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FRC reminder on reporting obligations following Carillion

15 February 2018

In the light of the collapse of Carillion, the Financial Reporting Council (FRC) has issued a News Alert reminding boards of companies of their reporting obligations and addresses the role of auditors. While it is aimed specifically at companies operating in the construction and business support services sectors, its messages will be relevant to many companies.

The FRC notes that the annual report and accounts must provide sufficient, clear and relevant information, segmented between business lines where necessary. Users must be able to:

  • Understand the company’s performance, financial position and prospects
  • Assess its going concern status, and
  • Assess its longer term viability.

The alert also highlights that the accounts must give a true and fair view of the assets, liabilities, financial position and profit or loss and that the analysis presented in the strategic report must be fair, balanced and comprehensive. These requirements, the FRC notes, require careful consideration of the content and clarity of the disclosures provided.

The alert goes on to highlight some specific areas of the annual report and accounts that are particularly relevant following recent events. Most matters covered have been raised by the FRC in previous publications such as their Annual Review of Corporate Reporting (see Business Edge December 2017) and as part of their thematic review programme (see Business Edge December 2017).

We recommend that you read the six-page News Alert in its entirety, particularly if you operate in one of the FRC’s 2018/19 priority sectors (which includes construction and business support services), but key messages include:

  • Going concern basis of accounting - The decision that the going concern basis of accounting is appropriate and that no material uncertainties exist may require the application of significant judgement. The board should consider carefully whether further disclosure is needed to meet the requirements relating to significant accounting judgements.
  • Strategic Report, risk and viability reporting – Section 172 of the Companies Act 2006 requires a director to act in a way considered most likely to promote the success of the company whilst having regard to the interests of stakeholders. These stakeholders include employees and proper consideration should be given to their interests, including employees’ (and former employees’) interests relating to the company’s pension scheme. It is the statutory purpose of the strategic report to describe how directors have performed their statutory duties. In addition, the strategic report of a Quoted company should include a description of the business model, supplemented by the key trends and factors affecting the business and the environment in which it operates. In the construction and business service support sectors, this is likely to require an explanation of the factors that are most important to the outcome of key contracts and, thereby, the continued success of the company. Information on risks borne by the company, how these have changed and the risk appetite of the board will also provide insight into the corporate culture.
  • Judgements and estimates - Effective systems and balanced judgements based on all current and relevant evidence are often required when applying key accounting policies. This is especially important where significant risks (for example, demand risk, costs changes and contractual targets) are borne by the company. The FRC’s recent thematic review on judgements and estimates (see Business Edge December 2017) sets out clear expectations on the disclosures required. There are some situations where management may need to quantify the key assumptions underlying their estimates in order for users to understand the company’s position and performance, and to facilitate intercompany comparison.
  • Cash flow and net debt indicators - As noted in the FRC’s October 2017 letter to audit committee chairs and finance directors, clear information on the levels of debt, cash flows and the conversion (including the processes of conversion, such as invoice discounting and reverse factoring) of operating profits into cash is also important.
  • Complex employee pension arrangementsThe FRC’s recent thematic review on pension disclosures (see Business Edge December 2017) highlights the importance of the disclosure requirements of IAS 19 and of the need to explain, in the strategic report, any principal risks and uncertainties identified with respect to its pension obligations.

The News Alert also highlights the role of auditors in areas such as:

  • The adoption of the going concern basis of accounting and any material uncertainties and significant judgments related to it
  • Whether disclosures in the annual report and financial statements, including narrative disclosures, comply with the requirements of law and accounting standards and provide useful information to users of the financial statements to help them to evaluate the company’s performance and financial position, and
  • The communication of key audit matters which include the most significant assessed risks of material misstatement which have the greatest impact on the overall audit strategy, the work undertaken to address those risks, and, where relevant, their findings in respect of that work.

Finally, the News Alert highlights the role of the audit committee in areas such as:

  • The communication of the work it has carried out in respect of any significant financial reporting risks and judgements made in connection with the preparation of the financial statements
  • Robustly challenging accounting policies, judgements and estimates, principal risks and uncertainties and management’s assessment of whether it is appropriate to adopt the going concern basis of accounting, and
  • Where any material uncertainties exist which need to be disclosed, or where the Directors have concluded that there are no material uncertainties, ensuring that the significant judgements made in reaching this conclusion have been properly disclosed.

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