Financial statements are the media through which entities unveil various economic elements pertaining to their daily business. The concept of agency between managers and shareholders has helped in the development of arguments for disclosure. Management is solely responsible for the presentation of financial information and must conform to several stipulations. Also, management must acknowledge that the shareholders and regulators are not the only party privy to the organization’s financial information. Other stakeholders such as creditors, debtors, vendors, potential investors, and consumers are also interested in such information to make informed decisions. Fundamentally, International Accounting Standard 1 (IAS) stipulates the procedure of disclosures by concisely outlining the elements to which preparers of financial statements should adhere. The increased value of relevant information has, in part, fueled the efforts to encourage entities to disclose more substantial information, which usually entails extending disclosure aspects to even the information not stipulated by such standards. Voluntary disclosures are gaining recognition across all industries as the demand for meaningful information rises. Limitations such as the complexity of financial statements continue to encourage this course. The purpose of this paper is to elucidate the aspects of necessitating and issues affecting the voluntary disclosure of material information in entities’ financial statements.
Background of Voluntary Disclosure
IAS and other international accounting bodies have played a pivotal role in streamlining organizations to conform to meaningful disclosure of financial information. Given the dynamic nature of business environments across the globe, it is prudent to make disclosure standards as flexible as possible. Nonetheless, such provisions are limited to certain areas that may have negative implications for an entity and its establishment. More importantly, financial disclosures required by statute and IAS must not contradict the autonomy of organizations in providing the sensitive information to the public. Today, investors, for example, need more than the figures and amounts documented in annual reports to make sound financial decisions. The costs and benefits analysis of voluntary disclosure has helped in the argument for and against the practice. Partaking voluntary disclosure, on the one hand, benefits external stakeholders such as investors. Contrarily, such revelations are also linked to creating a competitive disadvantage to an organization (Xia, 2016). Thus, it is the balance of the pros and cons that helps in explicating the worthiness of discretionary disclosures.
Delegate your assignment to our experts and they will do the rest.
Literature Review
Financial statements are inherently complex and pose interpretation risks to the users of such information. Risks of interpretation may take two forms: 1) overlooking specific economic indicators; and 2) failure to recognize vital relationships. Thus, the essence of voluntary disclosure is to eliminate such complexities, thereby making financial statements more comprehensible. Guay et al. (2016) find discretionary reporting as a useful tool in mitigating the rigidities associated with various types of financial statements. The study employs the number of forecasts as the determinative element of voluntary disclosure by an entity. It is worth mentioning that no stipulations (international or otherwise) require a company to present users of financial information with its economic prospects. Guay et al. (2016) argue that managers, as the agents to shareholders, seek for opportunities to report essential, yet non-mandatory information in annual reports. Such additions help in illuminating specific unclear or potentially controversial accounting aspects of an entity (Guay et al., 2016). In effect, discretionary reporting helps managers in mitigating risks associated with the complexity of financial statements.
Similarly, Noh et al. (2019) find an increase in the adoption of voluntary disclosure in public traded companies, despite the significant amendments made on the Securities and Exchange Commission’s (SEC) Form 8K. In 2004, Congress passed the Sarbanes-Oxley Act, which required entities to use real-time disclosures for substantial financial changes. Correspondingly, the economic context of business information expanded considerably, which meant that companies were no compelled to make discretionary reports. Nonetheless, these changes also stipulated the inclusion of a particular set of economic events, most of which companies have found to be irrelevant. In consequence, entities have been in cross-purpose with the provisions of Form 8K and have resolved to include additional relevant information for the users. Noh et al. (2019) explore key weaknesses of Form 8K in attaining the comprehensiveness of reports’ purpose, which then prompts firms to employ voluntary disclosure. Examples of such aspects include material contracts and codes of ethics. Accordingly, managers prefer the organization’s guidance to these stipulations as they fail to meet the goals of such disclosure sufficiently.
Further, Form 8K is not flexible when reporting personal information about an enterprise’s undertakings. Noh et al. (2019) argue that one of the motivations behind voluntary disclosure of relevant information is to convey positive information, also dubbed as good news , to existing and potential investors, and other stakeholders. Unlike the rigid 8K guidelines, managers have the discretion to reveal a wide range of favorable financial data, thus attracting investors and minimizing litigation risks (Noh et al., 2019). Therefore, entities seek discretional reporting in situations where the alternative means fail to enable them to create a desirable corporate image sufficiently. Such arguments that have made voluntary disclosure a substitute to Form 8K, rather than a compliment.
Contrarily, Dyer et al. (2016) question the presupposition that complexity in financial disclosures is the most crucial determinant of discretionary reporting. The authors find that while Guay et al.’s (2016) revelations are critical in understanding the causality of such rigidity in voluntary disclosures, the effect of economic factors should not be underestimated. The dynamic nature of the corporate world today has partly led to the contextual changes in financial statements in particular and financial reporting as a whole. With the rise in computing power and investor knowledge, preparers of financial statements do not necessarily have to conform to the length of annual reports to ensure conciseness. Dyer et al. (2016) further argue that complexity is not as relevant as it used to be in the past two decades as it is today in determining whether to partake voluntary disclosure or not. Instead, the dynamic economic aspects surrounding enterprises today have necessitated the reporting of non-mandatory financial information to educate users of crucial financial elements.
Conclusion
The value of financial information cannot be overestimated. The complexity of financial statements has necessitated the adoption of mechanisms to offer supplementary information to users. Such rigidity is manifested in the inability of financial statements to conform to organizations’ goals, such as appealing to investors. Fundamentally, financial statements are limited to providing financial potion and performance of the reporting period. Information such as an entity’s prospects can only be revealed discretionally. Also, existing reporting frameworks such as SEC’s Form 8K fail to provide a sufficient avenue for subjective reporting, which is crucial in promoting investment and growth. Further, the growing stakeholder knowledge has also prompted the extension of financial reporting, thereby demanding for discretionary disclosure. Further study is needed on the impacts of voluntary disclosure on an entity’s corporate image.
References
Dyer, T., Lang, M., & Stice-Lawrence, L. (2016). Do managers really guide through the fog? On the challenges in assessing the causes of voluntary disclosure. Journal of Accounting and Economics , 62 (2-3), 270-276. http://dx.doi.org/10.1016/j.jacceco.2016.08.001
Guay, W., Samuels, D., & Taylor, D. (2016). Guiding through the fog: Financial statement complexity and voluntary disclosure. Journal of Accounting and Economics , 62 (2-3), 234-269. https://doi.org/10.1016/j.jacceco.2016.09.001
Noh, S., So, E. C., & Weber, J. P. (2019). Voluntary and mandatory disclosures: Do managers view them as substitutes? Journal of Accounting and Economics , 68 (1), 101243. https://doi.org/10.1016/j.jacceco.2019.101243
Xia, B. S. (2016). Strategic implications of voluntary disclosure and the application of the legitimacy theory. International Entrepreneurship , 1 (2), 109-120. https://pdfs.semanticscholar.org/0464/8b69d60b983874abd61fa8fd35b17e27c279.pdf
