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Disclosure overload and complexity: hidden in plain sight kpmg.com
2 | Disclosure Overload and Complexity: Hidden in Plain Sight
Contents
Executive summary 2
Introduction 4
Historical financial reporting initiatives 6
Recently adopted disclosure requirements 8
Review of academic and other relevant literature 10
A. Recent academic literature on disclosure complexity 10
B. Other relevant literature 11
Review of reports on Form 10-K 12
A. Observations from review of reports on Form 10-K 12
Survey of FEI members: January–February 2011 16
A. Significant survey results 18
B. Survey results applicable to sources of disclosure overload and complexity 20
C. Survey results applicable to possible solutions to 32
disclosure overload and complexity
D. Results from the Audit Committee Institute Conference 36
Recommendations for reduction of disclosure overload and complexity 38
Appendix A – Comparative volume analysis for 25 selected companies 43
Appendix B – P
ension and other post-retirement benefit plan 45
footnote disclosures
Appendix C – Fair value, derivatives and hedging footnote disclosures 47
Appendix D – Survey for financial executives 49
Bibliography 52
2 | Disclosure Overload and Complexity: Hidden in Plain Sight
Executive summary
“The sheer quantity of financial the last six years and has confirmed double-digit volume growth
in this period.
disclosures has become so excessive
that we’ve diminished the overall value Financial disclosure complexity and overload issues have been
of these disclosures.”1 explored and debated by many individuals, groups and institutions.
Our research into disclosure overload and complexity consisted of
Although this statement could easily be made today, this quotation three major activities:
is from an article that was written by Ray Groves, a former partner
in the firm of Ernst & Young in 1994. In the 17 years since Groves’ 1 Reviewing relevant academic and other literature
article appeared, financial disclosure has expanded significantly.
2 Reviewing annual reports on Form 10-K filed by 25 FORTUNE 100
Financial reporting standards setters, including regulators in their
companies
role as financial reporting standards setters, have issued more
than 200 new documents in the form of Emerging Issues Task 3 Sending a survey to 6,500 financial executives.
Force (EITF) consensuses, accounting standards, Accounting
Standards Updates (ASU), Securities and Exchange Commission Our goal was to obtain empirical evidence about disclosure
(SEC) Staff Accounting Bulletins and Financial Reporting Releases expansion over the last six years, determine some of the sources
as well as interpretive guidance in letters and speeches. Post-1994 of the expansion and consider the qualitative value of disclosure
disclosure standards expansions have included very significant observed in the annual reports. Additionally, we explored the
new requirements such as the SEC’s 1997 rule making requiring question of whether more disclosure is always good or whether
disclosures about derivatives and market risk, the Financial there are factors that limit the value of expanded disclosure.
Accounting Standards Board’s (FASB) Statement No. 132 as
amended addressing Employers’ Disclosures about Pensions An important finding in the academic research indicates that
and Other Postretirement Benefits, FASB’s expanded disclosure disclosure has grown in volume and complexity and that it poses
requirements relative to fair value measurements and numerous a dilemma particularly for smaller investors who may make
SEC staff letters referred to as “Dear CFO Letters” that require suboptimal investment decisions due to the inability to absorb the
various industry and event-specific types of disclosures.2 volume and complexity of literature.3
As financial standards setting is moving toward convergence with The results of the Form 10-K filing review confirm that disclosure
International Financial Reporting Standards (IFRS) and as there has expanded approximately 16 percent overall during the six-year
is expectation that future standards setting will be based more period and footnote disclosure has grown 28 percent over the
heavily on principles with a resultant increase in the need for same period. Footnote disclosure has grown at a faster pace than
disclosure, the consideration of optimal disclosure becomes more overall disclosure and has been particularly acute in the pension
critical. Additionally the SEC’s mandate for detailed XBRL tagging and post-retirement benefits, fair value, financial derivatives and
of information in financial statement footnotes raises another hedging areas.
consideration relative to the cost of each quantitative disclosure;
The survey results from financial executives were consistent with
that is the XBRL mandate magnifies the overall cost of each
our observations in the review of the annual reports. Respondents
incremental disclosure requirement. For purposes of this paper,
indicated that the complexity of financial standards and the volume
the research has examined financial disclosure expansion over
of mandated disclosures are the most significant contributors to
1
Groves, Ray J., “Financial Disclosure: When More Is Not Better,” May 1994. Financial Executive. 3
Miller, Brian P... 2010. The Effects of Reporting Complexity on Small and Large Investor Trading.
2
Securities and Exchange Commission Release 33-7386, Disclosure of Accounting Policies for Working Paper. Indiana University. The Kelley School of Business.
Derivative Financial Instruments and Derivative Commodity Instruments and Disclosure of
Quantitative and Qualitative Information About Market Risk Inherent in Derivative Financial
Instruments, Other Financial Instruments, and Derivative Commodity Instruments, January 31, 1997.
Also referred to as Financial Reporting Release No. 48. See http://www.sec.gov/divisions/corpfin/
cfacctfinrptfrms.shtml.
Disclosure Overload and Complexity: Hidden in Plain Sight | 3
the issue of disclosure overload and complexity, and footnotes are
the most significant source or cause of complexity. Respondents 1 The SEC should issue an interpretive release to address the
identified fair value, derivatives and hedging as a particularly permissibility of cross-referencing and manner of addressing
problematic disclosure area. They also identified concerns about immaterial items to reduce redundant and unnecessary
materiality as contributing to increased disclosure volume. disclosures.
Based on the research results, the authors of this paper present
the eight recommendations to the right to address the disclosure 2 Summaries of significant accounting policies and discussions
of newly implemented or soon to be implemented accounting
complexity and volume challenges.
policies should be streamlined to eliminate unnecessary
Views on disclosure overload and complexity necessarily include redundancy and patently immaterial disclosures.
different perspectives because the views of preparers of financial
information will be different than those of users of information. 3 Preparers should expand their use of tabular and graphic
Data gathered for purposes of this paper included views of information delivery formats.
preparers gathered via a survey sent to members of Financial
Executives International (FEI), which is predominantly a preparer 4 The SEC should move forward with its 21st Century Disclosure
community. If financial information users such as an investor Project to enable greater use of technology to avoid unnecessary
community group had been surveyed, other valuable perspectives repetition of information in multiple filings.
would have been obtained. Since the data collection in this
phase of this project did not solicit user input except through the 5 The FASB should accelerate consideration of the Disclosure
consideration of academic literature and the consideration of the Framework to establish a systemic approach to disclosure that
results of a single polling question posed at the winter 2011 Audit properly balances disclosure considerations.
Committee Institute conferences, this paper is limited in that regard.
An important contributor to disclosure overload and complexity 6 Preparers should confine disclosure of risk factors to company
specific unique risk factors as contemplated by Item 503(c) of
is increased complexity of transactions, investments, financial
Regulation S-K.
instruments, and relationships. This research did not attempt to
identify the extent to which these considerations contributed to
disclosure expansion. Anecdotally, it was observed that some 7 Accounting standards that mandate disclosure in interim
annual reports expanded in years in which there were significant period financial statements should include provisions similar
complexities reported such as acquisitions, restructurings, spin- to that found in Regulation S-X that specifically permits
offs and similar events; however, since such events occurred in a omission of disclosure where there has been no significant
limited number of companies and were present in both the earlier change in the item since the date of the latest annual financial
and later years for which reviews were conducted, the effects statements.
appeared to be neutral as to the annual report review results.
8 The FASB and SEC should undertake incremental procedures
to ensure that there is an appropriate and adequate cost-
benefit analysis in support of all new disclosure requirements.
This should include expanded field testing of disclosure
proposals.
4 | Disclosure Overload and Complexity: Hidden in Plain Sight
Introduction
The topic of disclosure overload and complexity has been The project objective is not intended to be additive but, rather,
addressed by multiple organizations over many years. Some users to develop a framework for improved U.S. Generally Accepted
of financial information seem to have an insatiable appetite for Accounting Principles (GAAP) that promotes meaningful
more information. Others observe that finding the truly significant communication and logical presentation of disclosures and avoids
information among the volume of routine and otherwise unnecessary repetition.
uninformative information is a challenge.
In August 2011 the FASB discussed this Disclosure Framework
While regulatory and standards-setting requirements and other project at two public meetings. At the second of these
factors have resulted in a proliferation of disclosure, some two meetings the FASB discussed the first of three parts of the
observers have noted that even increased disclosure did not Disclosure Framework project. That first part included discussion
adequately provide investors with the information needed in the of a draft of a decision process that would be used in establishing
recent financial crisis. In an April 2011 press release announcing the financial statement disclosure items. The FASB Web site
publication of Cutting Clutter: Combating Clutter in Annual Reports, description of the process states:
the Accounting Standards Board of the U.K.’s Financial Reporting
Council observed, “Clutter in annual reports is a problem, The goal of the decision process is to improve the efficiency and
obscuring relevant information and making it harder for users to effectiveness of financial statement disclosures by focusing on
find the salient points about the performance of the business and matters that are most important to users of a particular entity’s
its prospects for long-term success.”4 One author has suggested financial statements. The desired result is a net reduction
that the Enron issues were obscured by disclosures that were in disclosure volume and a net increase in the utility of the
buried in footnotes.5 information disclosed.
Our paper’s objective is to examine relevant data to determine The FASB’s technical project plan indicates that the anticipated
the sources of disclosure overload and complexity and to next step is the issuance of an initial due process discussion
identify opportunities and provide recommendations for practical document in early 2012.
improvements. In addition to the U.K. projects that propose better
In 2008 the SEC announced a project dubbed the 21st Century
and more efficient financial reporting, other initiatives to improve
Disclosure Initiative.7 There does not appear to be any recent
disclosure are under consideration.
activity on this project at the SEC as it is not included on the
In July 2009 the FASB added a specific project to its overall project SEC Web site in the Topics of Current Interest. However, SEC staff
plan with the objective to:6 members have commented in recent months about their continuing
interest in developing approaches to advance the transparency and
(1) Establish an overarching framework intended to make financial understandability of financial and other disclosures.
statement disclosures more effective and coordinated and (2)
seek ways to better integrate information provided in financial
statements, Management Discussion & Analysis (MD&A), and
other parts of a reporting entity’s financial reporting package.
4
Financial Reporting Council. “Cutting Clutter: Combating Clutter in Annual Reports,” April 2011, 7
The 21st Century Disclosure Initiative, established in June 2008, is a broad internal effort to
available at www.frc.org.uk. reconsider the manner of delivery of financial disclosure. In January 2009, a report was issued
5
Radin, Arthur J., “Have We Created Financial Statement Disclosure Overload?” The CPA Journal. describing disclosure system and recommended future Commission action for a transition to
November 2007. the new system. The proposed new system that would use technology to collect, manage and
6
Financial Accounting Standards Board. Current Technical Plan and Project Updates. www.fasb.org. provide disclosure information structured in a manner that builds on a basic disclosure model with
periodic amendment to the basic disclosure.
6 | Disclosure Overload and Complexity: Hidden in Plain Sight
Historical financial reporting initiatives
The Wheat Commission chaired by Francis Wheat, a former SEC the Jenkins Committee. That committee’s report, “Improving
Commissioner, issued its report in 1971. The Wheat Commission Business Reporting – A Customer Focus,” was issued in 1994 and
was established to consider financial accounting standards took a broad view of its mission. Rather than being limited to an
setting in the U.S. The Commission report recommended the examination of the content of financial statements, the Jenkins
establishment of an independent accounting standards setter Committee looked at the topic of business reporting generally.
whose members had severed other ties with the financial reporting The Jenkins report advocates using a mandatory reporting
and accounting communities. That standards setter, the FASB, framework for business reporting to:
was established in 1973 and was recognized by the SEC as the
authoritative accounting standards-setting organization in the U.S. 1. Promote a common understanding of terms and alternatives
The Wheat Report recommended the establishment of the FASB that facilitate negotiations between users and companies
as an independent standards setter and initiated the concept that about the content of business reporting.
accounting standards setting should be an independent process
2. Promote neutral, unbiased reporting.
that is not tainted by political considerations.
3. Improve the comparability of information across companies.
In 1971, the American Institute of CPAs (AICPA) established the
Accounting Objectives Study Group chaired by Robert 4. Permit audits of information. Auditors verify that information
Trueblood, who was chairman of Touche Ross & Co. The is reported in accordance with standards; without standards,
Trueblood Commission Report was issued in 1973. The introduction audits would be less meaningful.
to the report indicates that:
5. Facilitate retrievability of information by organizing data
The main purpose of the study is to refine the objectives of according to a framework.
financial statements. Refined objectives should facilitate
establishment of guidelines and criteria for improving Of particular relevance to this paper the Jenkins report states:
accounting and financial reporting.
The Committee acknowledges that reporting standards could
The study solicited the views from diverse participants in the inflict costs on some companies without resulting benefit.
financial reporting environment, including preparers, members of That could occur, for example, if a company was required to
accounting firms, public interest groups, national and international report information that users do not need. However, reporting
accounting organizations and financial publishers. The study group standards need not eliminate flexibility in reporting, nor
held 35 public meetings and reviewed relevant published literature. increase costs without benefit. The solution is not to do
away with reporting standards but rather, to design
Not surprisingly, the first objective of financial reporting identified standards flexible enough to be responsive to the costs
was that financial information should provide useful information and benefits companies face in particular circumstances.
for making economic decisions. The report identified a number (emphasis added)
of necessary or desirable financial reporting characteristics such
as reliability and freedom from bias and consistency, but did not
address the topic of disclosure as a specific consideration.
In 1991, the AICPA established the Special Committee on Financial
Reporting chaired by Edmund Jenkins, a partner with Arthur
Andersen, from whom the committee derived its popular name,
Disclosure Overload and Complexity: Hidden in Plain Sight | 7
Throughout the last two decades, additional projects, reports, As noted previously, there are multiple projects, reports, and
studies, and papers have focused on the challenge of optimal recommendations concerning financial and business reporting,
business and financial reporting including disclosure complexity including the Enhanced Business Reporting Consortium’s ongoing
and overload. projects, documents issued by accounting firms and business
organizations as well as initiatives by the FASB, SEC and U.K.
In the late 1990s the FASB launched its Business Reporting Research Financial Reporting Council discussed in the introduction to this
Project that resulted in the issuance of its report in January 2000. paper.9 Notwithstanding the quantity and quality of resources
That project explored the effects that the expanding Internet had devoted to the goal of disclosure rationalization, the debate about
on dissemination and retrieval of financial and other business disclosure overload and complexity persists.
information. The report indicates, “The basic premise underlying this
Business Reporting Research Project is that improving disclosures
makes the capital allocation process more efficient and reduces the
average cost of capital.”8 8
Financial Accounting Standards Board, Business Reporting Research Project. 2000 Part II, page v.
See www.fasb.org.
9
The Enhanced Business Reporting Consortium defines itself on its Web site as “The Enhanced
Business Reporting Consortium (EBRC) is a collaborative, market-driven initiative that provides an
opportunity for users and providers of capital to work together for the public interest to improve
the quality of information provided to capital markets.” See http://www.aicpa.org/interestareas/frc/
accountingfinancialreporting/enhancedbusinessreporting/pages/enhancedbusinessreporting.aspx.
8 | Disclosure Overload and Complexity: Hidden in Plain Sight
Recently adopted disclosure requirements
Financial statement disclosure requirements are found Date of Adoption Topic
in the FASB’s Accounting Standards Codification (ASC),
AICPA Accounting and Audit Guides and, for public companies, June 2006 Accounting for Uncertain Tax Positions
additional disclosures requirements are found in SEC regulations. September 2006 Fair Value Measurements
The SEC’s rules and regulations specify disclosure requirements
December 2006 Executive Compensation for Stock and
both within and outside of financial statements. One of the
Option Awards (SEC requirement)
most frequently discussed disclosures outside of the financial
statements is the requirement in Regulation S-K, Item 303 that February 2007 Fair Value Option
specifies the disclosure requirements for MD&A. December 2007 Accounting for Business Combinations and
Non-Controlling Interests
Disclosures that are provided in response to mandatory
March 2008 Disclosures about Derivative Instruments and
requirements are supplemented with expanded disclosures both
Hedging Activities
inside and outside of the financial statements for various purposes
including incremental information about the entity, its environment, May 2008 Accounting for Certain Convertible Debt That
forward-looking information and, in many cases, extensive details May Be Settled in Cash
about current and potential litigation. September 2008 Disclosures about Credit Derivatives and
Certain Guarantees
The plethora of financial statement requirements presents a December 2008 Disclosures about Transfers of Financial
challenge to the financial statement preparer to identify all of Assets and Involvement With VIEs
the disclosure requirements and to apply all of the necessary
January 2009 Disclosures about Postretirement Benefit
resources to draft those disclosures. The ASC includes disclosure
Plan Assets
requirements under Subsection 50 of each accounting topic and
this has facilitated the identification of the disclosure requirements. June 2009 Transfers of Financial Assets and Variable
However, new disclosure requirements have been added over the Interest Entities
last several years at an unprecedented pace. Some of the more January 2010 Fair Value Measurements and Disclosures
significant disclosure requirements adopted in the last five years July 2010 Credit Quality and Allowance for Credit Losses
include those related to the FASB standards and SEC rule-making
activities at the right.Disclosure Overload and Complexity: Hidden in Plain Sight | 9
A sense of the extent of current disclosure requirements can about the Credit Quality of Financing Receivables and the Allowance
be gleaned from looking at any of the auditing firms’ standard for Credit Losses. Although this new accounting requirement is
disclosure checklists. These checklists illustrate the challenge of addressed primarily to disclosures about credit quality of financial
identifying the extensive range of disclosure requirements. These receivables and the allowance for credit losses, the standard
checklists are typically several hundred pages long and may be reaches into interim reporting generally because FASB ASC Section
supplemented with additional checklists for certain industries such 270-10-50 specifies a list of approximately 30 discrete pieces of
as financial services (including banks and insurance companies) financial information that must be reported by public and private
and oil and gas exploration, development and production companies that regularly report quarterly information. The research
companies. for this paper did not include specific observation and comparison
of interim reports, but the increase in interim disclosure has
Contributing to the expansion of disclosure requirements is been reported and observed anecdotally and is confirmed by the
the inclination to resolve difficult account issues by expanding observation of new interim disclosure requirements.
disclosure requirements and the tendency to frequently require
disclosures in the interim, as well as in annual periods. We note Some observers assert that more public disclosure enables
that the issuance of disclosure requirements contained in FASB more informed investor decision making and thus
Statement 132 as originally issued in 1997 and as revised in late all new disclosure requirements can be supported.
2003 related to pension and other post-retirement benefits is Therefore, expanded and more frequent disclosure is always
seen by some as the solution to the inability to timely address the considered an improvement. The fact that there should be some
further issues in accounting for pensions and other post-retirement limit to disclosure requirements was noted in the Jenkins report
obligations.10 As indicated in Appendix B our research determined cited. Substantially all rule-making and standards-setting bodies
that there has been approximately 50 percent growth in the are subject to requirements to consider costs and benefits of
volume of footnote disclosures related to pensions and other post- new rules, in recognition that unlimited disclosure cannot be
retirement benefits over the six-year period.11 provided without cost. Some academic literature concludes that
excessive disclosure may actually lead to suboptimal decision
It appears that FASB may also be pursuing the disclosure route as making by at least some investors as discussed in the report.
an alternative to the issue of balance sheet offsetting. On August 10,
2011 the FASB voted to proceed with a “disclosure requirements
only” document after failing to reach an agreement with the
International Accounting Standards Board (IASB) on a common
approach to accounting for balance sheet offsetting.12
The expansion of disclosure requirements applicable to interim
periods is evidenced in the extensive disclosures about fair value
measurements required by FASB ASC Section 820-10-50 that was
originally issued as FASB Statement No. 157 in September 2006
and was effective beginning in periods after 2007. The significant
expansion of interim period disclosure requirements was recently
repeated in July 2010 with the issuance of ASU 2010-20 Disclosures
10
FASB Statement No. 132, Employers’ Disclosures about Pensions and Other Postretirement Benefits, available at www.fasb.org.
11
This research has used page volume as a proxy for volume. The researchers observed and recorded page counts for total size of
reports on Form 10-K, MD&A total footnotes and specific footnotes. Hence the conclusion that disclosures pertaining to pensions
and other post-retirement benefits have increased approximately 50 percent over the period from 2004 to 2010 is based on the
observation that the number of pages of footnote disclosure has increased by 50 percent.
12
BNA Accounting Policy and Practice Report, “FASB Drafting Final Disclosure Requirements for Balance Sheet Offsetting,” August 19, 2011.10 | Disclosure Overload and Complexity: Hidden in Plain Sight
Review of academic and other
relevant literature
The research team identified academic reports and other • Longer annual reports are associated with reduced consensus
publications that discuss the topic of disclosure overload and and short-term trading profits for small investors in comparison
complexity within financial reporting and how it affects both the to larger investors. Smaller investors reduce their trading when
users and preparers. The research team conducted a search of filings increase in length.
articles, reports and papers published by academic institutions,
industry analysts and accounting and economic organizations • Although the MD&A was established to facilitate the forecasting
published from 2005 to July 2010 as well as identifying other task of investors, MD&A lacks a definitive requirement for a
selected relevant literature from earlier periods. strategic analysis of a company.
A. Recent academic literature on disclosure complexity The issue also arises that disclosure complexity affects the
The research indicates that disclosure complexity affects both preparers of the financial reports. Some of the key findings in the
users and preparers. It is apparent to investors that annual reports research for this group are:
filed by U.S. companies are increasingly complex. From the point
• Many preparers of financial statements find the requirements
of view of the user group, many issues arise from the quality of the
for reporting financial instruments too complex. The International
disclosure to the readability issue when trying to comprehend the
Accounting Standards Board (IASB) and the FASB have been
information in the financial reports. Many believe that complexity
urged by many to develop new standards of financial reporting
in financial reporting confuses investors and therefore they cannot
for financial instruments that are more principle-based and less
make optimal decisions. Many questions arise when studying this
complex than today’s requirements.
topic such as why regulators should be concerned with reporting
clarity. Some of the key findings from the user group include:
• The Chartered Institute of Management Accountants (CIMA)
• It is becoming a concern that the proliferations of required research, based on a global International Federation of
disclosures that accompany financial reports make it difficult Accountants (IFAC) study into the financial reporting supply
to decipher a company’s performance and factors that drive chain, concluded that preparers of accounts are struggling
performance. to communicate the true drivers of their business through
regulated financial reports.
• Investors are concerned with longer and more opaque
annual reports. • Preparers are also concerned about the amount and speed of
changes in regulations governing financial reporting. Changes
• One study examined the determinants of FASB Interpretation emerge from local regulators, legislation, international standards
No. 48 disclosure qualities among S&P 1500 firms and predicted setters and even market practice.
that firms with the highest proprietary costs of disclosure use
discretion to limit the information contained in the disclosure.13 • While there is some support for recent improvement in
accounting for impairments, there is also frustration that
• More complex (longer and less readable) filings are associated some standards seem inconsistent, which makes it harder
with lower overall trading. The study found that the association for preparers to see financial reports as a fair reflection of the
between report complexity and lower abnormal trading is driven business in question.
by both cross-sectional variation in firms’ disclosure attributes
and variation in disclosure complexity over time. • Some preparers feel that many of the disclosures are either
unnecessary for their businesses or create confusion around
the total remuneration for executives when they use complex
reward mechanisms.
13
FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, available at www.fasb.org. • Accounting professionals need to readdress the concept of
materiality and also need sunset provisions on disclosures.Disclosure Overload and Complexity: Hidden in Plain Sight | 11
B. Other relevant literature impairment will be finalized before any final document on the
Disclosure Framework will be completed.
In addition to the academic papers that address disclosure overload
and complexity, other recent commentators on financial reporting IFAC established a working group in 2007 to determine whether
complexity include the SEC’s Advisory Committee on Improvements financial reporting in recent years is more relevant, reliable and
to Financial Reporting (CIFR), the FASB, and the IFAC. understandable.15 The study group issued its report in 2008
entitled, Financial Reporting Supply Chain: Current Perspectives
CIFR issued its report in August 2008 and notable among its
and Directions. In the section that addressed the usefulness of
recommendations were those that addressed disclosure.
financial reports, areas of concern that were identified included
Recommendation 1.2 inferred disclosure challenges in that the
reduced usefulness due to complexity, regulatory disclosure
report included a recommendation that:
overload and difficult and frequently changing financial reporting
The SEC and the FASB should work together to develop a standards.
disclosure framework to...integrate existing SEC and FASB
In 2003, current SEC Commissioner Troy A. Paredes wrote an
disclosure requirements into a cohesive whole to ensure
article specifically addressing information overload.16 In his article
meaningful communication and logical presentation of
he observes:
disclosures, based on consistent objectives and principles.
This would eliminate redundancies and provide a single source To the extent that investors, analysts, and other securities
of disclosure guidance across all reporting standards. market participants are subject to information overload,
the model of mandatory disclosure that says more is better than
Shortly after the issuance of the CIFR report, the FASB added
less is incomplete and may be counterproductive.
a project to its agenda identified as the Disclosure Framework
project. At the time the project on the Disclosure Framework
was added to the FASB agenda, the FASB chairman acknowledged
disclosure complexity in his quote in the financial press saying
“improving the way (such) disclosures are integrated can help
decrease complexity.”14 Unfortunately the FASB Disclosure
Framework project has been delayed due to the many other
projects on the FASB agenda particularly those related to
convergence with IFRS. Because the convergence standards
include significant disclosure components, the result of the
prioritization is that many significant disclosures will be debated
and adopted before the framework for the disclosures has been
formulated.
A positive note in this regard is that in August 2011, the FASB held
public meetings to discuss the Disclosure Framework project
and has indicated its intention to publish an initial due process
discussion document in early 2012. Less positive is the plan and
likelihood that major standards-setting projects including the
project on financial instruments classification, measurement and
14
FASB Fights Disclosure Overload. July 10, 2009. WEBCPA. See http://www.accountingtoday.com/
news/FASB-Fights-Disclosure-Overload-51022-1.html.
15
See http://www.ifac.org/frsc/.
16
Paredes, Troy A. Blinded by the Light: Information Overload and Its Consequences for Securities
Regulation. Washington University Law Quarterly. Summer 2003. Pp 417–485.12 | Disclosure Overload and Complexity: Hidden in Plain Sight
Review of reports on Form 10-K
The research team examined the quantity and quality of financial Putting aside the proxy disclosure component, which admittedly
reporting and other disclosure complexity and volume by reviewing ignores a very significant consideration, there is no question that
the annual reports of 25 FORTUNE 100 companies with two financial statement footnote disclosure has grown at a faster pace
companies from each of 12 industries. The 25th company selected than other disclosure requirements.
for review was Berkshire Hathaway, which was selected solely for
the contrasting view of a multi-industry company. A. Observations from review of reports on Form 10-K
This section discusses the reviewers’ observations in terms of
The reviews consisted of reading and compiling data from each redundancy, immaterial disclosures and volume expansion due to
of the 25 companies’ annual reports for their fiscal years ending new requirements.
in 2004, 2009 and 2010. The 2004 and 2009 data were included to
provide a basis for five-year trend analysis while the 2010 reports Substantially all companies had some level of cut-and-paste
were reviewed to assess the impact of very recent specific redundancy throughout the Form 10-K. It appears that SEC
standards changes. Appendix A presents a chart that identifies guidance to provide disclosure of critical accounting policies has
the companies and data about the numbers of pages contained in led to repeating a large part of the significant accounting policy
Parts I, II, and III of the Form 10-K as well as the number of pages footnote in MD&A.
of footnotes.17 Appendix A also indicates the relative increase
or decrease in number of pages over the periods. The following Disclosures that address aspects of the business description
table summarizes data included in Appendix A and indicates the are repeated throughout most documents. Business description
mean and median change in volume of Form 10-K and footnote appears in the introduction to each document as required by
disclosures observed from the data on the 25 companies. Item #1 of Regulation S-K. Parts of it are then repeated in MD&A
and footnotes including segment footnote and risk factors.
For example, the Berkshire Hathaway Form 10-K business
Table 1 2010/2009 2010/2004 description posed an interesting question in terms of disclosure
Mean volume of Form 10-K (pages) +3% +16% redundancy. The Form 10-K for the fiscal year ended December 31,
2010 begins with the Regulation S-K Item 1 required disclosure
Mean volume of footnote disclosure
+6% +28% of the business description. Noting that Berkshire Hathaway is a
(pages)
very complex company with diverse business activities including
Median volume of Form 10-K (pages) 0 +17% insurance, railroad operations, manufacturing, service, public
utility and retail operations, the initial business description is
Median volume of footnote disclosures
+4% +24% presented in 18 very detailed pages. The MD&A, which is a 30-
(pages)
page presentation, repeats a significant amount of the information
that is included in the business description albeit in the context
Table 1 indicates that the relative volume of footnote disclosure of the operations and financial position. A short, one-page further
has grown at a faster rate than overall disclosure for the six-year description of the business is provided as the introduction to
period as well as year-over-year between 2009 and 2010. Analysis the financial statement footnote on segments. From a review
of Appendix A demonstrates, somewhat surprisingly, that overall perspective an argument could be made that the repetition of
Form 10-K disclosure may have stabilized or declined somewhat the description of the various business activities is beneficial to
for some companies in the past year and six years although the understanding of the complexity of the company. From the
undoubtedly, if proxy disclosure were added to the total mix, that perspective of volume and redundancy it is conceivable that some
would not be the case. might see the repetition of information as distracting.
17
As noted previously, page count is used in this research as a proxy for volume of disclosure.Disclosure Overload and Complexity: Hidden in Plain Sight | 13
Outside of the financial statements, risk factors frequently significant accounting policies and, in particular, disclosures that
repeat some aspects of the business description, and many involve:
include grossly obvious disclosures. A slightly modified risk
factor disclosure, which was not untypical of other risk factor (a) A selection from existing acceptable alternatives
disclosures identified throughout the Form 10-K reviews, reads:
(b) Principles and methods peculiar to the industry in which the
If overall demand for (the company’s products and services) entity operates, even if such principles and methods are
decreases, whether due to general economic conditions or a predominantly followed in that industry
shift in (customers) buying patterns, the company’s revenues
(c) Unusual or innovative applications of GAAP. 18
and profits could be impacted.
The mean average number of pages dedicated to the significant
Declining economic conditions could adversely affect our
accounting policies footnote in the surveyed companies’ annual
results of operations and financial condition.
reports on Form 10-K for 2010 was five pages with the range of
Our operations and performance depend on economic one to 13 pages. Keeping in mind the circumstances cited in FASB
conditions in the United States and other countries where we ASC Section 235-10-50 that require accounting policy footnote
do business. Deterioration in general economic conditions disclosure, we noted the following disclosures (slightly modified) in
could adversely affect the amount of (category of) products footnotes on significant accounting policies:
purchased by consumers and, therefore, reduce purchases
by our customers, which would negatively affect our revenue Cash and cash equivalents
growth and cause a decrease in our profitability. Interest rate Cash equivalents consist of funds invested in U. S. Treasury
fluctuations, financial market volatility or credit market Bills, money market accounts, demand deposits and other
disruptions may also negatively affect our customers’ ability to investments with a maturity of three months or less when
obtain credit to finance their businesses on acceptable terms. purchased.
Reduced purchases by our customers or changes in payment
terms could adversely affect our revenue growth and cause
Recently Adopted Accounting Guidance
a decrease in our cash flow from operations. Bankruptcies or
similar events affecting our customers may cause us to On January 1, 2010, the Company adopted Accounting
incur bad debt expense at levels higher than historically Standards Update (“ASU”) 2009-16, “Transfers and
experienced. Declining economic conditions may also Servicing (Topic 860): Accounting for Transfers of Financial
increase our costs. If the economic conditions in the United Assets.” This ASU is intended to improve the information
States or in the regions outside the United States where provided in financial statements concerning transfers of
we do business do not improve or deteriorate, our results of financial assets, including the effects of transfers on financial
operations or financial condition could be adversely affected. position, financial performance and cash flows, and any
continuing involvement of the transferor with the transferred
Within the financial statements we observed arguably immaterial financial assets. The Company evaluated the impact of
disclosures in the accounting policy footnotes. FASB ASC Section adopting the guidance and the terms and conditions in
235-10-50 requires financial statement footnote disclosure of all place at January 1, 2010 and determined that certain sales
18
See FASB ASC paragraph 235-10-50-3, available at www.fasb.org.14 | Disclosure Overload and Complexity: Hidden in Plain Sight
of accounts receivable would be classified as secured We noted one Form 10-K in which the issuer’s footnote
borrowings. Under the Company’s sale of accounts receivable disclosures consisted of 30 pages of which approximately
arrangements, the maximum amount of receivables available 25 percent were the significant accounting policies footnote. In
for participation in these programs was immaterial to the considering the topic of disclosure volume and the findings in the
financial statements at January 1, 2010. academic research, it is questionable how financial statement
users are served by extensive footnote recitations of very
Accounting Guidance Issued But Not Adopted as of general accounting principles that are immaterial to the financial
December 31, 2010 statements. ASC Section 235-10-50 requires this footnote to
address all significant accounting policies. An important question
In October 2009, the FASB issued ASU 2009-13,
to address is what is significant and what is the optimal level of
“Revenue Recognition (Topic 605): Multiple-Deliverable
accounting policy information that is useful without blinding the
Revenue Arrangements – a consensus of the FASB Emerging
user with distracting and irrelevant information.
Issues Task Force,” which amends the criteria for when to
evaluate individual delivered items in a multiple deliverable Although some of the companies provided concise accounting
arrangement and how to allocate consideration received. policy footnotes that provided useful information, a significant
This ASU is effective for fiscal years beginning on or after observation about the accounting policy footnotes was that for
June 15, 2010. The adoption of the guidance on some annual reports the volume and lack of significant information
January 1, 2011 is not expected to have a material impact resulted in the temptation to flip through the pages without
on the Company’s consolidated financial statements. reading. This presents the risk that useful information may not be
apparent because it is buried in a section that is predominantly not
Subsequent Events
informative. As with any challenge in which it is necessary to digest
We have evaluated material events and transactions that a large volume of data, readers will be tempted to look for the parts
have occurred after December 31, 2010, and concluded they can skip through. Thus, volume that appears to lack critical
that no subsequent events have occurred that require information has a high likelihood of not being read.
adjustment to or disclosure in this Form 10-K.
This is not to suggest that the research team concluded that
The reasons for which preparers include disclosures that are accounting policy footnote information is not of immense value.
identified as not having a material impact on the financial Rather the research team observed that a streamlined and
statements are not discernable from a reading of the documents. targeted approach to footnote disclosure that focuses the user on
However, based on the preparer survey responses, it can be truly useful information is preferable to an approach in which all
speculated that at least one possibility is to anticipate comments possible disclosure is provided making discernment of important
from the outside auditors, the SEC staff, or both. disclosures more difficult.Disclosure Overload and Complexity: Hidden in Plain Sight | 15
16 | Disclosure Overload and Complexity: Hidden in Plain Sight
Survey of FEI members:
January–February 2011
Between January 17 and February 22, 2011 a Web-based survey Company type
was conducted. The survey consisted of sending electronic forms
to 6,500 members of the Financial Executives International. The Q1. Is your company publicly traded on a stock exchange
survey consisted of 20 questions. A copy of the survey form is or privately held?
attached as Appendix D. The objective of the survey was to obtain
feedback from preparers of financial statements and related 100%
disclosure documents about the resource costs and benefits of
financial reporting requirements. In particular, the objective of
80%
the survey was to enable us to gain insight into the effectiveness
of current disclosure requirements, the perceived causes of
disclosure complexity and overload and how the perceived 60% 59%
disclosure complexity and overload impacts preparers.
41%
40%
Responses were received from 216 companies of which
127 respondents identified themselves as public companies and
88 identified themselves as private companies. Demographics of 20%
respondents are illustrated in the following charts.
0%
Public (n = 127) Private (n = 88)
Total (n = 215)
Annual Revenue
Q2. Annual revenues are:
100%
80%
60%
51%
40% 39%
30%
25% 23%
21% 21%
20% 18% 17%
14%
11% 11%
9% 8%
1%
0%
$100 million or less Greater than $100 million Greater than $500 million Greater than $1 billion Greater than $5 billion
but less than $500 million but less than $1 billion but less than $5 billion
May not equal100% due to rounding Total (n = 216) Public (n = 127) Private (n = 88)Disclosure Overload and Complexity: Hidden in Plain Sight | 17
Industry Market capitalization at 9/30/2010
Q3. Which of the following best characterizes Q4. If company is publicly traded, market capitalization
the industry your company is in? at 9/30/2010 was:
15% 7%
Electronics, Technology, 14% Less than $75 million 10%
Software & Services 16% 1%
10% 5%
Energy, Natural Greater than $75 million
13% 9%
Resources & Chemicals but less than $200 million
6% 0%
10% 8%
Healthcare & Greater than $200 million
13% 13%
Pharmaceuticals but less than $500 million
6% 0%
10% 4%
Greater than $500 million
Banking & Finance 9% 6%
but less than $1 billion
13% 1%
8% 38%
Greater than $1 billion 61%
Diversified Industrials 10%
5% 0%
8% 37%
Company not
Building, Construction 7% 1%
publicly traded
& Real Estate 97%
10%
5% May not equal100%
Food, Drink & due to rounding Total (n = 202) Public (n = 126) Private (n = 75)
6%
Consumer Goods
2%
5%
Insurance 5%
6%
3%
Retail 3%
3%
3%
Communications
3%
& Media
2%
2%
Investment 2%
Management 2%
21%
Other 16%
30%
May not equal 100%
due to rounding Total (n = 216) Public (n = 127) Private (n = 88)18 | Disclosure Overload and Complexity: Hidden in Plain Sight
A. Significant survey results
At a very high level, the most significant findings based on the survey are identified below.
1. Complexity of accounting standards and volume of 4. Financial reporting preparation and review time are most
mandated disclosure are the most significant contributors impacted by expanded disclosure requirements.
to the issue of disclosure complexity.
5. Overall, SEC initiatives (e.g., the plain English initiative) to
• Footnotes are the most significant source or cause of
reduce disclosure complexity have not had much impact.
disclosure complexity.
• Fair value, derivatives and hedging are the most 6. FASB and SEC should undertake incremental procedures
significant sources or causes of disclosure complexity and processes as part of improving the cost-benefit analysis
under specific GAAP requirements. while developing proposals for new accounting standards.19
2. Potential objection by the SEC and other regulators,
7. Most companies have not taken steps to reduce disclosure
including state regulators, or by external auditors,
complexity in their financial statements.
may cause companies to provide disclosure that is
otherwise immaterial.
3. Counsel is most likely to be involved when Risk Factors is
the topic associated with disclosures included in a filing
with the SEC or footnote to financial statements.
• Many say their inside or outside legal counsel does not
direct disclosure in some or all parts of public filings or
footnotes to financial statements.
19
On July 22, 2011 in the U. S. Court of Appeals for the District of Columbia case, Business Roundtable
v. Securities & Exchange Commission, the court vacated a recently adopted SEC rule involving
investor access to proxy solicitation materials for purposes of including shareholder nominees. In
its opinion, the court found that the SEC had “failed once again” to conduct an adequate analysis of
the costs and benefits of the rule under the Commission’s statutory obligation to balance “efficiency,
competition, and capital formation”.The opinion also cited other instances in which SEC rulemaking
was vacated due to faulty cost-benefit analysis. It is possible that the SEC may undertake changes to
its cost-benefit analysis processes in response to this and other court decisions.Disclosure Overload and Complexity: Hidden in Plain Sight | 19
20 | Disclosure Overload and Complexity: Hidden in Plain Sight
Many say the disclosure complexity issue is not
B. Survey results applicable to more serious in their industries than in others.
sources of disclosure overload Q5. With respect to the assertion that there is a disclosure
and complexity complexity problem, do you believe the disclosure
complexity issue is more serious in your industries than
in others?
Many respondents (77 percent) say the disclosure complexity
100%
issue is not more serious in their industries than in others.
In analyzing this question and responses, we note that among
the 25 companies included in our Form 10-K review there 80%
Total: 77%
are significant observable differences in the impact over the Public: 74%
five- and six-year periods of comparative data on one industry. 60%
Private: 80%
The most noticeable difference is between the banks and all
other companies. Using page volume as a proxy for disclosure 38% 42% 39%
40% 35% 39% 38%
overload and complexity, overall Form 10-K volume on average
increased 16 percent over the six-year period reviewed while 24%
22%
the two banks included in the survey experienced increases of 20% 19%
53 percent and 110 percent over the same period. Excluding the
financial institutions, our review of annual reports, which included 0%
1% 1% 1%
pairs of companies in similar lines of business, did not identify Yes No, but certain No I don't believe
any other category of company in which there seemed to be a industries there is a
contribute to
disproportionately greater increase in disclosure than in other complexity
disclosure
complexity
industries. because of problem
industry
specific issues
May not equal 100%
due to rounding
Total (n = 216) Public (n = 127) Private (n = 88)Disclosure Overload and Complexity: Hidden in Plain Sight | 21
Significant majority say potential objection by
SEC/other regulators may cause them to provide
disclosure that is otherwise immaterial.
Q6. What factors might cause you to provide a disclosure
that you believe is otherwise immaterial?
The reviews of the Form 10-Ks revealed significant occurrences
61%
Potential objection by
SEC or other regulator 83% of apparently immaterial disclosure. One notable example as
including state regulators 11% illustrated at the left is that many of the recent Form 10-Ks included
disclosures about adoption of recently issued new accounting
Possible objection by
56% standards that recited a detailed description of the new standard
74%
external auditor and concluded with the assertion that the newly adopted standard
15%
did not have a material effect on the financial statements. Although
Potential financial 21% both SEC rules and FASB standards make it clear that rules and
statement user objection:
e.g. analysts, bankers,
28% standards need not be applied to immaterial items, we observed
investors 6% many companies providing these and other apparently immaterial
disclosures. Based on the survey results as well as anecdotal
4%
Other 6%
conversations, companies are reluctant to omit disclosures other
0% than those that are clearly immaterial, out of concern that an SEC
comment or auditor comment will require the issuer to revise its
27% reporting to include the immaterial item. We find this observation
Not applicable 3%
is consistent with responses received in the survey discussed in a
81%
later section.
May not equal 100% due to rounding
Most (81 percent) private companies say the concern about SEC
Total (n = 181) Public (n = 127) Private (n = 53)
comments is not applicable to them. In considering why SEC or
auditor objection might be a concern to a private company, we are
A significant majority (61 percent) of respondents indicated that aware that some private companies hold themselves to a public
potential objection by the SEC and other regulators, including state reporting standard either because they feel that is a form of best
regulators, may cause them to provide disclosure that is otherwise practice or because members of their audit committees are also
immaterial (Public: 83 percent, Private: 11 percent). executives with public companies. Other companies anticipate
becoming a public company in the future.
A majority (56 percent) of respondents indicated that possible
objections by external auditors cause them to provide disclosure
that is otherwise immaterial.22 | Disclosure Overload and Complexity: Hidden in Plain Sight
Many say once disclosure is included in a public Many say their company’s disclosures
filing in response to an SEC staff comment, it is are influenced by concerns over potential
rarely or never omitted from future filings. future litigation.
Q7. If your company has expanded non-mandatory Q8. To what extent are your company’s disclosures
disclosures as a result of an SEC staff comment, influenced by concerns over potential
what statement best captures the consideration of future litigation?
including that same disclosure in future filings?
100% 100%
Total: 73%
80% Public: 83%
80%
74% Private: 57%
71%
61%
60% 60% 59%
53%
44% 44%
40% 39% 40%
29%
26% 27%
24%
20% 20%
20% 17%
13%
0% 0%
Once disclosure is included Once a disclosure is provided Significantly influenced Somewhat influenced Not a consideration
in a public filing in response in response to an SEC staff
to an SEC staff comment, comment, management would
May not equal100% due to rounding
it is rarely or never omitted continue to consider materiality
from future filings and would omit if it was later
determined to be immaterial
Total (n = 154) Public (n = 122) Private (n = 31) Total (n = 215) Public (n = 127) Private (n = 87)
71 percent say once disclosure is included in a public filing in 3 percent say their company’s disclosures are influenced by
7
response to an SEC staff comment, it is rarely or never omitted concerns over potential future litigation.
from future filings (Public: 74 percent, Private: 61 percent).
• Significantly influenced: 20 percent (Public: 24 percent, Private:
13 percent).
• Somewhat influenced: 53 percent (Public: 59 percent, Private:
44 percent).You can also read
