The Role of Financial Reporting in Corporate Governance

To say that there is no governance without financial accounting and reporting is like saying new borns need mothers’ milk. However, a dominant shareholder director or CEO may consider the statement an oxymoron. Regardless of their views let me set out below the importance of financial reporting for good governance;

Provide a system for checks and balances
Financial accounting system and related controls ensure that there are proper checks and balances for the transactions entered into by the company. The accounting system should provide the board of directors the right information to play their oversight role and prevent them from making arbitrary decisions that would have a negative impact on the company.

Avoid conflicts of interest
Focus on related party transactions and reporting them with the appropriate details is an important function to prevent any dominant party taking advantage of the company. A strong finance function would avoid or reduce conflicts of interest of owners affecting the company. Some examples of misuse are; using cash from a listed company to fund personal businesses at concessionary terms, transferring or selling goods at a reduced price to personal ventures, buying from personal businesses at higher than market prices, investment in related companies not at observable market prices, etc.

Eliminate reporting bias
Transparency in financial reporting is key to ensure that all stakeholders receive full disclosure of the operating results at the same time. However, there are occasions when owners and accountants may misrepresent financial information to mislead users of financial statements. To avoid this a good financial reporting system alone is not enough. It needs to be coupled with a good governance structure to improve transparency.

Risk management
Corporate governance enhances risk management in the business and provides guidelines for minimizing risks. In order to achieve this outcome, financial reporting systems have to facilitate the information flow to the decision makers. Good financial reports would help detect trends and anomalies early and also be useful to detect and report risks such as fraud and theft.

Improve compliance with regulations
A good financial reporting system should ensure timely action on payment of income taxes, employee obligations and other license or contractual obligations. It should not try to manipulate regulations and be unfair to the other party. Corrupt practices creep into an organization when the finance team resorts to manipulation and then the culture of the organization also learns to accept this and bribes become the norm. I’ve known several multinationals operating in Sri Lanka who have voluntarily paid the right dues of taxes or custom duties, despite having the opportunity to avoid. This was to indicate to the their employees the intolerance to bribes and the ‘tone at the top’. At the same time there are local companies who have avoided paying their dues, by resorting to other means!

Boost Investor Confidence
Growing investor confidence helps you generate additional capital and attract new investors. Investor confidence grows when they trust the results presented to them. When there are less inconsistencies, less prior year adjustments and less explanations for non compliances the reader would begin to trust the quality of earnings reported. The ethical standards of accountants should promote better corporate governance standards in the company. The opposite is also true, where I’ve experienced issues due to the accountants wanting to satisfy the CEO at the expense of ethical standards, for their own survival!

About surenraj

“Views expressed are my own”
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