The Financial Reporting Council’s (FRC) recently published Annual Review of Corporate Reporting provides an assessment of the state of corporate reporting in the UK. Its findings are based on broad outreach activities conducted by the FRC and evidence from its Corporate Reporting Review team (CRRT) on cases opened in the year to 31 March 2016 and recent thematic reviews.
The overall conclusion is that compliance with the accounting framework, particularly by larger public companies, is generally good and the introduction of the strategic report has improved the quality of narrative reporting: the review contains a number of specific examples of good practice. However, the FRC notes that there is room for further improvement. In particular, it says that excessive use of underlying profit figures or inappropriate use of alternative performance measures (APMs or non-GAAP measures) undermines the quality of corporate reporting and erodes the trust of stakeholders.
The CRRT reviewed 192 annual and interim reports as part of its 2015/16 monitoring activities. Two thirds of those reviews were closed without the need for follow up action. The rest resulted in substantive queries being raised and all of those substantive enquiries resulted in some degree of improvement in the quality of the company’s reporting. Two companies were required to refer, in their subsequent reports, to the action taken to address concerns about their prior year primary financial statements.
The most significant findings on financial statements in 2015/16 were:
- Accounting policies – The need to provide more specific, granular accounting policies, particularly around revenue recognition.
- Judgement and estimates – The FRC found too many examples of generic references to judgements and estimates that could be replaced by more concise explanations of how particular decisions or assumptions affect results. Companies should provide quantified information on how changes to estimates could affect the following year’s results, such as sensitivities or ranges of potential outcomes.
- Tax reporting – The FRC notes that it will continue to challenge companies who do not disclose the amount of uncertain tax provisions when these are subject to risk of material change in the following year. Read more on the findings of its thematic review.
- Pension disclosures – The need to adequately explain funding strategies and the risks to which the company is exposed by the pension plan.
The review maintains that the strategic report has been an effective tool for improving the quality of corporate reporting. Its overall quality can be improved, however, by ensuring strategic reports make linkages between different aspects of the business. One of the most common areas of challenge by the CRRT was whether reports reviewed were sufficiently balanced. There continue to be examples of companies giving too much emphasis to APMs or pro-forma information prepared on a non-IFRS basis and failing to adequately discuss their IFRS results. To improve performance in this area, the FRC indicates that it is undertaking a thematic review on the use of APMs in companies’ interim financial reports.
The FRC maintains that a good articulation of the business model and principal risks within the strategic report gives valuable insights, not only into the business and how it generates cash, but also into how the company operates more broadly and provides insights into its prevailing culture. Read more on the Financial Reporting Lab’s project on business model disclosure.
The FRC has now reviewed nearly 100 FTSE 350 viability statements. It found that some 75% of companies chose to use a three-year time horizon for their consideration of viability. It saw some good explanations of why a three-year period was chosen and the underlying risks to the viability statement. However, the FRC warns that three years should not become the default option and that directors are expected to give adequate thought to their company’s particular circumstances.
The FRC says it will continue to monitor disclosures by companies on the expected impact of implementing IFRS 9 (Financial Instruments), IFRS 15 (Revenue from Contracts with Customers) and IFRS 16 (Leases), highlighting that companies will need to plan well in advance as these standards represent significant changes for many.
The FRC’s annual review is too wide-ranging to summarise fully in a short article and we recommend that directors read it in full before they start the process of drafting their next annual report.
Read the FRC’s Annual Review of Corporate Reporting.
For help and advice on corporate reporting please get in touch through your usual BDO contact or Scott Knight.
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