Finance: Breaking the code in company accounts

FINANCIAL ACCOUNTS are generally seen as the key to understanding how companies are performing.

In recent years, of course, that image has been dented by the growing realisation that they offer only a snapshot of how a company is doing at any given time. Hence the ability of companies to collapse - as they did in the late Eighties and early Nineties - despite any obvious signs of ill-health in their annual reports.

Moreover, the fast-moving nature of business, combined with the growing acknowledgement of the importance of harder-to-measure indicators such as customer loyalty and employee satisfaction, has led to formal reports and company accounts being seen as of limited use to investors.

And amid all this have been the attempts to free small companies from some of the expense and regulation associated with compiling these reports. Hitherto, this has entailed making such entities exempt from certain accounting standards and reporting requirements. However, the Institute of Chartered Accountants of Scotland (ICAS) believes that this involves tackling the problem in the wrong way. A body renowned for its radical approach, ICAS says it has come to the conclusion that the way ahead is to start from a blank sheet of paper and base proposals on "the key information needs of the users of small company accounts".

Isobel Sharp, the Arthur Andersen partner who chaired the working party responsible for the ICAS paper, explained that the likelihood of information being increasingly widely available on the Internet led her team to produce a report designed to give the basic information.

"It should help users answer straightforward questions such as: `Where is the company based?'; `How and what is the company doing?'; `How do the directors run the company?'; `Is the company growing?'; and `What are its general plans and prospects?'" she says.

Central to the institute's thinking is the idea that company reports currently provide "a coded message". It argues that, by drawing up reports in accordance with the 1985 Companies Act and the various accounting standards, the messages in the finished product are "filtered and coded, leaving users who do not understand the codes in the dark about the company".

Accordingly, the ICAS report, "Breaking the Code... A Better Reporting Framework for Small Companies", published last week, sets out a model that aims to report "in a way which is far more relevant and useful to the users".

Richard Letham, the institute's assistant director, accounting and auditing, says: "As chartered accountants, we understand the codes which traditional reporting uses. In our new model, we are seeking to translate this coded data, to fill gaps in present reporting and remove the unnecessary."

Of all the changes it is proposing, ICAS thinks the most controversial may be the introduction of a report by an independent financial commentator. This would essentially take the form of a free-form narrative report on the company's results for the year, a review of the company's cash and general financial position and a commentary on its prospects for the next year.

As you will know if you have followed the debate over accountants commenting on quality of management and internal controls, this is a tricky area. As one member of the working party said: "It will be an exciting challenge for accountants."