November 9, 2017 Judgements and estimates
Language on its own can be an all too imprecise medium. When we converse we use gestures, facial expressions and tone of voice in order to enhance the meaning of our words. And our listeners respond appropriately, looking beyond the mere words to the entirety of the message in order to judge nuance or subtext.
But what happens when we have to resort to words alone; how do we accurately convey meaning when we are unable to deploy physical or verbal tools to underline our intentions? In those circumstances it can be all too easy for our words to be misunderstood or misinterpreted. After all, we may know what we are trying to convey, but then we are already in possession of the background facts which led to our own understanding of the situation. Our readers won’t necessarily be in possession of the same level of information and therefore may put a far different interpretation on our words than that which we meant to convey.
It’s a problem which faces all those who are tasked with compiling company reports. The requirement may be for clear and concise reporting but sometimes it is necessary to include additional information in order to provide an appropriate background. And if you want to deliver clarity, then the words you choose should be as far as possible incapable of misinterpretation.
With that in mind we were interested to see the Financial Reporting Council (FRC) issue three thematic reports in order to help companies to improve the quality of their reporting. Two relate to pension disclosures and the use of alternative performance measures but it is the third report which covers judgements and estimates that we are highlighting today.
In compiling an annual report, directors are required to provide information not only covering the previous reporting period, but also to comment on the company’s future prospects. When looking forward it is particularly important to choose words carefully. After all, past performance can be backed up by figures and statistics, something which is not always possible when looking forward.
The FRC acknowledges this commenting that “judgements, assumptions and other areas of estimation uncertainty are genuinely the most difficult, subjective or complex to report.” However it also comments that properly separating judgements from estimates “can help investors to understand the quality of management’s decisions.”
In this context the FRC’s advice should be required reading for all those engaged in compiling annual reports. Not only does it highlight areas which should be subject to commentary it also provides expectations of the decision process and information to be provided when including judgments and estimates in reports. Examples are also provided, although the FRC also makes it clear that it expects companies to make disclosures which are specific to the company rather than resort to industry generalities.
