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VOLUNTARY DISCLOSURE IN FINANCIAL REPORTING

By Jaya Sinha

Under the guidance of

Dr. Sanjib Kumar Basu

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AGENDA

Objective of the study Introduction What is voluntary disclosure Requirements of voluntary disclosure Benefits of voluntary disclosure Types of voluntary disclosure A real life case study-ENRON’S CASE A way out-GoI’s voluntary disclosure scheme Conclusion Recommendations Acknowledgement

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OBJECTIVE The objective of this study is to help companies

(the preparer community) improve their business reporting by providing evidence that many leading companies are making extensive voluntary disclosures and by listing examples of those disclosures. The examples serve to provide companies with helpful ideas of how to describe and explain their investment potential to investors.

The basic premise underlying this Business Reporting Research Project is that improving disclosures makes the capital allocation process more efficient and reduces the average cost of capital. The examples are not a list of recommended disclosures. They do illustrate, however, how companies are communicating with investors.

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INTRODUCTION Information is the lifeblood of global capital

markets.

High-quality, consistent, comparable and understandable reporting by business enterprises enhances investor confidence and market efficiency, and thereby contributes to the depth and liquidity of capital markets, which businesses depend upon for sustainability and growth.

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WHAT IS VOLUNTARY DISCLOSURE?

"Disclosure" is to reveal information.

"Voluntary Disclosure" is to give permission for that information to be revealed, such as allowing your doctor to reveal your medical records to your medical insurance company, or allowing your bank to reveal your financial information to a lending company.

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REQUIREMENTS FOR VOLUNTARY DISCLOSURE

Four conditions must exist to use Voluntary Disclosure:

1.The disclosure must be voluntary.

2.The disclosure must be complete and accurate.

3.The disclosure needs not involve a penalty.

4.Disclosure must be information that is related to current period, past events or future happenings.

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BENEFITS OF VOLUNTARY DISCLOSURE

1. Enhance transparency & credibility: Provide more information. Lower risk and uncertainty. Reduction of cost of capital & required rate of

return . Attract more investment.

Example: If a company disclosed nothing, its cost of capital, if any was available would be very expensive. However, informative disclosures that help investors interpret companies’ economic prospects are believed to reduce the cost of capital.

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BENEFITS OF VOLUNTARY DISCLOSURE2.Prevent information asymmetry: different level of information between management

and investors. investors can know if there are shirking & insider

trading by management.

3.Innovative business environment: manifest an increasing and changing demand for

business information and a larger role for voluntary disclosures.

setting or changing a new standard require much time & discussion.

the existing regulatory and standard-setting system may not be fast enough to keep up with the changes.

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BENEFITS OF VOLUNTARY DISCLOSURE4.Different aspects to disclose: Each single company has different factors and

aspects that are especially important to its success. Information about those factors and aspects for the

company will be especially useful to investors.

Example: 1. R & D activities appear to be important for companies that manufacture and sell medicines.

2. The qualities of pop stars appear to be important for entertainment companies .

The reasons are:1. Different companies have different views on their

own important aspects & factors2.Different companies compete with each other by

employing different strategies in a same industry

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BENEFITS OF VOLUNTARY DISCLOSURE

5.Unrecognized Intangible Assets Accounting standards only allow a few kinds of

intangible assets to be stated in balance sheets For Example: Internally generated goodwill is

not allowed to disclose in any financial statements

However in some companies, the value of their intangible assets are definitely more valuable than tangible assets

It is very unfair to those companies if their valuable intangible assets are not allowed to disclose

Result Unlikely to attract investors & may mislead users’ decisions

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A Real Illustration:

It is one of the Hong Kong famous media and entertainment companies to provide multimedia content and lifestyle information to the global Chinese community

Extracted from StarEastNet’s annual report:

“The celebrity element is what makes the Group unique……the Group has contracted with over 200 artistes……Leon Lai…..Jackie Chan…… Kelly Chan…………….”

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TYPES OF VOLUNTARY DISCLOSURE1.Business data:Example: high-level operating data.2.Management’s analysis of business data: Example: reasons for changes in the operating and

performance-related data.3.Forward-looking information:Example: opportunities and risks including those

resulting from key trends4.Information about management and shareholders:Example: directors, management, major

shareholders5.Background about the company: Example: broad objective and strategies6.Information about intangible assets : Example: R&D, human resources, customer relations

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REFERRING ENRON’S CASE

Implication 1. After the figures in financial statements were

audited, investors have to trust and they do not have other means to judge the correctness of the figures.

2. After the collapse of Enron, investors become more vigilant than before and look deeper into companies and demand full disclosures.

3.Voluntary disclosures provide an extra way for investors to judge a company’s performance.

4.Only successful companies are confident to disclose more information voluntarily as to increase transparency and attract more investments.

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A WAY OUT : GOI'S VOLUNTARY DISCLOSURE SCHEME

Government of India, The Central Board of Direct Taxes launched on June 18, 1997 the Voluntary Disclosure of Income Scheme (VDIS) which provides income-tax defaulters an opportunity to disclose their income at the prevailing tax rates under the umbrella protection of immunity from major laws relating to economic offences.

Those opting for the VDIS would be granted immunity from prosecution under the Foreign Exchange Regulation Act, 1973, the Income Tax Act, 1961, the Wealth Tax Act, 1957, and the Companies Act, 1956.

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A WAY OUT : GOI'S VOLUNTARY DISCLOSURE SCHEME The scheme, which comes into force from

July 1, 1997, will close on December 31, 1997. Those eligible under the scheme include persons who have failed to furnish I-T returns for any year or those who have part-disclosed their income in returns or have completely escaped assessment.

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CONCLUSION

Effective voluntary disclosures do signal success

In company’s view, voluntary disclosures increase transparency, reduce information asymmetry & disclose more intangible assets

Success Lower cost of capital, attract more investments, more credibility & enhance corporate governance

In Investor’s view, voluntary disclosures provide extra information

Success Able to make better investment decisions & better capital allocations

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RECOMMENDATIONS 1.Many leading companies are voluntarily disclosing

an extensive amount of business information that appears to be useful in communicating information to investors.

2.The importance of voluntary disclosures is expected to increase in the future because of the fast pace of change in the business environment.

3.Voluntary disclosures related to matters that are important to the success of individual companies are very useful, particularly disclosures of management’s view of the company’s “critical success factors” and trends surrounding those factors.

4.Although some disclosures were found about unrecognized intangible assets, additional data about those assets would be beneficial because of the importance of intangibles to a company’s value.

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ACKNOWLEDGEMENTS

Dr. Sanjib Kumar Basu

Dr. Madhushree Mukherjee, Dean of M.Com Department, St. Xavier’s College (Autonomous), Kolkata

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THANK YOU