Part 6: Where next for financial reporting in the public sector?

Improving financial reporting in the public sector.

In this Part, we discuss the challenges that continue to face standard-setters, preparers, and auditors to keep general purpose financial reporting relevant and useful.

Continuing to focus on user needs

In 2015, public entities reported for the first time under the new Accounting Standards Framework. We discussed in Part 4 how the new Framework has reduced the complexity of reporting requirements. We hope that less complex requirements will help users to better understand the performance of these entities.

We expect the new PBE accounting standard on service performance reporting, due to be issued by the XRB in 2016, to further improve the reporting of performance information. We expect performance information to be better integrated within the general purpose financial reports.

It is important that the XRB continues to improve the Accounting Standards Framework in line with the information needs of users. There will always need to be a balance between ensuring that the Framework is not overly complex and recognising that entities are operating in increasingly sophisticated environments.

The needs of the range of users of general purpose financial reports are also changing. Each user's need for information is different, and what an individual requires today might be different to what they require next week or next year.

Public entities are increasingly focused on telling users a full performance story that is about more than just dollars and cents. This has led to increased use of infographics, case studies, and other material in annual reports to better illustrate or explain entities' results and outcomes.

Responses by preparers to the ever-changing needs of users show how financial reporting can provide a range of simple and detailed information. Simplifying important financial information – for example, total assets or net surplus – and presenting it graphically makes it easier to view on mobile devices or catch attention on social media.

However, users should also be able to access detailed information if they want it. This is possible when, for example, entities provide a summarised annual report with detailed supporting documents available separately.

In our view, it is important that entities do not allow the demand for simple formats to result in removing information that should be available to users. Sometimes, an entity should provide detailed information on particular issues, regardless of whether the issues are complex or unexpected.

Generally accepted accounting practice supports a reporting approach that focuses on the materiality of disclosures in general purpose financial reports. We hope that public entities will focus more on providing useful information and less on complying with matters that might not be material or useful to users of the reports.

By their very nature, most general purpose financial reports look back at the performance of an entity, often providing comparisons with what was planned or budgeted. This is a challenging concept in a fast-paced world, where real-time information is in demand. If users continue to ask for faster reporting, the challenges will include being able to respond to disruptive changes to reporting cycles, and the way information is prepared, without affecting quality.

Helping users understand the inherent uncertainties

General purpose financial reports typically include the effect of estimates and judgements made by the entity. These can be as simple as predicting how much revenue earned during the year will not be collected because of customer defaults or as complex as valuing a derivative financial instrument. Often, the biggest numbers in the financial reports are based on estimates and judgements by those who govern the entity.

We expect such estimates and judgements to be made. However, the inherent uncertainties associated with these matters must be effectively communicated to users through general purpose financial reports so users can appreciate the potential variability in reported amounts.

To increase the visibility of such estimates and judgements in general purpose financial reports, a "key audit matters" section will soon be added to the audit reports of some New Zealand entities, including listed issuers. Entities (with a higher level of public accountability) reporting under the Financial Markets Conduct Act 2013 will also be included.

In the next few years, we expect to add a "key audit matters" section to a small number of our audit reports, including the University of Canterbury, Genesis Energy Limited, Air New Zealand Limited, and the Financial Statements of the Government.

Focusing on what matters most

There is an increasing focus on "reducing the clutter" in general purpose financial reports. For example, there is updated guidance in generally accepted accounting practice for preparers about the use of materiality and guidance by professional bodies such as the 2015 report by the Chartered Accountants Australia and New Zealand, Noise, Numbers and Cut-Through.

The new Accounting Standards Framework should help to "reduce clutter" to some extent, with PBE accounting standards tailored to the different types of entities and the transactions they carry out.

However, a further opportunity exists for all entities, including for-profit entities, to prepare general purpose financial reports that contain information that matters most to users. Preparers should look for opportunities to present information in a concise and accessible format, while including all relevant information.

Another positive initiative is the International Integrated Reporting Council's integrated reporting framework. This helps preparers to tell their performance story, with a focus on what matters most for the individual entity. An integrated report aims to provide insight about the use of resources (such as funding and human resources), the external environment affecting the entity, and how key relationships with stakeholders are maintained.

This is a broader story than general purpose financial reports currently provide. It aims to provide users with more information about the value and long-term sustainability of the entity. We expect the concept of integrated reporting or a similar concept to continue to grow in popularity.

Legislative reforms were aimed at increasing service levels and value-for-money for public services. The reforms included giving chief executives greater powers of delegation to enable partnering with agencies outside the public sector.

To help reflect a more flexible and fluid system, the legislative reforms also introduced more flexibility to the reporting of operational performance. This included allowing more flexibility in the elements of performance that are reported, depending on the nature of the entity. We support more flexibility in reporting about performance.

Reducing the number of reporting entities

Recent legislative changes have resulted in certain smaller entities no longer being required to separately report financial information. Instead, this information will now be reported only within the group.

Although this is a step in the right direction, by better balancing the costs and benefits of public reporting, we would like to see a continued focus on whether the "right" public entities are reporting. Further legislative change could be needed to ensure that only such entities are required to prepare general purpose financial reports.

As corporate structures continue to evolve, financial reporting might be required by "activity-based" units, rather than the traditional entity-based reporting.

Keeping pace with technology

As technology evolves, and public entities move towards reporting against wider objectives, there is likely to be an increasing focus on the capability of those tasked with preparing general purpose financial reports.

It is difficult to predict the future information needs of users, but preparers must continue to embrace change to provide what is required. This could include gaining increased expertise in technology and data analysis.

Summarised information can be useful because it is quicker to read and users are less likely to get bogged down and miss the main messages. However, there is a tension between giving readers high-level messages and providing enough detail to maintain accountability and transparency.

Negotiating these challenges will be important. However, most of all, the principles of the accounting and auditing professions – such as integrity, objectivity, transparency, governance, and accountability – need to continue to underpin general purpose financial reporting.