4.5 Disclosure and transparency

Disclosure and transparency are vital in financial reporting, ensuring trust in markets and informed decision-making. They provide stakeholders with relevant, reliable information to assess an entity's performance and prospects. This topic explores the importance, objectives, and types of disclosures.

Regulatory requirements, qualitative characteristics of useful information, and specific disclosure areas are examined. The notes cover financial statements, management analysis, accounting policies, segment reporting, related parties, risks, corporate governance, and ESG factors. Challenges in achieving transparency are also discussed.

Importance of disclosure and transparency

• Disclosure and transparency are crucial for maintaining trust and confidence in financial markets and ensuring the efficient allocation of resources
• Providing relevant, reliable, and timely information allows investors, creditors, and other stakeholders to make informed decisions about allocating their resources
• Transparency promotes accountability, reduces information asymmetry, and helps prevent fraudulent activities or misleading financial reporting practices

Objectives of financial reporting

Providing decision-useful information

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• Financial reporting aims to provide information that is useful for making economic decisions, such as investing, lending, or entering into contracts
• Decision-useful information helps users assess the amounts, timing, and uncertainty of future cash flows and the entity's financial position
• This information should be relevant, reliable, comparable, and understandable to meet the needs of various stakeholders

Ensuring accountability and stewardship

• Financial reporting serves as a means of holding management accountable for their stewardship of the entity's resources
• It allows shareholders and other stakeholders to evaluate the performance and effectiveness of management in utilizing the entity's assets and generating returns
• Accountability and stewardship are essential for maintaining the trust and confidence of stakeholders in the entity's governance and decision-making processes

Regulatory requirements for disclosure

Mandatory disclosure rules

• Regulatory bodies, such as securities commissions and accounting standard-setters, establish mandatory disclosure requirements to ensure a minimum level of transparency
• These requirements cover various aspects of financial reporting, such as financial statements, management discussion and analysis, and other regulatory filings
• Mandatory disclosures aim to provide a consistent and comparable basis for assessing an entity's financial performance and position

Voluntary disclosure practices

• Entities may choose to provide additional information beyond the mandatory requirements to enhance their transparency and communicate with stakeholders
• Voluntary disclosures can include non-financial information, such as environmental, social, and governance (ESG) factors, or more detailed breakdowns of financial information
• Voluntary disclosures allow entities to differentiate themselves, build trust with stakeholders, and provide a more comprehensive picture of their operations and strategies

Types of disclosures

Financial statement disclosures

• Financial statement disclosures provide additional information and explanations to support the figures presented in the primary financial statements (balance sheet, income statement, cash flow statement)
• These disclosures include notes to the financial statements, which explain the accounting policies, assumptions, and estimates used in preparing the financial statements
• Financial statement disclosures help users understand the underlying transactions, events, and conditions that impact the entity's financial performance and position

Management discussion and analysis

• Management discussion and analysis (MD&A) is a narrative report that accompanies the financial statements and provides management's perspective on the entity's performance, financial condition, and future prospects
• MD&A discusses the significant factors that affected the entity's results, such as changes in the business environment, strategic initiatives, and risk factors
• This disclosure helps users gain insights into management's decision-making process and the entity's future outlook

Other regulatory filings

• Entities may be required to make additional regulatory filings, such as annual reports, proxy statements, or prospectuses, depending on their jurisdiction and the nature of their operations
• These filings provide information on various aspects of the entity, such as its business model, competitive landscape, risk factors, and corporate governance practices
• Other regulatory filings complement the financial statements and MD&A, providing a more comprehensive view of the entity's operations and compliance with relevant regulations

Qualitative characteristics of useful information

Relevance and materiality

• Relevance refers to the ability of information to influence the economic decisions of users by helping them evaluate past, present, or future events or confirming or correcting their past evaluations
• Materiality is a sub-characteristic of relevance and relates to the significance of an item or information in the context of the financial statements as a whole
• Information is considered material if its omission or misstatement could influence the decisions of users taken on the basis of the financial statements

Faithful representation

• Faithful representation means that the information presented in the financial statements accurately depicts the economic phenomena it purports to represent
• To be a faithful representation, information must be complete, neutral, and free from error
• Completeness ensures that all necessary information is included, neutrality requires the absence of bias, and freedom from error implies that there are no omissions or misstatements

Comparability and consistency

• Comparability enables users to identify and understand similarities and differences between items in the financial statements, both within a single entity over time and across different entities
• Consistency refers to the use of the same accounting policies and procedures, either from period to period within an entity or in a single period across entities
• Comparability and consistency allow users to make meaningful comparisons and assess the relative performance and financial position of entities

Verifiability and timeliness

• Verifiability means that different knowledgeable and independent observers could reach consensus that a particular depiction is a faithful representation
• Verifiability provides assurance to users that the information presented is reliable and can be depended upon for decision-making purposes
• Timeliness refers to the availability of information to decision-makers in time to be capable of influencing their decisions
• Timely information is more useful for decision-making purposes, as it allows users to take action based on current and relevant data

Disclosure of accounting policies

Measurement bases used

• Entities should disclose the measurement bases used in preparing the financial statements, such as historical cost, fair value, or present value
• The choice of measurement basis can significantly impact the reported amounts and the interpretation of financial information
• Disclosing the measurement bases helps users understand the underlying assumptions and methodologies used in the preparation of the financial statements

Significant judgments and estimates

• Entities should disclose the significant judgments and estimates made by management in applying the accounting policies and preparing the financial statements
• These judgments and estimates may relate to areas such as the useful lives of assets, impairment assessments, provisions, or fair value measurements
• Disclosing significant judgments and estimates allows users to assess the subjectivity and potential variability in the reported amounts and make informed decisions

Changes in accounting policies

• Entities should disclose any changes in accounting policies, along with the reasons for the change and its impact on the financial statements
• Changes in accounting policies can arise from the adoption of new accounting standards, voluntary changes to provide more relevant information, or corrections of prior period errors
• Disclosing changes in accounting policies ensures that users are aware of the comparability and consistency of the financial information over time

Segment reporting disclosures

Operating segments

• Entities should disclose information about their operating segments, which are components of the entity that engage in business activities from which they may earn revenues and incur expenses
• Operating segment disclosures include information such as revenue, profit or loss, assets, and liabilities for each reportable segment
• Segment reporting allows users to understand the entity's performance and financial position in different areas of its operations and assess the risks and opportunities associated with each segment

Geographic information

• Entities should disclose geographic information about their revenues and non-current assets, broken down by country or region
• Geographic information helps users understand the entity's exposure to different economic, political, and regulatory environments
• This information is particularly relevant for entities with significant international operations or those that derive a substantial portion of their revenues from specific regions

Major customers

• Entities should disclose information about their major customers if revenues from transactions with a single external customer amount to 10% or more of the entity's total revenues
• Disclosing information about major customers helps users assess the entity's reliance on specific customers and the potential risks associated with customer concentration
• This information is important for evaluating the sustainability and stability of the entity's revenue streams

Related party disclosures

Nature of related party relationships

• Entities should disclose the nature of their related party relationships, including the identity of the related parties and the nature of their relationship with the entity
• Related parties can include subsidiaries, associates, joint ventures, key management personnel, or entities under common control
• Disclosing the nature of related party relationships allows users to understand the potential influence and conflicts of interest that may arise from these relationships

Types of transactions

• Entities should disclose the types of transactions that have been entered into with related parties, such as sales, purchases, loans, or guarantees
• Related party transactions may be conducted on terms that differ from those available to unrelated parties and can have a significant impact on the entity's financial performance and position
• Disclosing the types of related party transactions helps users assess the nature and extent of the entity's dealings with related parties

Amounts involved

• Entities should disclose the amounts involved in related party transactions, including the value of transactions, outstanding balances, and any provisions for doubtful debts or bad debts
• Disclosing the amounts involved in related party transactions allows users to quantify the financial impact of these transactions on the entity
• This information is important for assessing the materiality of related party transactions and their potential effect on the entity's financial statements

Risk disclosures

Financial risk management

• Entities should disclose information about their financial risk management policies and practices, including the nature of the risks they are exposed to and how they manage those risks
• Financial risks can include market risk (currency risk, interest rate risk, and price risk), credit risk, and liquidity risk
• Disclosing financial risk management information helps users understand the entity's risk profile and the strategies employed to mitigate those risks

Market, credit, and liquidity risks

• Entities should provide specific disclosures on their exposure to market, credit, and liquidity risks
• Market risk disclosures include sensitivity analysis showing the impact of changes in relevant risk variables (exchange rates, interest rates, commodity prices) on the entity's financial performance and position
• Credit risk disclosures include information on the entity's maximum exposure to credit risk, the credit quality of financial assets, and any collateral held
• Liquidity risk disclosures include a maturity analysis of financial liabilities and information on how the entity manages its liquidity risk

Sensitivity analysis

• Entities should provide sensitivity analysis to demonstrate the impact of changes in key assumptions or risk factors on their financial performance and position
• Sensitivity analysis can be presented in the form of a range of reasonably possible alternative assumptions or by showing the effect of specific changes in risk variables
• Sensitivity analysis helps users assess the potential variability in the entity's results and the robustness of its risk management strategies

Corporate governance disclosures

Board composition and independence

• Entities should disclose information about the composition of their board of directors, including the number of independent directors and the criteria used to determine independence
• Board composition and independence are important factors in assessing the effectiveness of the entity's corporate governance practices and the ability of the board to provide objective oversight
• Disclosing board composition and independence allows users to evaluate the balance of skills, experience, and independence on the board

Executive compensation

• Entities should disclose information about the compensation of their key management personnel, including salaries, bonuses, share-based payments, and other benefits
• Executive compensation disclosures help users understand the incentives and alignment of interests between management and shareholders
• This information is important for assessing the appropriateness and fairness of executive compensation and its potential impact on the entity's performance and decision-making

Ownership structure

• Entities should disclose information about their ownership structure, including the identity of significant shareholders and the percentage of shares held by each
• Ownership structure disclosures help users understand the concentration of control and the potential influence of significant shareholders on the entity's governance and decision-making
• This information is relevant for assessing the alignment of interests between shareholders and management and the potential for conflicts of interest

Environmental, social, and governance (ESG) disclosures

Sustainability reporting frameworks

• Entities may choose to report on their environmental, social, and governance (ESG) performance using various sustainability reporting frameworks, such as the Global Reporting Initiative (GRI) or the Sustainability Accounting Standards Board (SASB)
• Sustainability reporting frameworks provide guidance on the disclosure of non-financial information related to an entity's environmental impact, social responsibility, and governance practices
• Adopting a sustainability reporting framework helps entities provide consistent, comparable, and reliable ESG information to stakeholders

Climate-related financial disclosures

• Entities should consider providing climate-related financial disclosures, as recommended by the Task Force on Climate-related Financial Disclosures (TCFD)
• Climate-related financial disclosures include information on the entity's governance, strategy, risk management, and metrics and targets related to climate change
• These disclosures help users assess the entity's exposure to climate-related risks and opportunities and its resilience to the potential impacts of climate change

Social responsibility and ethical practices

• Entities should disclose information about their social responsibility and ethical practices, including their approach to human rights, labor standards, diversity and inclusion, and community engagement
• Social responsibility and ethical practice disclosures demonstrate the entity's commitment to sustainable and responsible business practices and its consideration of stakeholder interests
• This information is important for assessing the entity's reputation, social license to operate, and long-term sustainability

Integrated reporting

Linking financial and non-financial information

• Integrated reporting is an approach that combines financial and non-financial information to provide a holistic view of an entity's performance, value creation, and future prospects
• Integrated reporting aims to demonstrate the interconnectedness of an entity's strategy, governance, performance, and prospects in the context of its external environment
• By linking financial and non-financial information, integrated reporting helps users understand how an entity creates value over the short, medium, and long term

Value creation process

• Integrated reporting focuses on the entity's value creation process, which encompasses the resources and relationships used and affected by the entity (referred to as "capitals")
• The capitals can include financial, manufactured, intellectual, human, social and relationship, and natural capital
• Disclosing information about the value creation process helps users understand how the entity transforms inputs into outputs and outcomes and creates value for itself and its stakeholders

Future outlook and strategy

• Integrated reporting should include information about the entity's future outlook and strategy, including its short, medium, and long-term objectives and the actions it intends to take to achieve them
• Disclosing future outlook and strategy helps users assess the entity's ability to create value in the future and its resilience to potential risks and challenges
• This information is important for evaluating the entity's long-term prospects and the sustainability of its business model

Challenges in achieving transparency

Balancing disclosure and competitive advantage

• Entities may face challenges in balancing the need for transparency with the protection of their competitive advantage
• Disclosing certain information, such as detailed breakdowns of revenues or costs, may reveal sensitive information to competitors and potentially harm the entity's competitive position
• Entities need to carefully consider the level of disclosure that provides sufficient transparency to stakeholders while not compromising their competitive advantage

Complexity vs understandability

• As financial transactions and business models become more complex, achieving transparency through disclosure can be challenging
• Complex disclosures, while comprehensive, may be difficult for users to understand and interpret, potentially reducing the usefulness of the information
• Entities need to strike a balance between providing comprehensive and detailed disclosures and ensuring that the information is understandable and accessible to users

Assurance and verification of disclosures

• Ensuring the reliability and credibility of disclosures can be challenging, particularly for non-financial information that may not be subject to the same level of assurance as financial statements
• Entities may need to engage external assurance providers to verify the accuracy and completeness of their disclosures, especially for ESG and integrated reporting
• Obtaining assurance on disclosures can enhance their credibility and usefulness to stakeholders, but it also involves additional costs and resources for the entity