debate ii communication within annual reports is not satisfactory christina leung 50181644 wayne yip...

Debate IIDebate II

Communication within annual reports is Communication within annual reports is NOTNOT satisfactory satisfactory

Christina Leung 50181644Christina Leung 50181644

Wayne Yip 50196995Wayne Yip 50196995

Lynn Yan 50095059Lynn Yan 50095059

Communication is …Communication is …

A process by which A process by which informationinformation is exchanged between is exchanged between individuals through a common individuals through a common system of symbols, signs, or system of symbols, signs, or behavior.behavior.

Quality of InformationQuality of Information

Satisfaction in communication Satisfaction in communication depends on satisfaction of depends on satisfaction of information.information.

We divided it into 5 components We divided it into 5 components

The components …The components …

SufficiencySufficiency ReadabilityReadability UnderstandabilityUnderstandability RelevancyRelevancy ReliabilityReliability

It all begin like this…It all begin like this…

Oh~! An annual report, let me take a

look!

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.

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

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.

You uneducated people will not understand the report, give me the report and let

me explain it to you~!

Although I can read and understand it, but it does not provide me with

enough information about the company’s 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.

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.

Thanks for sharing your idea with me guys~! And now we let the presenters

to further discuss the issue.

SufficiencySufficiency

This is always a problem in the This is always a problem in the annual report, since the annual report, since the company want to protect some company want to protect some of its internal information.of its internal information.

Therefore, investor might not Therefore, investor might not have the information they have the information they needed.needed.

Denway Motor Ltd.Denway Motor Ltd.

Denway Motor Ltd.Denway Motor Ltd.

Source of profit is not clearSource of profit is not clear

The figure is such a big amount The figure is such a big amount which we cannot neglectwhich we cannot neglect

Truth and fairness of the Truth and fairness of the financial report might be financial report might be affectedaffected

Enron CaseEnron Case

Information about its Information about its subsidiaries financial position is subsidiaries financial position is not adequate.not adequate.

The seriousness of sufficiency The seriousness of sufficiency problem can lead to bankrupt of problem can lead to bankrupt of a big companya big company

Charts without sufficient detailsCharts without sufficient details

Profit from Countries

China

Japan

USA

UK China

Japan

USA

UK

Charts without sufficient detailsCharts without sufficient details

0

20

40

60

80

100

120

140

Y1 Y2 Y3 Y4

Dividends

Earnings

RecommendationsRecommendations

Disclosure of internal Disclosure of internal information should be increasedinformation should be increased

More disclosures of the More disclosures of the operation of subsidiariesoperation of subsidiaries


Standardize the format for the Standardize the format for the graph usedgraph used

What should be included in each What should be included in each type of graph type of graph

ReadabilityReadability

Annual reports are intended to Annual reports are intended to communicate selected information communicate selected information to a variety of intended audiences. to a variety of intended audiences.

One of the tenets of effective One of the tenets of effective communication is that the communication is that the message received by readers are message received by readers are interpreted in the same way as interpreted in the same way as that intended by the sender---that intended by the sender---readabilityreadability


If the readability level of reports is If the readability level of reports is beyond an intended audience’s beyond an intended audience’s readability level, the probability of readability level, the probability of miscommunication or non-miscommunication or non-communication increases as the communication increases as the gap widens.gap widens.

Overall Analysis of Annual Overall Analysis of Annual Report ReadershipReport Readership

Readership Readership PS PS II II % %% %Very thorough 5 26Very thorough 5 26Thorough 19 60Thorough 19 60Less thorough Less thorough 76 76 14 14 100 100100 100

PS: Private ShareholdersPS: Private Shareholders

II: Institutional InvestorsII: Institutional InvestorsSource: Lee. Tweedie (eds.), Source: Lee. Tweedie (eds.), Shareholder Use and Shareholder Use and

Understanding of Financial InformationUnderstanding of Financial Information, Garland, Garland


Half of the annual reports issued Half of the annual reports issued are “very difficult” to read (i.e. are “very difficult” to read (i.e. require a college education) and require a college education) and the remainder are “difficult” to the remainder are “difficult” to read (i.e. require a high school read (i.e. require a high school education). education).

Studies concluded that annual Studies concluded that annual reports were beyond the reports were beyond the comprehension of the general comprehension of the general population as well as many population as well as many stockholders. stockholders.


Which part of the annual report Which part of the annual report is most difficult to read?is most difficult to read?

The chairman’s statement, The chairman’s statement, auditor’s report, footnotes to the auditor’s report, footnotes to the financial statements, and mgt’s financial statements, and mgt’s discussion and analysis discussion and analysis statement have been graded to statement have been graded to be too difficult to readers.be too difficult to readers.


Which factors should be Which factors should be considered when preparing considered when preparing annual reports for readability annual reports for readability purpose?purpose?

Word length is related to a Word length is related to a reader’s speed of recognition, reader’s speed of recognition, while sentence length is related while sentence length is related to memory span.to memory span.

Measurement of ReadabilityMeasurement of Readability

Reading Ease (Flesch Formula)Reading Ease (Flesch Formula)

=208.835-.846S-1.015W=208.835-.846S-1.015W

S=no. of syllables per 100 wordsS=no. of syllables per 100 words

W=average no. of words per W=average no. of words per sentencesentence

The closer a score is to zero, The closer a score is to zero, the more incomprehensible is the more incomprehensible is the writing.the writing.

Extract from Enron’s Report 2000 of Extract from Enron’s Report 2000 of Independent Public AccountantsIndependent Public Accountants

… … projections of any evaluation of the system of interprojections of any evaluation of the system of internal control to future periods are subject to the risk thnal control to future periods are subject to the risk that the system of internal control may become inadeat the system of internal control may become inadequate because of changes in conditions, or that the quate because of changes in conditions, or that the degree of compliance with the policies or proceduredegree of compliance with the policies or procedures may deteriorate.s may deteriorate.

Our examinations were made in accordance with atOur examinations were made in accordance with attestation standards established by the American Instestation standards established by the American Institute of Certified Public Accountants and, accordingtitute of Certified Public Accountants and, accordingly, included obtaining an understanding of the systely, included obtaining an understanding of the system of internal control, testing and evaluating the desim of internal control, testing and evaluating the design and operating effectiveness of the system of integn and operating effectiveness of the system of internal control and such other procedures as we consirnal control and such other procedures as we considered necessary in the circumstances. dered necessary in the circumstances.

Arthur Andersen LLPArthur Andersen LLP

Extract from Enron’s Report 2000 of InExtract from Enron’s Report 2000 of Independent Public Accountantsdependent Public Accountants

Reading Ease (Flesch Formula)Reading Ease (Flesch Formula)

=208.835-.846S-1.015W=208.835-.846S-1.015W

=208.835-.846*180-1.015*50=208.835-.846*180-1.015*50

=3.805=3.805 The score is very close to zero The score is very close to zero

which indicates that it is very which indicates that it is very difficult to read.difficult to read.


Annual reports have become less Annual reports have become less understandable and readable for the understandable and readable for the unsophisticated private investors.unsophisticated private investors.

It is because of proliferation of It is because of proliferation of regulatory body pronouncements regulatory body pronouncements defining standard formats, terminology, defining standard formats, terminology, and accounting principles.and accounting principles.

In addition, most mgt and the accounting In addition, most mgt and the accounting profession believe that the professional profession believe that the professional investors and financial analysts are the investors and financial analysts are the annual report’s primary audience, thus annual report’s primary audience, thus less care is taken for unsophisticated less care is taken for unsophisticated private investors.private investors.

Recommendations:Recommendations:

Annual reports should be written for Annual reports should be written for the sophisticated investor, but in a the sophisticated investor, but in a style such that average reader can style such that average reader can understand them. How?understand them. How?

Write shorter sentences, simpler Write shorter sentences, simpler words in place of more complex words in place of more complex and longer ones.and longer ones.

Pay attention to layout and format Pay attention to layout and format to enhance reader interest: use of to enhance reader interest: use of personal pronouns and active personal pronouns and active verbs, better definition of technical verbs, better definition of technical terms, and improved use of colorful terms, and improved use of colorful language to emphasize a point…language to emphasize a point…

What aboutWhat aboutgraphical graphical communication?communication?

Increasingly popular presentation Increasingly popular presentation format in annual reports is use of format in annual reports is use of graphs and charts.graphs and charts.

Graphs and charts are supposed Graphs and charts are supposed to communicate complex & large to communicate complex & large amounts of information more amounts of information more clearly & quickly.clearly & quickly.

BUT !^-^BUT !^-^

Graphs & ChartsGraphs & Charts

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

See an example: See an example: Misleading graphsMisleading graphs

0

20

40

60

80

100

120

140

Y1 Y2 Y3 Y4

Dividends

EarningsWhether this area representsEarnings?

Or the whole area representsEarnings?

Why Sometimes Graphs & Why Sometimes Graphs & Charts are Misleading?Charts are Misleading?

Preparer’s ignorance and Preparer’s ignorance and carelessness.carelessness.

Professional accountancy and Professional accountancy and mgt organizations do not offer mgt organizations do not offer any direction regarding the any direction regarding the principles of accurate chart principles of accurate chart graphics construction.graphics construction.


Annual report preparers who use Annual report preparers who use graphs should graphs should consciouslyconsciously avoid avoid construction techniques and construction techniques and mislabeling axes which could mislabeling axes which could impair effective communication.impair effective communication.

Accountancy or mgt organizations Accountancy or mgt organizations should prescribe graphical should prescribe graphical construction techniques as part of a construction techniques as part of a broad annual report disclosure broad annual report disclosure policy.policy.

Information Redundancy Information Redundancy (Advantages)(Advantages) Repetition of an item can Repetition of an item can

enhance the understandability of enhance the understandability of particular messages, help to particular messages, help to avoid missing key information. avoid missing key information.

BUT !^-^BUT !^-^

Information Redundancy Information Redundancy (Disadvantages)(Disadvantages) Redundancy can constitute noisRedundancy can constitute nois

e in the communication process, e in the communication process, contribute to information overloacontribute to information overload, and diversify a reader’s attentid, and diversify a reader’s attention from more important disclosuon from more important disclosures.res.

Information Redundancy Information Redundancy (Disadvantages)(Disadvantages) Information overload may lead users Information overload may lead users

(especially individual investors) (especially individual investors) ignore all information provided ignore all information provided including those relevant and including those relevant and important ones according to important ones according to psychology.psychology.

For example, the book of Accounting For example, the book of Accounting Theory: too much information without Theory: too much information without emphasis.emphasis.

Ignore the whole book Ignore the whole book


Provide existing information Provide existing information (without further irrelevant (without further irrelevant information) in a simplified form information) in a simplified form with emphasis.with emphasis.

Meet users’ respective needs Meet users’ respective needs towards annual report. How?towards annual report. How?

Individual Investor’s, Institutional Investors’, Individual Investor’s, Institutional Investors’, and Financial Analysts’ View on the and Financial Analysts’ View on the

Importance of Annual Report ItemsImportance of Annual Report Items ItemsItems IndividualIndividual

Income statementIncome statement 11

Operation SummaryOperation Summary 22

Balance sheetBalance sheet 33

Funds flow Funds flow statementstatement

44

Product line dataProduct line data 55

Mgt analysisMgt analysis 66

Other footnotesOther footnotes 77

Accounting policiesAccounting policies 88

Auditor’s reportAuditor’s report 99

President’s letterPresident’s letter 1010

InstitutionalInstitutional

11

66

22

33

77

99

44

55

88

1010

FAFA

11

77

22

33

55

88

66

44

99

1010

Study indicates that…Study indicates that…

Income statements, balance sheets Income statements, balance sheets and funds flow statements are rated and funds flow statements are rated as the most useful items for both as the most useful items for both individual and professional investors.individual and professional investors.

Professional investors regard Professional investors regard accounting policies and other accounting policies and other footnotes very important as well, footnotes very important as well, which are rated as not so useful for which are rated as not so useful for individual investors.individual investors.


Preparers can separate annual Preparers can separate annual reports (on the web) into some reports (on the web) into some sections titled “for private investors” sections titled “for private investors” and “for professional investors”.and “for professional investors”.

Preparers can send only private Preparers can send only private sections to private investors and sections to private investors and professional sections to professional professional sections to professional investors. investors.


In the private section, items ranked before In the private section, items ranked before 7 (without Other footnotes, Acc policy, 7 (without Other footnotes, Acc policy, Auditor’s report and President’s letter) Auditor’s report and President’s letter) should be attached.should be attached.

In the professional section, items ranks In the professional section, items ranks before 8 (without Mgt’ analysis, Auditor’s before 8 (without Mgt’ analysis, Auditor’s report and President’s letter) should be report and President’s letter) should be attached.attached.

To avoid information asymmetry, all To avoid information asymmetry, all information is available on the web, thus information is available on the web, thus users can get further information if they users can get further information if they think essential.think essential.

ReliabilityReliability

SufficiencySufficiency ReadabilityReadability

UnderstandabilityUnderstandability RelevanceRelevance

BUT if…….BUT if…….


complied with regulatory complied with regulatory

specificsspecifics

reflects the integrity of reflects the integrity of

management in communicatingmanagement in communicating

objectively & comprehensivelyobjectively & comprehensively


Accurately depict the financial Accurately depict the financial conditioncondition

Free from errorFree from error

Show a true and fair viewShow a true and fair view

its content is subject to an its content is subject to an

independent check, which has independent check, which has

undergone due audit processundergone due audit process


Will the investors rely on the annual reWill the investors rely on the annual report to make investment port to make investment decision???decision???

How can the listed corporations use thHow can the listed corporations use the stock market to seek the financing???e stock market to seek the financing???

The bank will be encouraged to limit crThe bank will be encouraged to limit credit edit the corporation have difficulties the corporation have difficulties to finance its operation to finance its operation slowing an eslowing an economic recovery and dampening a reconomic recovery and dampening a rebound in stock pricesbound in stock prices


In reality……..In reality…….. Information included in annualInformation included in annual

account has undergone due audit account has undergone due audit processprocess the accounts should show the accounts should show a true & fair view a true & fair view this will this will considerably enhance the reliance considerably enhance the reliance people can place on the informationpeople can place on the information


To the Members of Hongkong Land Holdings Limited

We have audited the financial statements on pages 14 to 40. ThWe have audited the financial statements on pages 14 to 40. These financial statements are the responsibility of the Companese financial statements are the responsibility of the Company’s Directors. Our responsibility is to express an opinion on thy’s Directors. Our responsibility is to express an opinion on these financial statements based on our audit.ese financial statements based on our audit.

We conducted our audit in accordance with International StandaWe conducted our audit in accordance with International Standards on Auditing. Those Standards require that we plan and prds on Auditing. Those Standards require that we plan and perform the audit to obtain reasonable assurance about whetherform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. er the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence suppoAn audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. rting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles usAn audit also includes assessing the accounting principles used and significant estimates made by management, as well aed and significant estimates made by management, as well as evaluating the overall financial statement presentation. We s evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opibelieve that our audit provides a reasonable basis for our opinion…….nion…….

PriceWaterhouseCoopersPriceWaterhouseCoopers

London, 26London, 26thth Februrary 2001 Februrary 2001

Report of the AuditorsReport of the Auditors

HOWEVER…HOWEVER…


After After the Enron Casesthe Enron Cases…..….. Its bankruptcy has badly damagIts bankruptcy has badly damag

ed the credibility of the accountied the credibility of the accounting industry in generalng industry in general

Its bankruptcy has had a stronglIts bankruptcy has had a strongly negative impact on the image y negative impact on the image of accounting/auditing firmof accounting/auditing firm


Random sample survey of 100 senior financial executives in ARandom sample survey of 100 senior financial executives in America’s 1000 largest companies was conducted by Schulmamerica’s 1000 largest companies was conducted by Schulman, Ronca, & Bucuvalas, Inc.(SRBI), a financial strategy consuln, Ronca, & Bucuvalas, Inc.(SRBI), a financial strategy consultancy based in New York City.tancy based in New York City.

Reliability of auditingReliability of auditing 27% ~ very confident27% ~ very confident 73% ~ somewhat confident73% ~ somewhat confident

Credibility of auditing & accounting firm Credibility of auditing & accounting firm after Enron bankruptcyafter Enron bankruptcy 83% ~ significant problem83% ~ significant problem 17% ~ somewhat of a problem17% ~ somewhat of a problem


Need for new government Need for new government regulations over accounting regulations over accounting firmsfirms 65% ~ need to better enforce 65% ~ need to better enforce

existing regulationsexisting regulations 25% ~ reject 25% ~ reject 10% ~ need to create new 10% ~ need to create new

government regulationsgovernment regulations


Based on this statistics, we can Based on this statistics, we can conclude that perception of audit conclude that perception of audit integrity is declining integrity is declining

Credibility of auditor report is Credibility of auditor report is damageddamaged

Reliability of annual Reliability of annual report ???report ???


Independent auditingIndependent auditing clear separation of auditing and cclear separation of auditing and c

onsulting functiononsulting function

Government regulation over Government regulation over the accounting/auditingthe accounting/auditing firm firm Government regulatory take respGovernment regulatory take resp

onsibility to evaluate the auditor reonsibility to evaluate the auditor reportport


debate ii communication within annual reports is not satisfactory christina leung 50181644 wayne yip...

Documents

readability slide

garland slide

financial information

satisfaction of information

readability annual reports

selected information

readability problem

financial report