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The Bruce Column — Insights from the Financial Reporting Council

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09 Apr 2015

The Financial Reporting Council is encouraging far-reaching change and innovation in the fields of corporate governance and financial reporting. Robert Bruce, our resident, regular columnist, reports on an interview with the two executive directors involved in bringing about the changes.

There is a confidence about the Financial Reporting Council at the moment that suggests it feels comfortable about where it is on the business spectrum. The field of corporate governance, including financial reporting, is broadening. Companies, auditors and investors are looking to wider horizons. It now encompasses narrative reporting, reports and accounts that are ‘fair, balanced and understandable’, an emphasis on value creation and risk, transparency, viability statements, and the enhanced work of audit committees. All these are part of a corporate governance landscape that is evolving fast and which takes the emphasis way beyond a narrow focus on the figures. In the words of Melanie McLaren, FRC executive director, Codes and Standards: ‘We hope to see more innovation in reporting’.

In a video interview, both she and Paul George, the FRC’s executive director, Conduct, are clear that much of the recent changes in reporting and guidance have started to bed down and the innovation and improvements that they hoped to engender are beginning to be seen.  The aim is to provide encouragement. But they also emphasise that after all the recent change the key mantra for this year is to allow everything to bed down.

The underlying focus is on corporate communication. ‘The emphasis is on making things clear and concise’, says McLaren. It is all about moving away from the language of accounting standards and trying to express matters in clear English which analysts and other users can understand. The introduction of the strategic report has helped. It encourages companies to take a more holistic view, explain their strategy, how they make money and the risks involved. This makes life easier and more logical for companies. ‘We are working quite hard to free people up from red tape and regulation’, says McLaren. The strategic report, she points out, doesn’t all have to be written down like a traditional annual report. It can refer users to details on the company’s website, for example. ‘Companies tell us it is quite liberating’, she says. It is about moving away from reporting that is driven by regulatory compliance and instead communicating with investors providing a clear, crisp account of what is going on.

The FRC’s work is also about making sure that financial reporting is up to scratch. Under the watchful eye of Paul George the Conduct Committee still maintains a financial reporting review panel, which this year will be concentrating on areas like banking, insurance, financial services and business services. It is all a question, in George’s words, of ‘identifying sectors where there are specific stresses and strains which could create financial reporting risk.’ And that also includes looking at more complex revenue recognition issues, such as complex supply arrangements, across the next year.

But one of the major changes across the next few years will be a focus on financial reporting in the first year following a change of auditors. Since the audit market has been shaken up by European measures and pressure from competition authorities auditor change has become the norm rather than the rarity. ‘There is a perceived risk’, says George, ‘that a change of auditors might allow more aggressive reporting. It takes time for an auditor to get up to speed’. And the FRC’s focus will be on ensuring that accounting policies remain appropriate.

Another change in the landscape will be the arrival of viability statements from companies. As McLaren points out there was a misunderstanding in the markets about what the traditional going concern concept really meant. So now there will be viability statements to talk more about the future and provide a longer-term view of a company’s viability. The FRC is taking a deliberately soft line on this. ‘There will probably not be a lot of early adopters’, says McLaren. ‘Companies and directors are right to take their time’. Again this requirement will not be surrounded by red tape. Utilities, for example, which work off a five-year or a ten-year regulatory plan, would be expected to take that period of time into account. On the other hand: ‘We are not fixated on the timeframe’, says McLaren. ‘It is about the appropriateness to investors’.

It is a feature of the current confidence of the FRC that it encourages innovation and experimentation in reporting, from the strategic report to integrated reporting and allows it to evolve. McLaren takes the view that we are virtually there. ‘I am often asked’, she says, ‘”Will we adopt something like the International Integrated Reporting Council’s framework?” to which my answer is if you take the strategic report regulations and our guidance they are aligned with the framework. So we have provided a UK framework completely aligned with the international direction of travel. It is here today and people should use it’.

And she also thinks that companies may need more assurance from audit firms over, for example, integrated reporting. ‘We expect boards may well say they need more assurance here and they may well look to the audit firms as having the skill-set and the expertise to be able to look there’, she says. ‘But we would like that to be demand-led rather than being regulator-led’.

All of this change is creating a landscape where the emphasis is on innovation in corporate reporting rather than on stifling regulation. No wonder McLaren thinks companies and auditors are finding it a more liberating world.

 

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