Shortcomings of Traditional Financial Reporting
Question:
Discuss About Present Time Criticism of Traditional Financial Reporting ?
Traditional financial reporting has predominantly been used by quite a number organization to report their financial statements. The main aim of the financial reporting is to assess the performance and progress of the firm and thus serves as a pivotal instrument for decision making. Notwithstanding the value associated with these reports, there is emergence of immense criticism regarding the authenticity and inclusivity of this way of reporting. In this regard, analysts have tried to come up with ways to ensure that this kind of limitation is solved. Among them is the introduction of cost and management accounting, which among other things ensures that the cost reflects the current cost as opposed to traditional way where historical cost is used. The issue of inclusivity has also been put on spotlight where companies are required to prepare corporate sustainability reports to showcase whether the environmental and social cost aspect of the firm to the immediate society has been catered for. Below is the critical analysis of the shortcoming/criticism associated with the traditional financial reporting, theories that support the corporate sustainability reporting and cost and benefit of the same.
First and foremost, the traditional financial reporting is of historical nature in that transaction cost are recorded as they happened in the past. This aspect does not aid in future planning and other decisions made by the management.Instead,critics argues that current cost ought to be included in the reporting to ensure its reliability and dependability.Secondly,financial reports are just interim reports because the profitability and position as shown in it is not authentic. For example, due to cost concepts all transactions are recorded on a certain real cost but due to business dynamics this cost keep changing and thus calling for adjustment according to let say inflation of the market. This method of financial reporting is also subject to personal judgment of accountants regarding stock valuation, calculation of depreciation and provision of doubtful debts. Hence making these statements not to show the true view of the business. The traditional financial reporting is designed in such a way as to show only overall profitability, thus failing to show net profit per say, department or product in order to find activities which do not realize profit. This shortcoming leads to inefficiency in business activities. In traditional financial reporting only activities and transactions which are describable in monetary terms are recorded. Other aspects of business that is of non-financial and non-monetary like demand of products, good relation in industry and better working environment are neglected. The environmental and social aspects of the firm to the society is also neglected. This include the effect that the firm has to the society in which it operates. Some of these cost include the pollution that firm emits to the society which may affect the health of the residents. This is indeed is a cost to the society which should be accounted for by the firm. But in the traditional financial reporting such information is rarely considered and thus making the reports to be less conclusive.
Theories Supporting Corporate Sustainability Reporting
Social contract theory . This theory has its roots from the work of authors like Donaldson (1982) who considered that the relationship between business and the society in which it operates from a rational point of view.He postulates the existence of a contract between the society and the business which is social and which therefore imposes some obligations of business to the society. The same theory is also expounded by Dunfee.et.al (1999) who further expounded Dunfee et al. (1999) who propose a harmonious contract where managers make decision in a manner that does not negatively affect the society. This means that frims cares a lot about the society of which they are part and parcel. This notion stems from the feeling that it is out of approval from the society that the business operates so as to deliver as per the society`s expectation (Van Marrewijk, 2003). As per Dunfee (2006), this theory will be most suited to an economy in which economic resources are efficiently utilized, and where the macroeconomic elements are predictable and also in an environment where rights such as intellectual property rights are efficiently enforced (Rest.1999).Thus the theory of social contract focuses more on the obligations of the firm to the society. The said contract should be honored for the society to have confidence in the operations of the firm. Since for the firms goals and objective to succeed it has to rely on the the society to provide the much needed labor force among other support,the firm may be compelled to honor the contract.
Signaling theory –.This theory dwells on why it is beneficial when firms provide information to the capital market without any compulsion: Discretionary disclosure is important for the firms to favorably compete in the capital and financial market for risky capital. Since it is perceived that the Insiders possess knowledge about the company and its prospect than they do the investors, then the investors will resort to value the companies less by offering lower price for the company`s shares in the capital market (Omran and El-Galfy, 2014). However, the investors confidence can be boosted and the value increased if the firm reports CSR information that is dependable and reliable as this can reduce the uncertainty of the investors(Connelly et al.,).Originally, signaling theory was designed to explain the market failure (information asymmetry) in the labor market(Spence,1973), (Ross,1977) has used it to explain discretionary disclosure in reporting the corporate performance. Due to information asymmetry, firms disclose some CSR information to investors to outdo other firms so as to attract investment and enhance their public image (Verrecchia, 1983). CSR disclosure is one of the indicative sign, companies used to disclose more than the mandatory required information by the law in order to indicate that they are better off (Mahoney, 2012).Implementation and voluntary presentation of environmental policies in the annual reports contribute importantly to the shaping of the environmental reputation as opposed to the previous financial performance.( Toms ,2002). Hasseldine et al. (2005)provide an integrative quality-indicative theory resource based perspective of the firm in order to evaluate the divergent effect of the quality and quantity of environmental disclosure on the firms reputation.Therfore firms must show the intention to provide the information regarding the CSR in order for the society to have a positive image of the firm.
The cost of proper implementation of CSR is very high because during its infant stage it requires a high labor workload. This is because of planning cost involved and massive time spent. All these lays a burden to the company.CSR goes against the main objective of the firm which is to maximize profit. Large amount of cash may be used to provide CSR hence reducing the earnings of the firm.CRS may reduce the working morale of the employees in case the employees are required to work extra hours than their scheduled time. Employees would prefer to quit the job and find job elsewhere. This will increase the cost to the company of hiring new staff and training them. The benefit associated with CSR are among other, leads to improved public image of the company i.e. companies that shows great commitment are considered to be more philanthropic than their counterparts. Also CSR boosts the employees engagements i.e employees like working for companies with good public image and that company that is in the media for positive reasons.CSR may lead to attraction of invetors.Investors want to know that their funds are being used properly not only to generate profit but should have a strong sense of corporate sustainability responsibility.
Conclusion
It is therefore evident that the companies have always been inclined toward reporting information’s that only discloses their economic performance i.e. monetary performance as opposed to reporting on all issues affecting the firm and its immediate society, hence rendering these reports to be biased and hence cannot be used to make viable future decision by the management. This concern proves the need for the firms to be more inclusive and authentic in their reporting. The manner in which financial information is prepared ought to be changed to include the non-financial information like environmental and social aspects. Reporting of this information will lead to enhancement of the companies` reputation an image. Preparation of financial information that truly reflects the actual position of the firm will aid in furnishing decision makers with accurate and information hence leading to efficient decision making. Therefore departing from the traditional financial reporting method and embracing the new techniques would be a great milestone in accounting.
References
Deegan, C., and Unerman, J.,( 2011). Financial accounting theory. Sydney: McGraw-Hill.
O?Dwyer, B., 2003. Conceptions of corporate social responsibility: The nature of managerial Capture. Accounting, Auditing and Accountability Journal, 16(4), 523-557
Omran, M.A., and El-Galfy, A.M.,( 2014). Theoretical perspectives on corporate disclosure: a
critical evaluation and literature survey. Asian Review of Accounting, 22(3), 257–286
Rest, J., Narvaez, D., Bebeau, M., and Thoma, S.,( 1999). Postconventional moral thinking: A
Neo-Kohlbergian approach. Lawrence Erlbaum Associates, New Jersey.Spence.,(1973).Job Signalling.Quarterly Journal of economics,87(3),355-374.
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Toms, J.,( 2002). Firm resources, quality signals and the determinants of corporate
environmental reputation: some UK evidence. The British Accounting Review, 34(3),
Verrecchia,R.E.,(1983).Discretionary disclosure. Journal of Accounting and economics,5(3),179-194.
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