Relevant to – all those working in UK public companies, especially listed companies
On 12 April, Stephen Haddrill, Chief Executive of the Financial Reporting Council (FRC), published a public letter to investors highlighting ‘some recent changes and developments in reporting’. Although addressed to investors, and perhaps rather too late in the reporting cycle for many companies, his comments are interesting from the perspective of those preparing company reports.
Aim of the annual report
One of the most interesting comments is right at the beginning of the letter: ‘The purpose of the annual report is to communicate relevant information to investors.’ We hear a great deal about the need to report to stakeholders and the wider public, but here the FRC unequivocally reiterates that the purpose is to communicate to investors.
When the FRC wrote to companies in October 2016, the letter emphasised the requirement for clear and concise reporting and clarity of communication. The FRC is now encouraging investors to engage with companies ‘to provide a steer on what information they believe is relevant and to challenge where reporting falls short of expectations’.
There remains a clear focus on the quality and clarity of business model reporting – explaining how the company makes money – and on the use of alternative performance measures (APMs). The latter are regarded with much suspicion by financial regulators and many investors, as they are regarded as susceptible to ‘gaming’ by executives. In how many successive years can a similar ‘extraordinary item’ actually be regarded as ‘extraordinary’? The FRC advice to investors is that: ‘You should expect to see disclosures that give a clear and complete understanding of the APMs presented, how they are calculated and why they are useful and, where relevant, reconciliation to amounts presented in the financial statements.’
Risk reporting and viability statements
The FRC reports that: ‘Our initial assessment of statements suggests that there is little variation in disclosures between business sectors’ and so companies are being encouraged ‘to provide clear disclosure of why the period of assessment selected is appropriate for the particular circumstances of the company, what qualifications and assumptions were made, and how the underlying analysis was performed’.
In July 2016, the FRC drew companies’ attention to the need to report on the risks and uncertainties that may be associated with Brexit. This letter to investors emphasises the FRC’s expectation that companies will ‘provide increasingly company specific disclosures with, ultimately, quantification of the effects.’
The FRC is actively encouraging investors to ‘challenge companies where they do not believe that explanations given are sufficiently persuasive’. The FRC has indicated that some companies have not provided adequate explanation of diversions from the UK Corporate Governance Code. Its definition of explanation is repeated in this letter: ‘This means setting out the background, providing a clear rationale for the action being taken and describing any mitigating activities’.
Financial statement disclosures
In October 2016, the FRC published a thematic study of tax reporting, which identified areas where disclosure might be improved. ‘We reminded companies that they should articulate how they account for material tax uncertainties by explaining the bases for recognition and measurement. We expect more companies to disclose the amount of their tax provisions than in previous years’.
The FRC also draws investors’ attention to its reminder to companies ‘that they should consider the impact of low interest rates on the amounts reported in their financial statements’, especially insofar as they relate to the valuation of long-term assets and liabilities, ‘for example the effects of adjusted discount rates on pension scheme liabilities and suppressed returns on pension scheme assets. Companies may need to provide sensitivity analysis to highlight the potential impacts’.
The FRC also refers investors to the work of the Financial Reporting Lab on best practice in dividend disclosures. These have improved, but the FRC notes that investors ‘may wish to challenge companies that provide insufficient information in this area’.
Accounting policies, significant accounting judgements and estimates
This is another area in which the FRC considers there is scope for improvement in reporting: ‘It is important that companies explain significant judgements and accounting policy choices, particularly where there is diversity of treatment, in pension reporting, for example. There continues to be room for improvement in the disclosure of accounting policies, particularly in relation to revenue recognition.’ Again the FRC is encouraging investors to examine the information provided.
Developments in IFRS
Attention is drawn to the three new standards published by the International Accounting Standards Board that will become effective in the next few years: IFRS 15 Revenue from Contracts with Customers (effective for periods beginning 1 January 2018), IFRS 9 Financial Instruments (effective 1 January 2018), and IFRS 16 Leases (effective 1 January 2019). The FRC advises investors they ‘should expect to see companies provide information on this progress and disclose the likely impacts of each of the new standards once they can be reasonably estimated’.
Mr Haddrill’s letter to investors can be found on the FRC website.