Theory: reporting in the company

For those in a hurry

Reporting covers everything that is geared to improving the level of information.
It should capture all relevant information deemed necessary for planning, steering and control.
Formally designed information systems pay little attention to managers’ actual need for information.
It can really only be about increasing transparency, with identifying the causes of structural change taking centre stage.
Accounting is generally regarded as the most important supplier of figures in a company.
Accounting data, however, is normally not available at the time it is needed, or only with a considerable delay.

Improving the level of information

As already mentioned in the first part, a company is made up of three subsystems: the goal system, the social system and the information system. We are now going to take a closer look at the information system, that is, we want to show how important the supply of information is for corporate management. But what lies behind that cumbersome term?

“The information supply system covers everything that is geared to improving the level of information.” In the broadest sense, this definition describes a company’s reporting system.

As such a system, the supply of information is understood as a preliminary stage to the actual planning and control. Starting from a given level of information, a planning and control system is intended to support decisions. That means that the quality of the information system has a significant influence on the actual management of the company.

The desired target state of an information system, and the one to be aimed for, is therefore the capture of the relevant information deemed necessary for planning, steering and control.

The relevance of the information cannot always be determined unambiguously, however. Especially since the question of whether a piece of information is to be regarded as relevant or not depends strongly

on the person taking the decision,
on the person conveying the information and
on the particular decision-making situation.

A friend of COMMITLY, management expert Georg Jocham, devotes himself to this fascinating aspect of communication with decision-makers under the title “The Decider Code”. But that is another topic.

Information consequently has to be geared to the employee’s position in the organisation as well as to their intellectual abilities. A further difficulty is that the creation and the gathering of information fall apart in factual, organisational and temporal terms. Furthermore, the question has to be asked for whom the information is intended and which decisions it is meant to support.

A not entirely unknown commentator by the name of DELANEY made an attempt to clarify the question of a piece of information’s relevance:

“Information is relevant to a decision if it makes a difference to the decision-maker’s ability to predict events or to confirm or correct expectations.

Relevant information reduces the decision-maker’s assessment of the uncertainty surrounding the outcome of a decision, even if it must not change the decision itself.

Information is relevant if it provides insights into past events (feedback value) or future events (predictive value) and if it is timely.”

The following problems arise when designing an information system:

The quantity problem – typical of this problem is “information poverty amid an abundance of information”. Meaningful information therefore has to be created through filtering, condensing and channelling.
The time problem – the dynamics of the environment call for shorter planning and control cycles.
The quality problem – this refers to the relevance of information to decisions already discussed.
The communication problem – this raises the question of how the information is to be conveyed. This problem arises because information is normally not generated where it is needed.

The fundamental problem here is that formally designed information systems pay little attention to managers’ actual need for information.

Who does not know them: overloaded dashboards with countless charts and figures?

Because of the sheer number of these problems and because of the dependency between the information system and planning and control, developing such a system is an extremely complex and therefore time-consuming task.

For these reasons, various requirements have to be placed on an information supply system:

The criterion of relevance was already addressed above.
In addition, there is the requirement that it be appropriate in terms of timing, language and the people involved.
Furthermore, such a system must be flexible towards unforeseeable information needs.
Cost-effectiveness must also be taken into account, that is, an information supply system has to be designed according to economic criteria. The economic value of a piece of information is determined by its benefit for business decision-making processes and by the cost of obtaining it. This founders, however, on the fact that the costs and the benefits can hardly be quantified.

The report, which represents the output of the information system so to speak, forms the basis of information for the decisions to be taken in a company. In this context it should be noted:

Expectations of an information system should not be set too high, because the complexity of the real world cannot be compensated for by methods. Rather, it can only be about increasing transparency, with identifying the causes of structural change taking centre stage.

But where does the information come from?

Accounting is generally regarded as the most important supplier of figures in a company. The annual financial statements in particular – that is, the balance sheet, the profit and loss account and the notes (where required) – serve interested parties as an important instrument. Various tasks can be identified in this regard: the information, documentation and profit determination functions and the rules on distributions, all of which derive directly from statutory provisions.

In this context, the information function specifically regulated in section 190 of the Austrian Commercial Code (UGB) and section 238 of the German Commercial Code (HGB) deserves closer attention. Both laws specify the applicable bookkeeping obligations as follows:

The bookkeeping must be such that it can give an expert third party an overview of the business transactions and of the company’s position within a reasonable period of time.

Section 195 UGB follows on from this provision and states, with regard to the content of the annual financial statements:

They must give the entrepreneur as true a picture as possible of the company’s assets and earnings position.

In addition to the provisions listed above, the UGB provides special rules for corporations:

Section 222 (2) The annual financial statements must give as true a picture as possible of the company’s assets, financial position and earnings. Where this is not achieved because of special circumstances, the necessary additional disclosures must be made in the notes.

Section 236 deals explicitly with the notes:

The notes must explain the balance sheet and the profit and loss account as well as the accounting and valuation methods applied to them in such a way that as true a picture as possible of the company’s assets, financial position and earnings is given.

Information from accounting for external parties only?

The detailed elaboration of the tasks of the information function is significant:

protecting creditors,
protecting shareholders,
protecting employees who share in the profits,
protecting the tax authorities,
protecting the public with an interest in the business, and
protecting the business through self-information.

The statutory provisions of the UGB make it clear that the legislator is primarily aiming at protecting parties outside the company.

Only through the interpretation or extension provided by accounting theorists do we arrive at secondary purposes of the financial statements, that is, the task of financial reporting to produce figures relevant to planning for the company’s management.

This also immediately reveals the fundamental weakness of accounting as a basis for internal reporting. It means nothing other than that accounting is really there first and foremost to draw as true a picture as possible of the company for external parties.

US rules similar, but more pragmatic

Although US annual financial statements convey almost the same information as their European counterparts, different objectives can be discerned within rules that otherwise agree on fundamental matters.

“In recent years the SEC has worked together with the Financial Accounting Standards Board (FASB). Because it is confronted daily with the accounting and reporting practices of US companies, the SEC often passes problems that arise on to the FASB to deal with. In return, the SEC advises the Financial Accounting Standards Board (FASB) on request.”

The FASB also makes an important contribution regarding the objectives of reporting by publishing “Statements of Financial Accounting Concepts (SFAC)”, which, unlike the “Statements of Financial Accounting Standards (SFAS)”, do not establish GAAP. SFAC 1, for example, governs the “Objectives of Financial Reporting by Business Enterprises”. Three objectives are essentially defined in this statement.

“The first objective of a company’s reporting is to provide information that is useful in business and economic decisions.”

“The second objective of reporting is to provide understandable information that helps investors and creditors to predict a company’s future cash flows.”

“The third objective of reporting is to provide information about a company’s economic resources (obligations) and the effects of transactions, events and circumstances that change resources and claims to resources.”

Info box:

This development can be explained by the different economic philosophies of Europe and the United States. Following the great stock market crash of 1929, the Securities and Exchange Commission (S.E.C.) was founded in the USA in 1934, a federal authority that laid down the form and content of annual financial statements in binding terms. Subsequently, however, further state intervention was avoided and the problem of regulation and interpretation was passed on to private organisations. Today there is a complicated system of private organisations in America that work together with the SEC. The Financial Accounting Foundation (FAF), for instance, consists of the Financial Accounting Standards Advisory Council (FASAC) and the Financial Accounting Standards Board (FASB). The FASB is to be credited with establishing the “Generally Accepted Accounting Principles” (GAAP), the American counterpart to the German-language “principles of proper bookkeeping” (GoB).

The objectives refer to internal and external addressees, but they also record that a company’s management has an information advantage over outsiders.

Information about economic resources is understood here to mean indicators of a company’s strengths, weaknesses and liquidity.

Further components of the third objective are information about economic developments and earnings, about solvency and cash flows, about management’s performance (in the sense of generating profits) as well as information about corporate governance and its effects on the company’s future development (in the sense of assuming management responsibility).

So while SFAC 1 focuses in particular on the information to be provided, SFAC 2 attempts to identify those characteristics that qualify information for the decision-making process management is aiming at.

Figure: managing the decision-making process based on SFAC 2 (Hierarchy of Accounting Qualities)

Information consequently has to meet the following criteria:

Qualities for the user: the information must be useful and understandable and, subsequently, comparable and consistent
Qualities of the information: information must be relevant and reliable
Information is considered relevant if it is available in good time and has feedback value and predictive value.
Information is considered reliable if it is verifiable, representative of the matter in question and equally neutral.

Accordingly, only material matters should be assessed. The cost-benefit ratio has to be taken into account in that assessment. At the end of the day it is in the entrepreneur’s very own interest to prepare only those matters that are worth it. These remarks make it clear that in the American accounting system the priority is primarily on the adequate gathering of information to support decisions, especially for corporate management but also for external parties.

What is also essential here is that the concept of liquidity is dealt with far more thoroughly.

The fundamental shortcomings of accounting must not be overlooked, however. The limits of “classic” accounting are

that it maps only the effects and not the causes,
that it reduces the n-dimensional events within a company to the dimension of values, and
that evaluations from accounting are provided with a delay, because they have to comply with statutory requirements and with the care that this necessarily involves.

Nevertheless, according to the textbooks, internal reporting should be built on accounting data:

Through the principle of double-entry bookkeeping, budgeting, the balance sheet and the income statement provide an excellent and proven model for classifying information.
The most important formal goals of planning are formulated in the language of “classic” expense and income accounting (revenue, profit, assets).
For reasons of efficiency alone (capture once, evaluate many times), the information already captured and classified by accounting should wherever possible also be used as the data basis for internally oriented evaluations.
The information provided by the balance sheet leads to financial consequences (profit distributions, tax payments) that are of fundamental importance for planning and control.
The information provided by the balance sheet influences the decisions of external decision-makers, which in turn can be of great importance for corporate planning.

Once again, the most important point of criticism is passed over: accounting data is normally not available at the time it is needed, or only with a considerable delay.

Topics covered in the theory series:

Part 1: companies, goals and liquidity

Part 2: corporate management and liquidity management

Part 3: decisions and liquidity management

Part 4: reporting in the company

Credits: Photo by Patryk Grądys on Unsplash