An Information Highway in Need of Capital Improvements (1994)

External reporting is an information highway that should serve the needs of those who use it. This has been the guiding principle of the American Institute of CPAS special committee on financial reporting, which is putting together its final recommendations for improving external reporting. The committee was established in 1991 by the board of directors to recommend the nature and extent of information management should make available to others and the extent to which auditors should report on the elements of that information. In November 1993, after two years of research into the needs of external reporting users (investors, creditors and their advisers), the committee published a summary of its initial findings, The Information Needs of Investors and Creditors (see AICPA Issues Report on Information Needs of Investors and Creditors, JofA, Jan.94, page 21), in which it said the critical information needs of external reporting users were not being met. The committee observed that over time a financial reporting process that failed to meet investors' and creditors' information needs would result in less effective capital markets, which could misallocate and misprice capital--to almost everyone's detriment. The consequences of a failing reporting process are severe. When their ability to make informed capital allocation decisions is limited by a lack of information or by poor information, investors and creditors may increase the cost of capital or reduce their market participation. Deserving companies may be unable to obtain capital or may be able to obtain it only at excessive cost. A thinner capital market decreases opportunities for risk-sharing and reduces capital market liquidity. Companies find it more difficult to grow and remain competitive, causing overall competitiveness and the economy as a whole to suffer. This article is intended to provide an understanding of the special committee's deliberations and the significance of its work. A second article later this year will discuss the committee's recommendations and focus on their implications for the future of external reporting. EXTERNAL REPORTING A BIRD'S--EYE VIEW Some argue the external reporting highway is in crisis and dangerously close to collapse. Many have voiced serious concerns, including accountants, business professionals, academics, study groups in both the United States and abroad, members of Congress arid certain regulators. Others argue that while there may be a few bumps, the external reporting highway is fundamentally sound and meets the needs of those who use it. Any past problems were caused by factors currently being addressed by standard setters, regulators and businesses; such problems are not evidence costly construction of a new highway is necessary. The committee's charge requires that in developing recommendations it determine how information currently provided by financial statements is understood and how assurances provided by auditors are perceived. This charge has resulted in an extensive effort to understand users' information needs and their perceptions of external reporting. CHANGES IN THE BUSINESS ENVIRONMENT--USERS' PERSPECTIVES In an age characterized by rapid change, increased globalization of the economy and business and constant technological and financial innovation, the information needs of investors and creditors are evolving. Rapid change. Perhaps the most challenging factor today is the accelerating rate of change. Such change requires perceptive, knowledgeable, creative and flexible management and a work force capable of responding quickly. It also requires a flexible capital market capable of allocating and reallocating capital on a timely basis. In an era of rapid change, reporting that focuses primarily on past history no longer provides an adequate basis for predicting future results. …