The bulletin ‘Bulletin 4: Recent Developments in Company Law, The Listing Rules and Auditing Standards that affect United Kingdom Auditor’s Reports’ (“the bulletin”) covers: 

The introduction of the Strategic Report;

The option for companies to provide its members with a stand-alone ‘‘Strategic Report with Supplementary Material’’ in place of the company’s full accounts and reports. ‘‘The Strategic Report with Supplementary Material’’ replaces the previous option of providing a Summary Financial Statement;

Amendment of the Regulations that specify the information to be included in a quoted company’s Directors’ Remuneration Report;

Changes in the requirements of the Listing Rules with respect to directors’ remuneration disclosures; and

Changes to ISA (UK and Ireland) 700 ‘‘The Independent Auditor’s Report on Financial Statements’’ made in October 2012 and June 2013 and the issuance, in November 2013, of a Clarification Statement in respect thereof. 

The bulletin provides an explanation of each of these developments and the auditor’s responsibility in relation to the strategic report and the directors’ remuneration report.  The bulletin indicates that the directors have the same statutory reporting responsibility for the strategic report as they currently do for the directors’ report. 

The FRC note that they will update ISA (UK and Ireland) 720 to take into account these new auditor responsibilities “once the International Audit and Assurance Standards Board (IAASB) has finalised the revision of its equivalent standard”.  

The impact of these developments on auditor’s reports is also provided in the form of illustrative examples.  The changes to the director’s remuneration report have no impact on the auditor report. 

The bulletin includes two appendices that illustrate the impact that these developments have on financial statements prepared under the Financial Reporting Standard for Smaller Entities (FRSSE) and those prepared for a publicly traded premium listed group. 

The FRC comment that their bulletins are “persuasive rather than prescriptive, but are indicative of good practice”. 

Click for (all links to FRC website):

• Press release
• FRC bulletin: Bulletin 4: Recent Developments in Company Law, The Listing Rules and Auditing Standards that affect United Kingdom Auditor’s Reports’

In his speech, Mr Hoogervorst looked at the moral hazard that is always present wherever people work with other people's money and he explored the question of what the role of accounting standards is against this backdrop of moral hazard.

According to the IFRS Foundation Constitution, the goal behind accounting standard-setting is to require entities to provide high quality, transparent and comparable information in their financial statements so that investors can make informed decisions. Mr Hoogervorst claimed, however, that the mission of the IFRS Foundation was much more far reaching - according to him it was "building trust in financial markets" and one way to do so would be to minimise moral hazard through discipline and rigour and through eliminating information asymmetry.

In addition to some historical examples of what the IASB has achieved in this area, Mr Hoogervorst pointed at the current battle fought in the leases project. "Stripped bare, the leasing project is all about preventing the understatement of liabilities." He stated that there was huge resistance against bringing these liabilities to the balance sheet and yet he said he had no doubt that discussing leasing liabilities in the boardroom and with investors would soon be as much routine as discussing pension liabilities is now.

However, he also conceded, sometimes the IASB did not manage to do what it set out to do. He cited the incurred loss model for impaired financial assets that was designed to prevent earnings management by banks. However, the global financial crisis showed that that model could actually be used to delay showing the true financial situation of companies. Nevertheless, Mr Hoogervorst refused to connect the financial crisis with the current debate on reintroducing the concept of prudence into the Conceptual Framework:

But I also want to be clear about what Prudence as a concept cannot mean. It cannot mean a return to old-fashioned accounting with hidden reserves. It cannot lead to a systemic bias toward conservatism that is at odds with neutrality. Prudence should not be invoked to create a taboo on using current measurement. There is nothing more imprudent than to measure derivatives at cost or to measure an insurance liability at historic interest rates.

Speaking about governance and moral hazard, Mr Hoogervorst turned to the question of whether the fact that the IASB is privately organised does not make it vulnerable to pressure from private interests. Although he conceded that this question deserves a serious answer and should not be shrugged off lightly, he also pointed out that a public governance structure of standard-setting was in itself no guarantee for avoiding moral hazard. He cited as an example public sector accounting where in most jurisdictions the public accounting standards are set by the public authorities themselves. "Whether these standards always lead to a complete picture of a country's financial position is in doubt," he added. Therefore, he concluded that the key to successful standard-setting was its ability to fend off capture by special interests irrespective of its provenance and the key to preventing moral hazard in standard-setting was to find the right balance between independence and accountability.

Please click for access to the full text of Mr Hoogervorst's speech on the IASB website.

The European national enforcers of financial information monitor and review financial statements published by issuers with securities traded on a regulated European market and who prepare their financial statements in accordance with International Financial Reporting Standards (IFRS) and consider whether they comply with IFRS and other applicable reporting requirements, including relevant national law.

ESMA has developed a confidential database of enforcement decisions taken by individual European enforcers as a source of information to foster appropriate application of IFRS.

The publication of enforcement decisions is designed to inform market participants about which accounting treatments European national enforcers may consider as complying with IFRS, i.e. whether the treatments are considered as being within the accepted range of those permitted by IFRS. ESMA considers the publication of the decisions, together with the rationale behind them, will contribute to a consistent application of IFRS in the European Union.

Topics covered in the latest batch of extracts, fifteenth in the series and covering the period from December 2012 to November 2013, include:

Click for access to the full report (link to ESMA website).

The package includes:

• A proposal to revise the Shareholder Rights Directive (Directive 2007/36/EC) (link to European Commission website).
• A Recommendation on the quality of corporate governance reporting (‘comply or explain principle’) (“the Recommendation”). 

Proposal to revise the Shareholder Rights Directive (Directive 2007/36/EC) 

The European Commission explains that the proposal to revise the Shareholder Rights Directive has been made to address “corporate governance shortcomings relating to listed companies and their boards, shareholders (institutional investors and asset managers), intermediaries and proxy advisors”.  The European Commission identify that such “shortcomings include” insufficient engagement of institutional investors and asset managers and insufficient linkage between pay and performance of directors.  

The European Commission highlight that “long term shareholder engagement would contribute to a significant improvement in the performance, profitability and efficiency with which the investor engages” and in turn this will “contribute to an increase in long-term financing of the EU economy, something that the European Commission has recently adopted a package of measures on.  

Key aspects of the proposals (extracts of text taken from the Directive) to revise the Shareholder Rights Directive include:  

• Improving engagement of institutional investors and asset managers.  Institutional investors and asset managers will be required to develop a policy on shareholder engagement.  They will be required to disclose to the public their engagement policy, how it has been implemented and the results.  Where institutional investors or asset managers decide not to develop an engagement policy and disclose the results they shall give a clear and reasoned explanation as to why this is the case.  

These duties are similar to those in the FRC’s Stewardship Code (link to FRC website); however, only asset managers are subject to a regulatory requirement to comply or explain against this Code, whereas the proposed directive will also apply to institutional investors and proxy advisors. 

• Strengthening the link between pay and performance for directors.  The European Commission highlight that “today, there is an insufficient link between management pay and performance and this encourages harmful short-term tendencies”.  The proposal aims at creating more transparency on remuneration policy and the actual remuneration awarded to directors and creating a better link between pay and performance of directors by improving shareholder oversight of directors’ remuneration.  The proposal does not regulate the level of remuneration and leaves decisions on this to companies and their shareholders.  Listed companies will be required to publish information on the remuneration policy and remuneration of individual directors.  The remuneration policy must be submitted to shareholders at least every three years and, among other things, must explain how the pay and conditions of employees were taken into account when setting the policy on directors' remuneration by explaining the ratio between the average remuneration of directors and the average remuneration of full-time employees of the company and why this ratio is appropriate.  Shareholders will have the right to approve the remuneration policy and to vote on the remuneration report which describes how the remuneration policy has been applied in the last year. 

The transparency and voting requirements are similar to those already in place for UK quoted companies. Unlike the UK position, there are no detailed requirements for disclosure, although the European Commission may develop these once the Directive comes into force. 

Recommendation on the quality of corporate governance reporting 

The European Commission comment that there are “shortcomings in the way the ‘comply or explain’ principle is applied” by European listed companies.  Specifically they highlight that “companies often do not provide appropriate explanations when they depart from corporate governance codes”.  

The Recommendation mainly aims to “provide guidance on how listed companies should explain their departures from the recommendations of the relevant corporate governance codes”.  It will not be legally binding but is intended to “improve the overall quality of corporate governance statements published by companies”. 

The revisions made to the UK Corporate Governance Code in 2012 already require an enhanced quality of ‘explanation’ 

Additionally a new Directive has been proposed which aims to make it easier and less costly to set up companies across the EU especially in relation to subsidiary companies. 

The Association of Chartered Certified Accountants (ACCA) has welcomed the package of measures that they say will “contribute to competitiveness and long-term performance”.  However they comment that “different economic environments in Europe must be acknowledged and companies have to be provided flexibility by allowing them to manage their corporate governance according to their specialities in each member state”.  The Institute of Chartered Accountants in England and Wales (ICAEW) warn that "individual regulatory measures are unlikely to be effective in isolation" to address short-termism and a "co-ordinated plan" will be required to help promote long-term shareholder engagement.

The Financial Reporting Council (FRC) comment that the Recommendation on the quality of corporate governance reporting will “help to enshrine good corporate governance throughout Europe”.  They further comment: 

The FRC advocates the concept of comply or explain as a key feature of European corporate governance structures and one which the FRC champions through the UK Corporate Governance Code.  A European corporate governance framework will assist companies in how they report and help investors better to understand the companies in which they invest. 

The proposals to revise the shareholder Directive must now be submitted to the Council and European Parliament for their consideration and final adoption.  Once adopted the revised Directive will need to be implemented into the laws of all EU Member States.  EU Member States have until spring 2015 to notify the European Commission of measures they have taken in relation to the Recommendation. 

Click for:

• Press release (link to European Commission website).
• Other links including text of the proposed Directive and Recommendation (link to European Commission website).
• ACCA press release (link to ACCA website).
• FRC press release (link to FRC website).
• ICAEW press release (link to ICAEW website).
• Our previous UK Accounting Plus news item on the European Package of measures on long-term financing.

The ED proposes amendments to IFRS 5 Non-current Assets Held for Sale and Discontinued Operations, IFRS 7 Financial Instruments: Disclosures, IAS 19 Employee Benefits and IAS 34 Interim Financial Reporting. 

EFRAG published their draft comment letter in January 2014 and the final comment letter was published in March 2014. 

The feedback statement (link to EFRAG website) provides an analysis of the EFRAG tentative position expressed in the draft comment letter, describes the comments received from constituents and then highlight how these comments were considered by the EFRAG Technical Group (EFRAG TEG) in reaching their final position on the IASB ED set out in their final comment letter to the International Accounting Standards Board (IASB). 

Click for:

• Press release (link to EFRAG website).
• Feedback statement in full (link to EFRAG website).
• Our previous story on the Exposure Draft ED/2013/11 Annual Improvements to IFRSs 2012–2014 Cycle. 
• Our UK Accounting Plus project page on the Annual Improvements to IFRSs 2012–2014 Cycle.

Highlights were the adoption of:

As consequence of the financial crisis, more questions are being asked about the value of corporate reporting and the related assurance. Often these questions concern perceptions that the story presented by management in the narrative commentary within the annual report is not free from bias and does not provide users with an insight into the way in which the organisation is being directed. 

Currently there is no obligation for companies to have the 'front half' of annual reports audited.  However the new narrative reporting regulations have increased the attention stakeholders pay to the ‘front half’ of annual reports.  The ICAS DP ‘Balanced and reasonable’ focused on the provision of auditor assurance over the ‘front half’ of the annual report in the form of a new ‘Balanced and reasonable’ positive opinion over the narrative reporting of the board.  The DP also explored the challenges for the auditor of providing such an opinion and whether this would be feasible under the current International Auditing and Assurance Standards Board (IAASB) framework.  The debate on the provision of such assurance was further extended by the Institute of Chartered Accountants in England and Wales Narrative Assurance Working Party in their report ‘The Journey: Assuring all of the Annual Report?’

The ICAS report ‘Assurance on management commentary – what next?’ continues along the same theme and suggests next steps for ICAS to take.  The ICAS report summarises the responses received to ‘Balanced and reasonable’ from respondents and participants in a number of events held by ICAS.  These included “nine of the current top 10 UK accounting firms”, “senior staff from the Financial Reporting Council (FRC)” and IAASB.

The ICAS report highlights that there is “broad support” for the proposals put forward by ICAS with many audit firms considering that the provision of such assurance will become “inevitable” over time.  It also highlights “some confusion” regarding user views as to how much and what type of assurance is currently provided by auditors under the Financial Reporting Council’s (FRC’s) ‘fair, balanced and understandable’ requirement, introduced as part of revisions to the UK Corporate Governance Code in 2012 and amendments to ISA 700 (UK and Ireland) 'The Independent Auditor’s Report on Financial statements'.

Although supportive of the proposals, respondents were “split” over whether they could be adapted to fit within the existing framework.  Many cited barriers to implementation such as whether auditors had the necessary skills and ability to undertake this type of work, the need to revisit the auditor liability regime and whether assurance could be provided on all of the information contained within the front half of the annual report.  Just under half of respondents (44%) also highlighted that there was a need to first identify that this type of assurance was required.  The ICAEW Narrative Assurance Working Party found that organisations are already asking for additional assurance reports aside from the traditional audit report on the financial statements.  The importance of demonstrating benefits compared to costs was also mentioned by 41% of respondents.

ICAS is keen to “promote a framework for corporate reporting and assurance which meets the needs of the users, primarily the investment community, at a cost which is acceptable”.  The ICAS report identifies a number of next steps to further this objective.  They comment:

A first step is to commission research into the changes observed in the current reporting and assurance environment. The findings from this research will form the basis of a discussion and interaction between auditors, preparers and investors to understand how the far the new regime has gone in meeting their needs and if they would like any further assurance to be provided

A number of other projects “under consideration” are also identified in the paper which can be downloaded using the links below.

Click for:

• Press release (with links to the ICAS report) (link to ICAS website).
• Our previous UK Accounting Plus news item on the ICAS report ‘Balanced and reasonable’.
• Our previous UK Accounting Plus news item on the Institute of Chartered Accountants in England and Wales Narrative Assurance Working Party report ‘The Journey: Assuring all of the Annual Report?’

The regulation forms the legal basis for the continuation of financing the IFRS Foundation and PIOB for the period 2014-2020 and of EFRAG for the period 2014-2016. The financing period of EFRAG is limited to three years in view of prospective reforms that might arise from the Maystadt Report.

Regarding the premises of continued financing, the regulation states:

The Commission, taking into account developments following the recommendations set out in the special advisor's report, should submit reports in March 2014 and on a yearly basis as of 2015, at the latest in June, on EFRAG's progress in the implementation of its governance reforms. The IASB has initiated the review of the Conceptual Framework. Following the issue of the revised Conceptual Framework, the Commission should report to the European Parliament and to the Council on any changes that have been introduced in the Conceptual Framework and reasons thereof, with a particular focus on the concepts of prudence and reliability ensuring that a ‘true and fair view’, as laid down in Directive 2013/34/EU, is respected.

Please click to access the full text of the regulation on the European Union website (available in all languages of the EU).

The consultation paper outlines three key strategic objectives around financial statement audits, global developments and collaboration, and puts forward a work plan for 2015-2016 which prioritises the topics of quality control, professional scepticism and special audit considerations relevant to financial institutions. 

ESMA believe that “the strategic objectives of the IAASB for 2015-2019, as indicated in the CP, are appropriate and reasonable given the time and organisational constraints of the IAASB”. 

ESMA supports the priorities identified by the IAASB in the proposed work plan for 2015-2016 including the special audit considerations related to financial institutions, the IAASB’s decision to review the International Standard on Quality Control 1 (ISQC1) – Quality control for firms that perform audits and reviews of financial statements, and other assurance and related services engagements and the IAASB’s intention to revise ISA 600 – The work of related auditors and other auditors in the audit of group financial statements . 

Consistent with comments made by the Financial Reporting Council (FRC) and the Association of Chartered Certified Accountants (ACCA), ESMA highlights that the IAASB should consider additional areas to address in their work programme and provide a number of suggestions in their comment letter.

The full comment letter can be obtained from ESMA's website.

More information about the issues is set out below:

You can access all our comment letters to the IASB, IFRS Foundation, and IFRS Interpretations Committee here.