High quality financial reporting has been a mission of the Financial Reporting Council (FRC) for a number of years. Its aim is to promote transparency and integrity within business and to ensure that the needs of investors and other stakeholders are met.
However, with an increasing volume of reporting regulations, and new and complex accounting standards, it is acknowledged that it can be particularly challenging for smaller listed and AIM quoted companies to produce the level of financial reporting that is being demanded.
In order to address issues raised by the FRC about the quality of financial reporting by smaller listed and AIM quoted companies, the FRC and the ICAEW have published a Practical Guide which offers cost-effective suggestions, practical tips and questions for audit committees to consider.
What challenges do smaller companies face?
Over the last four years, the FRC has released two key publications focussing on financial reporting by smaller listed and AIM quoted companies:
Both publications highlighted the fact that financial reporting could be improved but that it is not always seen as a priority for smaller companies, which often have limited time and resource dedicated to this area. A number of financial reporting developments within the last 12 months have only increased the challenge:
- The ‘Big 3’ new accounting standards on financial instruments (IFRS 9), revenue (IFRS 15) and leases (IFRS 16) are now all effective. These complex standards have resulted in significant challenges for many companies with increased disclosure requirements and changes to recognition and measurement requiring amendments to internal systems.
- For accounting periods beginning on or after 1 January 2019, companies are required to prepare a Section 172 Statement. This new statement should describe how the directors have performed their duty to promote the success of the company, whilst having regard to a number of matters such as the interests of the employees, customers and suppliers, the impact of the company’s operations on communities and the environment, and the likely consequences of any decisions in the longer term. The Section 172 Statement should refer to strategy and key decisions relating to the year under review in addition to describing the applicable policies.
- From 28 September 2018, AIM quoted companies have been required to provide details on their website of which ‘recognised corporate governance code’ they have decided to apply. Many AIM quoted companies have applied the QCA Corporate Governance Code that, like the FRC’s UK Corporate Governance Code, requires certain disclosures within the financial statements.
Investors are placing increasing reliance on the annual report of smaller listed and AIM quoted companies as analyst coverage is thinner at this end of the market. These reports act as a key source of information on both historical financial performance, financial position and future development and risks. The direction of travel is clear – the investors and other stakeholders are determined to improve the quality of UK reporting.
How can the Audit Committee help to improve quality?
The Practical Guide focuses on the role of the audit committee. As the committee provides independent governance over the annual reporting process and manages the relationship with the external auditor, it has an important role in driving the quality of financial reporting and its work is likely to come under increased scrutiny in this respect.
The Practical Guide splits the annual reporting process into its separate distinct stages and provides examples of questions the audit committee could ask as well as practical tips, such as where to finds relevant guidance. The key theme is around the four areas in which actions could help to improve the quality of reporting:
- Adequate time and resource available
- Early engagement with those charged with governance
- Deeper understanding of relevant reporting standards
- Appropriate rigour by the auditor.
By asking the right questions at the right times, there could be significant improvements throughout the process, ensuring engagement with those responsible for reporting and providing opportunities to learn and improve in subsequent years. Examples of such questions are:
- Planning: Have there been any financial reporting standard changes during the year?
- Production of interim and annual reports: Are there any unidentified risks we should be articulating in the annual report?
- Review performance: Does management generally address issues raised during the audit?
- Formulate action plan for next year: What information are current and future investors likely to be interested in?
Use of the Practical Guide is not mandatory, nor is it a complete list of the responsibilities of the audit committee. It is, however, a thought-provoking source of practical suggestions and questions that the audit committee can ask of themselves, the board and the auditor. The combined result should be a more effective financial reporting process in which those charged with governance have greater time to plan and direct limited resources and, ultimately, provide higher quality financial reporting.
Read the guide ‘Smaller Listed and AIM Quoted Companies – A Practical Guide for Audit Committees on Improving Financial Reporting’
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