Main Causes of Poor Quality Financial Reporting

Main causes of poor quality financial reporting

Jonas and Blanchet (2000 p. 354) state that quality financial reporting represents ‘full and transparent financial information that is not designed to obfuscate or mislead users’. On the other hand, poor quality financial reporting forms unreasonable expectations and fraudulent information of likely returns and so lead people to make misguided consumption and investment decisions (Penman 2003). The main factors that Penman (2003) believes that lead to poor quality in financial reporting are: poor thinking that was induced by Generally Accepted Accounting Principles (GAAP), the gaming of poor regulation which means using GAAP to draw a picture of earnings growth, and the subversion of good prescriptions of GAAP. This essay will discuss these three main sources of poor quality of financial reporting respectively along with some examples.

Poor thinking, related to the regulation and management is one of the main reasons for the poor quality financial reporting. As Penman (2003) says, GAAP and the Conceptual Framework are imperfect, many suspect practices are allowed under these principles. That is to say, management is allowed to choose one practice to conduct even though the practice will result in misleading.

By admitting the existence of an imperfection in the accounting, considerable problems of measurement may impose poor thinking on company’s financial reporting. Penman (2003) illustrates couple of examples, such as GAAP for the Statement of Shareholders’ Equity confuses earnings with share transactions; residual earnings and earnings growth valuation models ignore potential gains and losses on these transactions and misvalue the equity; and conservative accounting creates higher book rates of return and earnings growth with no economic justification. The issue of imperfection also affects areas such as bad debts, inventory obsolescence, sales returns, possible fixed asset impairment, and warranties and loss...