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How governance professionals should ring in the New Year

07 December 2017 by Lorraine Young

How governance professionals should ring in the New Year - Read more

The end of the year offers a chance for company secretaries to take stock of best practice and prepare for upcoming events

As we approach the start of another year, the minds of many company secretaries will be taken up with planning for the year’s end and the annual report.

Several recent organisations have published on developments in best practice, as well as other things to keep in mind. What follows is a selection of the best advice.

FRC communications

In October, the Financial Reporting Council wrote to audit committee chairs and finance directors with a summary of key developments for 2017/18 annual reports.

It has also published its Annual Review of Corporate Reporting 2016/2017, incorporating the letter, and concluded that although reporting is generally good, explanations could be more detailed and reports could be clearer.

The FRC reviewed 203 annual and interim reports, 44% of which resulted in substantive queries being raised with the companies concerned, which required a response.

“Companies should provide a fair and balanced assessment of performance, covering both positives and negatives”

Among the advice given is that key judgments and estimates should be properly explained and quantified. Companies should also provide a fair and balanced assessment of performance, covering both positive and negative aspects.

Links between financial statements and the narrative, including the use of alternative performance measures, should be clear, and organisations should provide information that is company-specific and material to an understanding of the business, its performance and prospects.

New accounting standards

The ones in focus are the new International Financial Reporting Standards: IFRS9 Financial Instruments, IFRS15 Revenue Recognition and IFRS16 Leases.

Although these are not yet in force, some companies are expected to adopt them early, and those that choose not to should nonetheless be assessing the impact they will have on the financial statements in future, taking any steps necessary to enable prior year comparatives to be reported under the new standards.

This will certainly be a matter for the audit committee agenda. The impact of the change in standards will depend on the type of business the company undertakes.

The FRC advises that companies should disclose in their accounts the likely impact of the new standards as soon as they can be measured. As the implementation dates approach, the FRC expects to see detailed quantitative disclosure on this.

Non-financial reporting

A new EU directive on non-financial and diversity information – sometimes called the Non-Financial Reporting Directive – requires certain large companies and qualifying partnerships with more than 500 employees to provide additional information about the environment, employees, social matters, human rights, anti-corruption and anti-bribery.

The regulations are effective for financial years beginning on or after 1 January 2017. The FRC has published a factsheet to help with this disclosure; revised guidance will be available in the first half of 2018.

It is expected that the updated guidance will also aim to improve the way in which companies disclose how the interests of stakeholders have been taken into account when determining how to promote the long-term success of the company.

Companies should first determine whether they are affected by the new requirements before taking any action.

Strategic reports

The FRC observes that strategic reports can be improved through better explanations of the relationships between different pieces of information, for example between key performance indicators (KPIs) and pay policies.

The letter to audit committee chairs suggests that companies can improve where a ‘compliance’ approach to the strategic report leads to a lack of coverage or if the report appears to be lacking balance. The strategic report should be ‘fair, balanced and understandable’.

“KPIs should be clearly described and explained, and any changes to them should also be reported and explained”

The findings of the Corporate Reporting Review team on strategic reports are given in detail in the Annual Review document.

Examples of circumstances where companies were challenged include when there was little or no discussion on: a major source of revenue; a significant product line; brands making up about half of revenue; and significant variations in the profitability of certain segments.

There were also comments on specific elements of the strategic report. The FRC said KPIs should be clearly described and explained, and any changes to them should also be reported and explained.

The FRC also challenged companies on their reporting in principal risks and uncertainties (PRUs), where, for example, descriptions were not clear or detailed enough; the directors’ judgments in deciding on the PRUs were unclear or not given; only one such risk or uncertainty was disclosed; or the risks which the company considered to be principal were unclear.

Additionally, the council expects firms to refer to the impact of climate change where this is relevant for an understanding of the company’s activities. Some energy companies had not done enough in this area.

Dividend disclosure

Elsewhere, dividend disclosure is a particular area to be aware of, and ensuring that the company declaring a dividend – the individual legal entity, not the overall group – has sufficient distributable reserves to make the payment.

If a company pays an interim dividend out of profits it has made since its last annual accounts, it must prepare a set of interim accounts and file these at Companies House to demonstrate it has sufficient distributable reserves to make the payment. It is not necessary for these accounts to be sent to shareholders.

This is an accident blackspot, with more firms than you might expect having to ask shareholders to ratify payments made in breach of the Companies Act requirements. The Financial Reporting Lab published an implementation study on this in October 2017.

Risk reporting and viability statements

Risk reporting and viability statements continue to be areas of focus and the Financial Reporting Lab is also expected to issue a report on it in the near future. Many companies have chosen a period of three years over which to make their viability statements.

Investors are now calling for greater differentiation in these time periods and also suggesting that companies should consider other factors – including things like investment and planning periods, the nature of the business, and its stage of development – in addition to the company’s medium-term business plan.

Whether companies are willing to move out of the three-year comfort zone remains to be seen.

Brexit

Last year, companies were making general statements about the likely impact of the result of the UK referendum on the EU. Disclosures in this area should be kept under review and updated as the situation develops and companies refine their analysis.

Thematic reviews

The FRC has published three thematic reviews, covering judgments and estimates, pension disclosures, and alternative performance measures. These are designed to assist companies when preparing disclosures in potentially tricky areas.

The council has also announced its thematic reviews for 2018/19. For corporate reporting these will be:

  • Targeted aspects of smaller listed and AIM-quoted company reports and accounts
  • The effect of the new IFRSs on revenue and financial instruments on companies’ 2018 interim accounts
  • The expected effect of the new IFRS for lease accounting
  • The effects of Brexit on companies’ disclosure of principal risks and uncertainties.

The priority sectors for this review will be financial services, with particular emphasis on banks, other lenders and insurers; oil and gas; general retailers; and business support services.

IA pay guidance

In early November, the Investment Association published its 2018 Principles of Remuneration with an open letter to the chairs of remuneration committees of the FTSE 350. There are a few points on disclosure worth noting.

Regarding pay ratios, there is an expectation that companies will disclose the pay ratios between the chief executive and average or median employee pay, as well as between the chief executive and other executives. Although this is not required for the 2018 reporting season, the Investment Association is looking for companies to do this voluntarily.

Meanwhile, any relocation benefits should be disclosed at the time of appointment and only be paid for a limited period, and annual bonus targets should be disclosed within a year of payment. If the bonus is to be more than 100% of salary then a portion of it should be deferred.

All the publications by the FRC and Financial Reporting Lab mentioned above can be accessed from frc.org.uk. The Investment Association remuneration guidance and associated documents can be accessed from theinvestmentassociation.org.

Lorraine Young is company secretarial director of Shakespeare Martineau

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