example, improvements in reporting made possible by technological advances have created opportunities for competitors, including software and database companies. Electronic data processing experts or others could seek the opportunity to attest to the reliability of alternative information sources.

* A growing awareness of the declining importance of financial statements may bring the government into the standard-setting process. This could result in less respect for the CPA certificate and a threat to the AICPA's self-regulatory powers.


Further research into this issue seems essential. The AICPA has already taken steps to fill the need for new kinds of financial information (see RELEVANT AICPA INITIATIVES). Following are some of the other actions the Institute might take:

* Systematically evaluate the changing business climate and its effects on users' needs against the information financial statements provide; explore improvements in financial reporting made possible by telecommunications and EDP, such as the possibility of real-time financial statements disseminated to on-line users.

* Examine alternatives to the current financial statement model; evaluate its role and responsibility in the development of one or more new models; and consider structural changes in its organization to enhance its ability to improve the accounting model.

* Identify sources of competition in meeting users' needs and study what information other than financial statements is being, or could be, provided. This effort would include determining opportunities for new attestation services.

* Develop a policy to more aggressively influence the financial reporting standard-setting process to ensure financial statements are relevant, informative and cost-effective.

* Sponsor a new blue-ribbon commission--similar to the Accounting Objectives Study Group, commonly known as the Trueblood commission--to study relevance in financial reporting.

* Generate dialogue on the issues among practitioners, industry members, firms and academicians and encourage academic research and publications by educators and practitioners.


New demands create challenges for CPAs, but they also offer opportunities to shape the future of financial information. A positive response from the profession could lead to the following results:

* An expansion or reformation of the content of GAAP statements to make them more relevant and understandable. CPAs also might identify and help create new ways to disseminate timely financial information with varying amounts of attestation that would enhance the role of CPAs in the capital and financial markets.

* A narrowing of the expectation gap about CPA responsibilities as the profession identifies and implements accounting principles that keep pace with user needs.

* A better debate on accounting issues if CPAs in public practice and industry play a more active part in discussions on financial reporting.

* Enhanced stature and continued strong economic viability for CPAs.


Here are some actions the Institute has taken to address the changing demands for financial information:

* The auditing standards division's Guide for Prospective Financial Statements covers how they should be prepared, including the assumptions, and how forecasts should be examined.

* The auditing standards division's Statement on Standards for Attestation Engagements, Attestation Standards, provides guidance on the examination of assertions other than those in financial statements.

* The accounting standards division's Report of the Task Force on Risks and Uncertainties, issued in May 1987, contains recommendations on the disclosure of significant risks and uncertainties affecting particular businesses.

* The accounting standards division's Guidance for an Experiment on Reporting Current Value Information for Real Estate, issued in December 1984.

* The Statement on Standards for Attestation Engagements, Reporting on Pro Forma Financial Information, issued in September 1988.

* The expectation gap standards, Statement on Auditing Standards nos. 53 through 61, especially SAS no. 59, The Auditor's Consideration of an Entity's Ability to Continue as a Going Concern.

THOMAS W. RIMERMAN, CPA, is managing partner of Frank, Rimerman & Co., Menlo Park, California. A past chairman of the American Institute of CPAs future issues committee, he is vice-chairman of the AICPA board of directors.
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Article Details
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Author:Rimerman, Thomas W.
Publication:Journal of Accountancy
Date:Apr 1, 1990
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