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Preparers are vital to the capital formation process

Author: ICAEW Insights

Published: 25 Aug 2021

The American Accounting Association (AAA) played host to a stellar line-up in a session that interrogated the role of preparers of financial information in the financial reporting system.

The quality of financial reporting is the product of a whole system, not just the parts that lie within the profession, emphasised a panel of financial reporting heavyweights at an AAA annual meeting in August 2021. However, said Sarah McVay, Professor of Accounting Deloitte & Touche Endowed Professor in Accounting, Washington University, if a company invests in accounting, it thereby invests in the entire company’s performance.

Brandon Szerwo, Assistant Professor, Accounting and Law, School of Management, University at Buffalo, concurred and said that it is important to look beyond CEOs and CFOs for action from other governance actors, and pointed to the challenges of doing research into audit committees and the internal audit function.

Tom Quaadman, Executive Vice President, Center for Capital Markets Competitiveness at the US Chamber of Commerce, pointed out that financial reporting is an extremely important device investors use to make decisions. That makes the quality and reliability of that information vital for the capital formation process to occur. He said Sarbanes Oxley in the US has been effective, and that the business community believes strongly that a system of internal controls is necessary for that business to grow to a significant size.

He commented on the tension within the system around whether some of those internal controls are scalable, and that some adjustments have been made in the US to small company reporting definitions to match the size of the company, as well as what the company was doing.

He cited, by way of example, the small biomedical company that needs access to public capital markets to help fuel its research. The company might not be selling products or hiring a large workforce, but it will need to perform research in order to grow. In such cases, it is important that those internal controls match what the company is actually doing, he said, despite its size.

It should not be forgotten that many of these conversations around internal controls in the US have their roots in the Enron scandal that occurred 20 years ago. The internal control issues that are now under scrutiny in the UK and Germany have the benefit of the US experience of Sarbanes Oxley to draw on, the panel pointed out.

More importantly, they said, we now have a step change in technology in the guise of the distributed ledger, for example, that will help improve audit quality as well as put systems in place to strengthen financial reporting.

While there has been significant pressure on audit firms around the quality agenda, there has simultaneously been plenty of activity around internal control measures companies are taking of their own volition. Quaadman stressed that the quality debate should encompass both elements.

Ruby Sharma, Managing Partner, RNB Strategic Advisors, added the ecosystem perspective to the conversation. She reminded us that we are living in, and businesses are operating in, an environment in which they are facing a multitude of disruptive forces. Business has become complicated, she said, even for a small privately owned business, and that was the case before COVID. The availability of talent, the regulatory and compliance requirements, white collar crime are all elements she listed as evidence of this complexity. There is a whole ecosystem of stakeholders, not just investors and regulators, who require transparency of corporate behaviour despite this complexity.

She reiterated that financial oversight of the quality of financial reporting is important for the integrity of our capital markets and the availability of liquidity, and that many stakeholders – internal executive management, board members, directors, regulators, auditors and legal advisors – all have responsibility for that integrity.

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