FRC publishes Discussion Paper on proposals to improve the quality of reporting by smaller listed and AIM-quoted companies

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02 Jun, 2015

The Financial Reporting Council (FRC) has today published a Discussion Paper on proposals to improve the quality of reporting by smaller listed and AIM-quoted companies. Although the FRC highlights that the quality of reporting by such companies is generally regarded by investors to be “timely and of a good standard”, the FRC highlights that there is “room for improvement in a number of key areas” and these are the areas that investors pay most attention to.

The Discussion Paper provides the results of the first phase of an FRC project launched in July 2014 which aims to achieve a step change in the quality of financial reporting by smaller listed and AIM-quoted companies over a three year period.  The first phase focused on gathering and assessing evidence of the issues that smaller listed and AIM-quoted companies face (including being attractive to investors), understanding the barriers to higher quality reporting and then exploring ways that the FRC might assist such companies to address the quality of their reporting so as to improve confidence in the integrity of their financial statements and of the markets as a whole. 

The Discussion Paper highlights a number of factors that contribute to a “higher incidence of poorer quality annual reports by smaller quoted companies than by their larger counterparts” including:

  • Smaller companies think that investors do not read their annual reports and hence see the preparation of the annual report as a “compliance exercise rather than being seen as an opportunity to provide relevant information to stakeholders”.  The FRC highlights, however, that investors “have told the FRC that such reports are important to them”.    
  • Smaller quoted companies find preparing their annual reports a challenge.  Such challenges might include a lack of skilled resources to prepare the report or a lack of up-to-date technical knowledge with current reporting requirements and standards.
  • Smaller companies might have limited access to external financial reporting expertise. 

The FRC notes that “such factors can combine and contribute to a lack of focus, poor planning and insufficient time for adequate review and audit; as basic errors creep in”.  Although the finance function has a part the play in raising the bar on quality, the FRC also highlights that “those charged with governance and auditors can make a real and substantial difference to the quality of annual reports by engaging more effectively in the reporting process”. 

To assist smaller listed and AIM-quoted companies to improve reporting quality, the Discussion Paper provides a number or proposals under three broad areas: 

Reporting requirements and practices

The FRC highlights that use of boilerplate disclosure and disclosure of information that is not material to the financial statements are both likely to deter investors.  To encourage smaller listed and AIM-quoted companies to provide a more tailored annual report the FRC will (taken direct from the Discussion Paper):

  • consider whether the Capital Markets Union provides an opportunity to develop a differentiated disclosure framework for smaller quoted companies, building on the IFRS-based approach adopted in UK GAAP;
  • include specific consideration of smaller quoted companies in its Clear & Concise reporting initiative;
  • provide focused annual reminders to Boards of smaller quoted companies setting out the key areas of focus for investors, common errors that we encounter in annual reports and suggestions for improvements in these areas; and
  • encourage more participation by smaller quoted companies and their investment community in the practical work of the FRC’s Financial Reporting Lab to identify ways to improve the quality of corporate reporting.  Such participation would:
    • help to ensure that corporate reporting better meets the needs of both; and
    • explore additional methods of sharing with small companies the innovative suggestions developed in the Lab that are tested with investors, so they can be put into practice.

 Audit practices 

The Discussion Paper notes that phase 1 considered whether auditor ethical standards “inappropriately deny smaller quoted companies access to specialist skills and, if so, whether they should be amended to allow auditors of smaller quoted companies to have greater involvement in the preparation of all or part of the annual report”.  There was only “limited support” for any relaxation of the ethical standards for auditors but the FRC will consider as part of its 2015 review of ethical standards, providing greater clarity for auditors on what is acceptable and what is not.  The FRC will also review whether the process of granting of 'Responsible Individual' status could be improved to ensure that audit partners are suitably qualified and experienced to carry out audits of smaller quoted companies. 

Company governance and resources 

To address the challenges faced by smaller listed and AIM-quoted companies regarding a lack of skilled resources the FRC will (taken direct from the Discussion Paper):

  • discuss with the accountancy and audit Professional Bodies (ICAEW, ACCA, ICAS, CAI) and others, ways of providing more focussed training to finance staff to fulfil CPD requirements;
  • discuss with the London Stock Exchange and UK Listing Authority ways to ensure that companies understand the importance of and have adequate financial reporting resources to meet their ongoing reporting obligations and encourage them to consider educational initiatives to assist companies in their reporting responsibilities; and
  • develop practical guidance for audit committees and boards on evaluating the adequacy of a company’s financial reporting function and process.

By improving the quality of reporting by smaller listed and AIM-quoted companies, the FRC indicates that it would “provide better and more relevant information to investors and potentially open up greater access to capital”.

The FRC invites users and preparers of annual reports to comment on the proposals by 31 July 2015.

The FRC will be holding an event to discuss the proposals in the Discussion Paper on 9 July 2015.  More information, including how to attend the event can be found on the FRC website.

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