11.vol 0003www.iiste.org call for paper no 2 pp 100-116
Issues in Social and Environmental AccountingVol. 3, No. 2 Dec 2009/Jan 2010Pp 100-116Social and Environmental Determinants of Risk and Uncertainties Reporting* Camelia Iuliana LUNGU Chiraţa CARAIANI Cornelia DASCĂLU Gina Raluca GUŞE Accounting, Audit and Controlling Department Academy of Economic Studies of Bucharest RomaniaAbstractRecently, risk reporting has gained interest in financial reporting practice, regulation, and inter-national research. Social and environmental reporting is seen to benefit shareholders more byreducing risk than by increasing return. The researchers showed that the annual report is themost favoured channel of disclosure, along with presentation to investors. The general messageis that, as far as annual reports go, quantified, verifiable disclosures have the most credibilityand relevance. Our paper is meant to develop an analysis of specific requirements regardingrisks and uncertainties reported into the financial statements according to different standards(US-GAAP, IFRS, and European Directives) and their connection to social and environmentalinformation that an entity should disclose. We focus on fundamental research that is related toinductive accounting theory and uses scientific methods for identification of corporate report-ing theoretical and practical difficulties in European and international economic entities.Keywords: Risks and uncertainties, Corporate risk disclosure, Social and environmental re-porting Financial statements, Non-financial risks1. Literature review: Social and envi- on corporate aspects which are notronmental information and risk re- shown in financial statements is steadilyporting growing. Adequate steering indicators and internal reports for social and envi-In the knowledge society we are now ronmental aspects introduced by theliving in, the importance of information management of an entity have stimu-Camelia Iuliana LUNGU, PhD is Associate Professor at Accounting, Audit and Controlling Department, Academy ofEconomic Studies of Bucharest, Romania, email: firstname.lastname@example.org. Chiraţa CARAIANI, PhD and CorneliaDASCĂLU, PhD are Professor of Accounting at Accounting, Audit and Controlling Department, Academy of Eco-nomic Studies of Bucharest, Romania, email: email@example.com & cornelia.dascalu @cig.ase.ro. Gina RalucaGUŞE, PhD is Assistant Professor , Accounting, Audit and Controlling Department, Academy of Economic Studies ofBucharest, Romania, email: firstname.lastname@example.org
101 C.I. Lungu et. al / Issues in Social and Environmental Accounting 2 (2009/2010) 100-116lated external reports to present those to however, can be rarely determined un-the broad public. Villiers and Staden equivocally, and consequently are not(2006) conducted a content analysis of regarded as reliable in principle. Thismore than 140 corporate annual reports conflict between relevance and reliabil-over a nine-year period in order to iden- ity in accounting can never be solvedtify the trends in environmental disclo- due to the uncertainty of the futuresure. There is a consensus that the busi- (Altenburgeret and Schaffhauser-ness reporting model needs to expand to Linzatti, 2007). Current tendencies, es-serve the changing information needs of pecially in the International Financialthe market and provide the information Reporting Standards, emphasize the in-required for enhanced corporate trans- creasing inclusion of present and future-parency and accountability (Lungu et al., oriented information, imposed by risks2008). and uncertainties, in corporate reporting.In our paper, data coming from account- Corporate social and environmental re-ing literature, accounting settlers’ re- ports today represent several decades ofquirements and entities’ experience are incremental change, but the incentivesgathered, analyzed and interpreted in are still different in developed countriesorder to bring to light an underlying co- and in developing countries. While onherence and sense for the new risk re- the surface they appear improved (thereporting perspective. This kind of analy- are more factual data), the managementsis will offer us the opportunities of processes used to craft these reportsdeeply research the concepts, the poli- have changed very little. Some studiescies and the social and environmental conducted in the context of developedindicators, as risks and uncertainties countries (Albuquerque et al., 2007; O’generating factors. It is the stand-point Dwyer, 2002; Solomon and Lewis,in developing corporate reporting re- 2002) argue that incentives should bequirements, based on current reporting encouraged to force companies to dis-standards. closure its information. However, only few papers have discussed this issue inThe main reporting instruments (as bal- the developing world context (Ite, 2004;ance sheet, profit and loss account, notes Pedwell, 2004). According to Solomonetc.) contain reliable data as they report and Lewis (2002), in the Britain context,on the past. This orientation to the past companies consider the recognition ofreduces their forecasting power whereas their social commitment as main causeactual and potential stakeholders need for corporate environmental disclosure.future-oriented data to be able to prepare However, in opinion of some userstheir decisions. Future-oriented data, groups, the corporate responsibility is not considered main cause for reporting, they have the opinion that organizations disclose environmental information only*) This paper is part of a research project Research to improve their image. Both in devel-regarding reassessment of financial reporting in thelight of risks and uncertainties generated by contingent oped and developing countries, issuerssocial and environmental factors, ID 1819, granted on consider their reason as much more al-the base of the national competition conducted by Na- truistic than the opinion of the differenttional University Research Council (CNCSIS) withinRomanian Ministry of Education. users group.
C.I. Lungu et. al / Issues in Social and Environmental Accounting 2 (2009/2010) 100-116 102The lack of information on risks facing corporate crises gave rise to risk report-companies is one of the main weak- ing in non-financial sectors. In generalnesses in the accounting information terms, risk reporting shall allow outsid-disclosed by firms. Current literature ers to assess the risks of an entitys fu-assumes corporate risk reporting to be ture economic performance (Schrandinformative for its users. Nowadays, and Elliott, 1998; Linsley and Shrives,companies are obliged to issue few items 2006).of this kind of information. Linsley andShrives (2006) assert that current analy- In recent times, the demand for disclo-ses of risk are dominated by Beck’s no- sure of most important listed companiestion that a risk society now exists has dramatically increased and the fail-whereby we have become more con- ures of large companies listed on thecerned about our impact upon nature most important stock exchanges havethan the impact of nature upon us. Beck placed extra pressure on them and stan-refers to these risks as manufactured dard setters for the increase in the qual-uncertainties and observes that they can ity of corporate reporting (Beretta andarise out of a desire to reduce risk. Bozzolan, 2004). In answer to this, we witnessed a significant administrativeWorldwide, regulators view narrative reform, in terms of the increasing num-disclosures as the key to achieving the ber of major companies proclaimingdesired step-change in the quality of cor- their social responsibility, and backingporate reporting. Accounting researchers up their claims by producing substantialhave increasingly focused their efforts environmental and social sustainabilityon investigating disclosure and it is now reports (Cooper and Owen, 2007). Stuartrecognised that there is an urgent need to and Owen (2007) critically evaluate thedevelop disclosure metrics to facilitate degree of institutional reform, designedresearch into voluntary disclosure and to empower stakeholders, and therebyquality. This was the main theme in enhance corporate accountability in UKmuch of the early literature on social and quoted companies. Also, a study on Theenvironmental accounting (Bebbington World Bank’s performance in develop-and Thompson 1996; Gray et al., 2001) ing countries argues that the conven-and has been largely responsible for tional accounting framework is not anprompting many companies to publish appropriate tool to guide organized ef-social and environmental reports (Lober fort in balancing the competing-et al., 1997). It is no longer a particular- interdependent needs of multiple stake-ity of the banking and insurance sectors holders (Rahaman et al., 2004), in orderwhich currently reassess the role of risk to be aware of contingent social and en-reporting for market discipline (IAIS, vironmental risks and uncertainties.2002; Dardis, 2002; Helbok and Wag-ner, 2006; Crumpton et al., 2006). Another concern is that companies do not provide sufficient information aboutChanging economic and regulatory envi- risk and risk management (ICAEW,ronments, more complex business struc- 2002). The information as it currentlytures and risk management, increasing stands is too brief, not sufficiently for-reliance on financial instruments and ward looking and not wholly adequateinternational transactions, and prominent for decision-making purposes (Helliar et
103 C.I. Lungu et. al / Issues in Social and Environmental Accounting 2 (2009/2010) 100-116al., 2002; Beretta and Bozzolan, 2004; Ahmed and Courtis, 1999; O’Sullivan,Cabedo and Tirado, 2004). Therefore, 2000; Adams, 2002; Camfferman andaccounting bodies have been motivated Cooke, 2002; Stanton and Stanton,to take greater interest in establishing 2002; Watson et al., 2002). Beattierisks to be reported and to require enti- (2005) surveyed UK financial account-ties to collect and disseminate a greater ing research published over a 10-yearbody of risk information (Sarbanes- period and found that 23% of the entireOxley, 2002; ICAEW, 2002; Linsley and output comprised studies on corporateShrives, 2006). Thomas (1986) explored disclosure. One strand of this literaturethe hypothesis that certain disclosure and on corporate disclosure concerns infor-measurement practices in corporate re- mation on risk. Existing explorationsporting are contingent upon environ- have tended to concentrate on specificmental uncertainty, technology and or- aspects of risk disclosure, and in particu-ganisation size. The findings showed lar the disclosure of market based risk inthat while the disclosure of forecast in- relation to financial instruments (Berettaformation is associated with environ- and Bozzolan, 2004; Linsley andmental homogeneity, certain measure- Shrives, 2006).ment practices are primarily influencedby company size. Apart from the financial sectors, pub- lished research on risk reporting has toRegulators and other industry associa- date been rather limited. Most efforts aretions have recognised the importance of empirical and the conclusions are so dif-considering the industry setting when ferent. Parts of the literature considerdetermining environmental and social risk reporting as largely beneficial forpolicy and reporting requirements. How- disclosing entities, assuming both lowerever, environmental and social impacts cost of capital (ICAEW, 1999; Solomonvary greatly from industry to industry. et al., 2000) and disciplining effects onGuthrie et al. (2007) find that the sample risk management and governancecompanies reported more on industry- (Linsley and Shrives, 2000; Jorion,specific issues than general environ- 2002). While this implies prevalent in-mental and social issues. This finding centives to voluntarily report on risk,also highlights the need for researchers empirical research documents poor vol-examining environmental and social dis- untary risk reporting on average (Berettaclosures to consider incorporating indus- and Bozzolan, 2004; Mohobbot, 2005).try-specific items into their disclosure Given this observation, parts of the lit-instruments. The study also finds that erature also infer that (some) managersthe companies tended to use corporate have limited incentives of disclose pri-websites for their environmental and vate risk information and recommendsocial reporting, indicating the need for extending risk reporting requirementsresearchers to consider alternative media (Carlon et al., 2003; Lajili and Zeghal,(Jackson and Quotes, 2002). 2005). However, empirical studies find large variations and deficits in risk re-According to Abraham and Cox (2007), porting even in the presence of disclo-a significant extent of UK research has sure rules (Rajgopal, 1999; Kajüter andexplored corporate disclosure (Cooke Esser, 2007). What emerges is in lineand Wallace, 1990; Meek et al., 1995; with recent accounting research find-
C.I. Lungu et. al / Issues in Social and Environmental Accounting 2 (2009/2010) 100-116 104ings: Incentives matter even in the pres- their potential impact, but a strong evi-ence of regulation. This is particularly dence consistent with size effect (Berettalikely when considering risk reporting, and Bozzolan, 2004); a large variation,because it is subjective and partly non- particularly in voluntary risk reporting,verifiable, which inherently allows for while risk reporting is mainly qualita-discretion. Yet, there is very little work tive, there are few disclosures on riskon risk reporting incentives and their assessment and few risk forecasts (Lajilirelation to regulation, in general, and and Zeghal, 2005; Mohobbot, 2005);even less going beyond the question of increasing quantity of risk disclosureswhether or not to impose mandatory dis- over time, but non-compliance with ac-closure, in particular. counting requirements. Even some au- thors who have seen themselves as fol-According to Cabedo and Tirado (2004), lowing a management accounting ap-companies are essentially exposed to proach have, in practice, placed consid-two types of risks: nonfinancial risks, erable emphasis on its role in generatingwhich are not directly related to mone- information on environmental and socialtary assets and liabilities, although they contingent factors that impose a risk re-will have an effect on future cash flow porting affecting the decisions of exter-losses (business risk and strategic risk) nal stakeholders. For example, an Israeland financial risks, which do have a di- and Zimiles study (2003) asserts thatrect influence on the loss of value of from 1996 to 2000, 10% of the Fortunemonetary assets and liabilities (market 1000 lost over 25% of its shareholderrisk, credit risk, liquidity risk and opera- value within a one-month period. Manytional and legal risks). Each one of these of these loses can be attributed directlyrisks must be quantified so that financial or indirectly to non-financial issues suchstatements can present information on as social or environmental.their equity, financial and economicsituations together with the business Uncertainty of information endowmentrisks to which they are exposed, thereby and issues of credible communicationproviding potential users with the most can explain restricted risk reporting ob-appropriate information necessary for served empirically. Linking regulatorythe decision making process to go ahead. attempts to these restrictions implies thatThe most recent empirical studies con- regulation may mitigate the incentives-ducted on corporate risk reporting driven restrictions to some extent, but(Dobler, 2008) are based on annual re- can have adverse effects on risk report-ports’ content analysis of a various num- ing (Dobler, 2008). In summary, the ac-ber of listed companies in different counting literature shows a great deal ofcountries (Australia, Italy, Canada, Ja- interest in introducing information onpan, Germany etc.). The main results company risks in financial statements.consist in diverse application of risk re- The incorporation of this kind of infor-porting requirements and large variation mation within the present disclosurein content and level of detail of volun- model will provide users with more real-tary risk reporting (Carlon et al., 2003); istic information, and will facilitate theirvoluntary risk reporting is mainly quali- decisions on which investments to make.tative and there are few disclosures on We consider the recent practical andinterrelations between risk factors and policy developments in the disclosure of
105 C.I. Lungu et. al / Issues in Social and Environmental Accounting 2 (2009/2010) 100-116risk-related information in order to es- sure did not provide users with informa-tablish the current state of the art of cor- tion about the risks to which companiesporate risk disclosure. The incorporation are exposed, and which, may affect theof information on company risks within future profits of the firm. This lack ofthe present financial statements model information had been highlighted bywill provide users with more realistic several accounting institutions. Theinformation, and will facilitate their de- American Institute of Certified Publiccisions on which investments to make. Accountants (AICPA, 1987) Report of the Task Force on Risk and Uncertain- ties recognised that users, faced with the2. The development of risks and un- uncertain environment in which firmscertainties reporting over the years are operating, are demanding informa- tion to help them to evaluate companyCompanies need to assess carefully what risks related to future cash flows andare their principal risks and uncertain- results, and, consequently, to improveties, and report on those, together with their decision-making processes. Laterthe approach to managing and mitigating the Accounting Standards Executivethose risks, rather than simply provide a Committee (AcSEC) of the AICPAlist of all their risks and uncertainties. (1994) prepared a report on the disclo-The disclosure of principal risks and sure of information on risk and uncer-uncertainties is likely to warrant greater tainty in financial statements. The State-attention in near future. The extent and ment of Position 94–6 Disclosure ofspeed of change in market conditions as Certain Significant Risks and Uncertain-a result of the financial crisis affecting ties concluded that firms should disclosebanks and, more recently, other sectors information on risks and uncertainties inof the economy, together with unprece- their financial statements. SOP 94-6 re-dented increases in some commodity quires additional disclosures about theprices means that all companies are fac- nature of their operations. The disclo-ing increased, and possibly different, sures required by SOP 94-6 focus on arisks when compared to prior years. Ex- companys principal markets, includingperience has shown that risk to a com- their locations. Segment information forpany’s business model cannot be disre- business enterprises, in contrast, focusesgarded on the grounds that its materiali- on the nature of the segments operationssation would require a fundamental and their identifiable assets and the geo-change in the market in which a com- graphic location of assets outside thepany operates (FRC, 2008) enterprises home location. Disclosure of the locations of a business entitys prin-As shown, the accounting literature has cipal markets provides information use-pointed out the need to report risk. How- ful in assessing risks and uncertaintiesever, few references deal with the prob- related to the environments in which itlem of how to incorporate information operates. The risks and uncertaintiesabout risk in the present model of disclo- associated with selling products and ser-sure. Furthermore, these references vices in various geographic regions maymainly focus on financial risks. differ significantly. Knowing the envi- ronments in which an entity sells itsTwenty years ago, the scheme of disclo- products or provides services helps users
C.I. Lungu et. al / Issues in Social and Environmental Accounting 2 (2009/2010) 100-116 106of financial reports assess certain risks concern about the need to report riskbased on day-to-day national and world gave rise to a study into the situation ofevents. the disclosure of risks in United King- dom firms. The report “No Surprise: theThe need to inform on risk has also been Case for Better Risk Report-expressed in the United Kingdom. The ing” (ICAEW, 1999) shows that firmsfirst references to this were seen in the disclose most information about theirCadbury Report (1992), which recom- risks through leaflets, whilst the infor-mended that the main risks facing the mation on risks included in the financialcompany be identified, evaluated and statements is less detailed.managed, and that they be made publicas one of the items on the agenda for the The ICAEW (1997) classifies the risksreform of the operative supervision and according to their causal factors, eithercontrol process in UK companies. Sub- internal or external factors. The Institutesequently, the Combined Code (1998) proposes a series of techniques to bemodified the initial requirements set out used when quantifying risks: the analy-by the Cadbury and Greenbury reports sis of ratios, concentration measures,on the governance of corporations, and tendency analysis, benchmarking, sensi-pointed to the need for a review of their tivity analysis and value at risk. How-internal control systems and for the re- ever, the ICAEW does not show howporting of company risks to sharehold- these techniques should be used for eachers. In answer to the Combined Code, of the risks on which firms must report.the Institute of Chartered Accountants in The Companies Act 1985 asks simplyEngland and Wales (ICAEW) published for a description of the principal risksthe Turbull Report (1999) to help com- and uncertainties facing the company.panies apply principles of the Combined This requirement is less than the disclo-Code, which states that “the board sures recommended in the Reportingshould maintain a sound system of inter- Statement, together with an assessmentnal control to safeguard shareholders’ of how companies are reporting theirinvestment and the company’s assets”. risks and uncertainties. The CompanyThis report emphasises the need to dis- Act 2006 made changes to the narrativeclose the risks facing firms (which are a reporting requirements. All companies,part of their internal control system) in other than small, are already required toorder to improve management. This produce a business review. In the caseneed has also been recognised in Canada of quoted companies, the directors willby Boritz (1990). be required – to the extent necessary for an understanding of the business – toThe ICAEW (1997) Financial Reporting report on environmental matters, theof Risk: Proposals for a Statement of company’s employees and social/Business Risk not only reveals the lack community issues.of risk information in financial state-ments, but also formally proposes that The ASB has assessed how companiesrisks should be reported. The ICAEW are reporting as against the ten main ar-proposes the set of risks to be reported eas of the best practice recommenda-on, and a set of techniques that can be tions contained within the ASB’s Re-used for quantifying these risks. The porting Statement on the Operating and
107 C.I. Lungu et. al / Issues in Social and Environmental Accounting 2 (2009/2010) 100-116Financial Review. The 1993 Accounting gether with a commentary on the direc-Standards Board (ASB) Statement on tors’ approach to them. Therefore, thethe Operating and Financial Review annual report should disclose strategic,(OFR) established a voluntary and prin- commercial, operational and financialciple-based framework to guide the re- risks where these may significantly af-porting of business risk, including capi- fect the entity’s strategies and value.tal structure, treasury policy, going con-cern and balance sheet value, taxation, The Reporting Statement (paragraph 28)funds from operating activities and other recommends that ‘to the extent neces-sources of cash, and current liquidity sary’ to meet the overall requirements of(ASB, 1993). Among those, our interests the OFR, the OFR should include infor-were in: principal risks and uncertainties mation about: environmental mattersand in environmental, employee and (including the impact of the business ofsocial issues, and contractual arrange- the entity on the environment); the en-ments/relationships. tity’s employees; social and community issues and persons with whom the entityMost business risk information was not has contractual or other arrangementsbeing disclosed within the annual report, which are essential to the business of thethat some firms had decided to resist entity. Meeting the first three recom-publication of an OFR, some published mendations above are often satisfied byone but presented little information, companies producing corporate respon-whilst others published one and reported sibility sections within the annual report.extensively (ICAEW, 2002; Cabedo and Many companies also produce standTirado, 2004; DTI, 2004). In response, alone Corporate Social Responsibilitythe ASB Statement on the OFR was re- (CSR) reports which are referenced tovised (ASB, 2003), and subsequently from the annual report. The annual re-superseded by Reporting Standard (RS) port should contain for environmental1 ‘The Operating and Financial Review’, matters, the entity’s employees, and so-issued 10 May 2005 (Reporting Stan- cial and community issues the policiesdard 1, 2005), to coincide with the statu- of the entity in each area and the extenttory reporting requirement for quoted to which those policies have been suc-companies to publish an OFR for finan- cessfully implemented.cial years on or after 1 April 2005 (FRC,2006). Regarding the influence of over-seas regulation, from 1 April 2005 the 3. International regulatory aspects ofEuropean Union requires all its listed risk and uncertainties reporting incompanies, except eligible small compa- annual reportsnies, to publish a business review withinwhich there must be a discussion of The accounting profession in Europeprincipal risks and uncertainties (DTI, and internationally (ASB – Accounting2007). Standard Board; FEE – Federation des Experts Europeens; IASB – InternationalThe Reporting Statement (paragraph 52) Accounting Standard Board; ICAEW –recommends that the OFR should in- Institute of Certified Accountants ofclude a description of the principal risks England and Wales) has consideredand uncertainties facing the entity to- these facts and has provided guidance to
C.I. Lungu et. al / Issues in Social and Environmental Accounting 2 (2009/2010) 100-116 108its members, although the prevailing uncertainty of information availabil-consensus seems to be that existing fi- ity;nancial accounting practices, so long as A manager may not report availablethey are properly applied, are adequate risk information either because heto deal with environmental and social cannot credibly do so or chooses toeffects on business and do not require misreport, particularly in connectionchange. These bodies of work can be with forecasts;seen as adopting a ‘financial accounting’ A manager may not report risk infor-approach, with a focus on reporting to mation because he fears creating dis-external stakeholders. In Australia, the advantages for the firm.United States of America, Taiwan, Japanand European Union countries such as Regulators may respond to each of theseFrance, the Netherlands, UK and Den- levels of restrictions. Regulators maymark, incentives and requirements to require adequate corporate risk manage-enlarge the scope of conventional corpo- ment systems to address managerial in-rate financial reporting to include non- formation endowment or impose en-financial information are rapidly unfold- forcement mechanisms to address theing (Bushman et al., 2004; Chua, 2007). credibility of risk reporting. While theseSome actions are motivated by national measures apply to both voluntary andenvironmental and social policy goals, mandatory disclosure, regulators mayothers by investor pressures to obtain a mandate risk reporting. While some dis-clearer picture of corporate performance. cretion is inherent in the nature of riskOne facet of the risk debates relates to reporting, regulation may limit discre-the communication of risk information tion compared to voluntary reporting byby companies to stakeholders. Schrand mandating risk disclosures by type andand Elliott (1998) document American format. Most regimes follow a piece-Accounting Association/Financial Ac- meal approach. They mandate selectedcounting Standards Board (AAA/FASB) risk-related disclosures referring to spe-1997 conference debates that suggested cific categories of risks as opposed toUS companies were providing insuffi- requiring comprehensive risk reportingcient risk information within their an- (Dobler, 2008).nual reports. The Institute of CharteredAccountants in England and Wales Risk reporting requirements of US-(ICAEW) also noted this risk informa- GAAP and IFRSs are roughly compara-tion gap and issued three discussion ble. Particularities concern disclosuresdocuments (1998, 1999 and 2002) en- of risk concentration arising from majorcouraging UK company directors to re- customers (SFAS 131 Disclosures aboutport upon risks in greater depth. Segments of an Enterprise and Related Information), going concern uncertain-The reporting models analyzed by Do- ties (IAS 1 Presentation of Financialbler (2008) imply three major explana- Statements), risks associated with a re-tions for restricted risk reporting ob- structuring, for example, terminationserved empirically: benefits (IAS 19 Employee Benefits and A manager may not report because he SFAS 146 Accounting for Costs Associ- does not or pretends not to hold risk ated with Exit or Disposal Activities) information. This relates to models of and the special clause in IAS 37 Provi-
109 C.I. Lungu et. al / Issues in Social and Environmental Accounting 2 (2009/2010) 100-116sions, Contingent Liabilities, and Con- on contingencies (SFAS 5 Accountingtingent Assets, which allows to omit for Contingencies, SOP 94-6 Disclosuresome disclosures in extremely rare cases of Certain Significant Risks and Uncer-where disclosures can be expected to tainties, IAS 37), financial and marketprejudice seriously the position of the risks and their management (SFAS 133entity in a dispute with other parties. Accounting for Derivative InstrumentsBoth regimes use various notions of risk, and Hedging Activities, IFRS 7 Finan-but do not mandate risk forecasts. Dis- cial Instruments: Disclosures).closures are located in the notes, focus Table 1 US GAAP / IFRS risk reporting requirements Characteristics USA IFRSsRegulatory approach Piecemeal approach Piecemeal approachMajor regulation SFAS 5, 131, 133; SOP 94-6 IAS 1, 37; IFRS 7 SEC Regulations, FRR 48Reporting instruments Notes SEC forms, MDandA Management commentary pro- posedNotion of risk Various, mainly uncertainty- Various, mainly uncertainty- based basedRisk management dis- Mainly concerning use of finan- Mainly concerning use of finan-closures cial instruments cial instrumentsFocus of risk disclo- Financial and market risk, con- Financial and market risk, con-sures tingencies tingenciesDisclosure of risk con- Financial risk, major customers Mainly financial riskcentrations and otherDisclosure of going- Required only by audit stan- Required in notesconcern uncertainties dards (SAS 59)Risk quantification Required for financial risk, for Required for financial risk, for contingencies, where practicable contingencies, where practicableDisclosure of risk fore- Not required, encouraged in Not requiredcasts MDandANegative reports Not required Not requiredSpecial opt-out clause No Yes (IAS 37.92)Source: Dobler, 2008Risk reporting is an emerging reporting and foreign exchange rates, and in stockchallenge in Europe and around the and commodity prices. However, theworld. Thus, the International Account- rules do not refer to any other risks af-ing Standard Board (IASB), under rules fecting firms, such as non-financial risksIAS 32 and 39, and the Financial Ac- and financial risks other than marketcounting Standard Board (FASB), under risks (Cabedo and Tirado, 2004). Evenrule SFAC 133 only establish the com- in the presence of regulation on risk in-pulsory disclosure of market risks aris- formation endowment and enforcement,ing from the use of financial assets. a voluntary risk reporting regime thatLikewise, the SEC (1997) obliges listed relies purely on disclosure incentivescompanies to disclose the market risk tends to yield poor risk reports.arising from adverse changes in interest
C.I. Lungu et. al / Issues in Social and Environmental Accounting 2 (2009/2010) 100-116 110The importance of narrative reporting and to note general precautions for issu-accompanying the financial statements ers when preparing such disclosure.has long been recognised by regulatorsand standard-setters in a number of ma- At a meeting held in October 2002 be-jor jurisdictions, for example tween the International Accounting‘Management Discussion and Analy- Standards Board (IASB) and its partnersis’ (MDandA) in the United States and national standard-setters, it was agreedCanada, ‘Management Reporting’ in that work should begin on a project toGermany, and a ‘Review of Operations examine the potential for the IASB toand Financial Condition’ in Australia. develop standards or guidance for man-There are also EU legal requirements for agement commentary (MC). For manynarrative reporting. The Accounts Mod- entities, management commentary isernisation Directive requires companies already an important element of theirto present an annual report that provides communication with the capital markets,‘at least a fair review of the development supplementing as well as complement-and performance of the company’s busi- ing the financial statements. Manage-ness and of its position, together with a ment commentary encompasses report-description of the principal risks and ing that is described in various jurisdic-uncertainties that it faces’. In addition, tions as management’s discussion andthe Transparency Directive requires – analysis (MDandA), operating and fi-from 20 January 2007 – all securities nancial review (OFR), or management’sissuers to provide annual and half-yearly report.management reports. The annual man-agement report must be in accordance There was general acknowledgementwith the provisions of the Accounts that guidance on this topic was neededModernisation Directive. The half- and that preparers of financial state-yearly management report ‘shall include ments were looking to both the IASBat least an indication of important events and IOSCO (and others) to provide it.that have occurred during the first six The IASB asked the Financial Reportingmonths and their impact on the financial Standards Board (FRSB) of the Institutestatements together with a description of of Chartered Accountants of New Zea-the principal risks and uncertainties for land to provide staff to lead the project,the remaining six months of the financial with further members being provided byyear’. staff of the ASB, the Canadian Institute of Chartered Accountants (CICA) andThe International Organisation of Secu- the Deutsches Rechnungslegungs Stan-rities Commissions (IOSCO) endorsed dards Committee (DRSC). The maindisclosure standards in 1998, one of conclusion of the MC discussion paperwhich established standards applicable is that the IASB can improve the qualityto the narrative information that foreign of financial reports by developing a stan-issuers should provide in documents dard on management commentary. Theused in initial offerings and listings of project team’s proposals for what such aequity securities by foreign issuers. In standard should contain are largely simi-2003, IOSCO published its ‘IOSCO lar to those in the ASB’s ReportingGeneral Principles Regarding MDandA Statement.to explain the purpose behind MDandA
111 C.I. Lungu et. al / Issues in Social and Environmental Accounting 2 (2009/2010) 100-116On 23 June 2009 the International Ac- uncertainties necessary to understandcounting Standards Board (IASB) pub- management’s objectives and strategieslished for public comment a proposed for the entity—both when they consti-non-mandatory framework to help enti- tute a significant external risk to the en-ties prepare and present a narrative re- tity and when the entity’s impact onport, often referred to as management other parties through its activities, prod-commentary. The exposure draft is open ucts or services affects its performance.for comment until 1 March 2010. Delib-erations of issues raised by respondentsis tentatively scheduled to begin in May 4. Conclusion2010. Management commentary is anopportunity for management to outline Certain disclosures required by interna-how an entity’s financial position, finan- tional financial reporting standards maycial performance and cash flows relate to and should contain qualitative and sus-management’s objectives and its strate- tainable information in risks and uncer-gies for achieving those objectives. Us- tainties the entity’s activity is affected.ers of financial reports in their capacity To illustrate, the reduction of wasteas capital providers routinely use the streams leading to lower costs shouldtype of information provided in manage- appear in the form of decreased ex-ment commentary as a tool for evaluat- penses in the financial report, whileing an entity’s prospects and its general revenue from productive use of wasterisks, as well as the success of manage- streams should be included as income.ment’s strategies for achieving its stated Liabilities such as vulnerability toobjectives. changes in environmental regulation or international labour conventions can beDisclosure of an entity’s principal risk captured in the liabilities section of theexposures, its plans and strategies for balance sheet. On a more general level,bearing or mitigating those risks, and the economic, environmental and socialeffectiveness of its risk management trends can appear in the sections of fi-strategies, helps users to evaluate the nancial reports that relate to the discus-entity’s risks as well as its expected out- sion and analysis of future risks and un-comes. It is important that management certainties.distinguish the principal risks and uncer-tainties facing the entity, rather than list- Dobler (2008) confirms that regulationing all possible risks and uncertainties. cannot overcome incentives in risk re-Management should disclose its princi- porting at each level of analysis. If apal strategic, commercial, operational manager does not report because he hasand financial risks, being those that may no risk information or pretends not tosignificantly affect the entity’s strategies have any, requiring a minimum level ofand development of the entity’s value. information endowment through riskThe description of the principal risks management benchmarks the marginsfacing the entity should cover both expo- for discretion, but cannot eliminate themsures to negative consequences and po- even in case of verifiable information.tential opportunities. Management com- For both verified and unverified disclo-mentary provides useful information sure, more precise information held bywhen it discusses the principal risks and the manager does not necessarily imply
C.I. Lungu et. al / Issues in Social and Environmental Accounting 2 (2009/2010) 100-116 112more precise risk reporting. This is ASB (Accounting Standards Board)partly due to both the restrictions to (1993, 2003) “Operating and fi-credible disclosure and the possibility of nancial review”, http://misreporting private risk information www.frc.org.uk/asb/technical/when considering unverified disclosure. principles.cfmThe empirical findings of Solomon et al. Adams, C.A. (2002) “Internal organisa-(2000) indicate that institutional inves- tional factors influencing socialtors do not generally favour a regulated and ethical reporting. Beyond cur-environment for corporate risk disclo- rent theorizing”, Accounting, Au-sure or a general statement of business diting and Accountability Journalrisk. The respondents agree that in- Vol. 15, No. 2, pp.223 - 250.creased risk disclosure would help them Ahmed, K. & Courtis, J. K. (1999)in their portfolio investment decisions. “Association between corporateHowever, for other aspects of the risk characteristics and disclosure lev-disclosure issue they are more neutral in els in annual reports: A metaattitude. analysis”, British Accounting Re- view, Vol. 31, No. 1, pp. 36 – 61.Both the accounting literature and the Albuquerque, P., Bronnenberg, B. &main international accounting organisa- Corbett, C. (2007) “A Spatio-tions recognize the need to complement temporal Analysis of Global Dif-the information currently supplied by fusion of ISO Certification”, Man-companies with reports on the levels of agement Science, Vol. 53, No. 3,risk they assume, in order to serve the pp. 451 - 468.purposes of users in their decision mak- Altenburger, O. & Schaffhauser-ing processes. However, a formal frame- Linzatti, M. (2007) “About scopework has still not been established and focus of notes – a new ap-within which companies can operate proach to highlight intangibles”,when it comes to deciding which risks 30th Annual Congress of Europeanthey should report, how these risks Accounting Association, http://should be quantified and where they www.licom.pt/eaa2007/papers/should be presented. The aim of this pa- EAA2007_1086_final.pdfper is to offer a systematic view of the American Institute of Certified Publicrisks affecting business activity and of Accountants (AICPA) (1987) Re-the requirements that accounting and port of the task force on risks andreporting standards refer to so that busi- uncertainties, New York.ness report risks in financial statements. American Institute of Certified Public Accountants (AICPA) / Account- ing Standards Executive Commit-References tee (1994) Statement of Principle SOP 94-6, Disclosure of RisksAbraham, S. & Cox, P. (2007) and Uncertainties and Financial “Analysing the determinants of Flexibility, New York. narrative risk information in UK Beattie, B. (2005) “Moving the financial FTSE 100 annual reports”, The accounting research front forward: British Accounting Review, Vol. the UK contribution”, The British 39, pp. 227 - 248.
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