May

The Bruce Column — Focusing on the factors which bring you a reputation dividend

10 May, 2016

In a world where intangible assets have become the largest part of a company’s market value attitudes to risk and reputation need to change. Our regular, resident columnist, Robert Bruce, explains why and how.

Intangible assets and reputation have been making increasingly larger contributions to company value. US corporate reputations, across the S&P 500, amounted to USD$3,329bn, some 17% of total market capitalization, in 2015. Some £790bn of UK shareholder value was attributable to a ‘reputation dividend’ at the start of 2016, amounting to some 36% of market capitalization in the FTSE 350, all according to recent research.

This is a relatively new world. And explaining the value of a company or organisation now has to be a subtler exercise. It is all about how a company presents itself to the public. It is no longer just about the financials and what, after careful analysis, they may show. It is about how a company reacts to something going wrong, for example. It is about the more general drivers of growth. In the US Apple topped the tables with a 49.5% reputation contribution, some $320,317m in January 2015. The Walt Disney Company had a reputation contribution of 49.4%, some $78,758m, while Nike had a reputation contribution of 40.7% representing $33,256m.

In the UK Unilever chalked up a reputation contribution of 57.8%, some £48,356m at the start of 2016. Shell came in at 53.8%, some £62,061m. And AstraZeneca posted a 47.4% reputation dividend, amounting to some £25,198m.

However you look at these figures, all from recent reports, they point in one direction. Shareholders and the markets are no longer looking at just the financials. They look at how companies have dealt with or are anticipating risk, and where and how companies are adding value. It is not all about financial success. And reports are starting to appear which also measure the disasters when everything goes belly up and a company’s reputation, share price, and ability to operate, plummets. Finding themselves listed in the top ten Most Controversial Companies 2015 are Volkswagen, Sony, General Motors, Honda, and HSBC Private Bank (Suisse). The state of a company’s reputation and either the added value or its suddenly shredded value are increasingly what investors focus on. People, in short, want to know what is driving value.

We live in different times. Manufacturing companies are very different from technology driven companies. Now, if reputations drop, it is probably as much to do with a technology company simply running out of ideas and hence losing its ability to dominate its market, as it is with a manufacturing company having, for example, to recall defective cars. The difference between good news and bad news can be as much a factor of perception as a factor of failings on the production line or in the testing process.

The ratio of intangible to tangible assets in the US is probably the most telling. In the report from consultants Ocean Tomo it shows 1975 values relying heavily on tangible assets, some 83%. These were the days of heavy industry, when investors wanted to see the heft of the engineering, the production lines, the range of extractive possibilities. In 2015 all that had fallen to just 16% of market value. The service sector in the UK, for example, now provides almost 80% of the UK economy. The revolution may have been slow but it is with us.

Now, say the reports from consultants Reputation Dividend, in both the US and the UK, the important components that influence corporate value are very different. ‘Perceptions of people management’, comes out on top in the US, followed by ‘quality of management’, and ‘long-term investment potential’. In the UK you are looking for ‘financial soundness’, followed by the ability ‘to attract, develop and retain talent’, followed by ‘quality of leadership’.

The other side of the coin comes in the Most Controversial Companies 2015 report from RepRisk AG. As its CEO puts it in the report’s Foreword: ‘The aim of this report is to outline the sequence of events that can lead a corporation to an unforeseen crisis, causing it to suffer a major fall in stock prices, face substantial product recalls and record fines, and in some cases, even result in the removal of the company’s senior officials’.

What now often brings manufacturing companies to their knees are not the tangible building-blocks of yesteryear going awry but the intangible, the least-expected factors, which suddenly rear out of an empty road ahead. It can be as much about the speed of change as about the change itself. The report shows that sometimes it can be the tangible effect of economics, as the failings of a dam in Peru impacted on a Grupo Mexico gold mining project. And the report also shows clearly how problems in the supply chain, for example, and the linkage which spreads across particular sectors can bring about serious reputational damage. The failures in air bags at their manufacturer, Takata, didn’t just harm the Takata reputation but also impacted manufacturers like General Motors, Honda and Volkswagen which suffered accordingly. All the examples show how easy it is to damage or lose a well-built reputation. Reputation failure is not just an in-house risk. It can spread from suppliers like a contagion. As examples of integrated reporting show, you need to understand the risks at your suppliers as much as where any home grown problems may lie.

All this matters. Companies need to burnish their reputations and manage them but at the same time they need to also tell the world what they are doing. There is a strong link between corporate reporting and the building and protecting of reputation.

It is worth sitting up and taking notice. After all, as the 2014 reputation dividend report showed, on average in cash terms, a 1% improvement of reputation at a FTSE100 company delivered around £266m of additional value.

IFRS Foundation updates its pocket guide to IFRS

10 May, 2016

The IFRS Foundation has published the 2016 version of 'Pocket Guide to IFRS Standards: the global financial reporting language'. The guide provides an overview of the adoption of IFRS in 143 countries and other jurisdictions around the world.

The summaries on the use of IFRS are derived from information obtained by national standard-setters and other organisation that have responded to a survey by former IASB member, Paul Pacter.

Pocket Guide to IFRS Standards: the global financial reporting language can be downloaded free of charge from the IASB's website. It is accompanied by The Global Financial Reporting Language, an analysis of what can be learned from the jurisdiction profiles that form the basis for the pocket guide. For more information, see the press release on the IASB's website.

FASB clarifies revenue guidance on practical expedients

10 May, 2016

The US Financial Accounting Standards Board (FASB) has issued Accounting Standards Update (ASU) No. 2016-12 'Narrow-Scope Improvements and Practical Expedients', which amends certain aspects of the Board’s new revenue standard, ASU 2014-09 'Revenue From Contracts With Customers'.

The amendments, which were issued in response to feedback received by the FASB–IASB joint revenue recognition transition resource group (TRG), include the following:

  • Collectibility — ASU 2016-12 clarifies the objective of the entity’s collectibility assessment and contains new guidance on when an entity would recognise as revenue consideration it receives if the entity concludes that collectibility is not probable.
  • Presentation of sales tax collected from customers — Entities are permitted to present revenue net of sales taxes collected on behalf of governmental authorities (i.e., to exclude from the transaction price sales taxes that meet certain criteria). A similar policy election does not exist under the IASB's new revenue standard, IFRS 15 Revenue from Contracts with Customers.
  • Noncash consideration — An entity’s calculation of the transaction price for contracts containing noncash consideration would include the fair value of the noncash consideration to be received as of the contract inception date. Further, subsequent changes in the fair value of noncash consideration after contract inception would be subject to the variable consideration constraint only if the fair value varies for reasons other than its form. IFRS 15 does not prescribe the measurement date.
  • Contract modifications at transition — The ASU establishes a practical expedient for contract modifications at transition and defines completed contracts as those for which all (or substantially all) revenue was recognised under the applicable revenue guidance before the new revenue standard was initially applied.
  • Transition technical correction — Entities that elect to use the full retrospective transition method to adopt the new revenue standard would no longer be required to disclose the effect of the change in accounting principle on the period of adoption (as is currently required by ASC 250-10-50-1(b)(2)); however, entities would still be required to disclose the effects on preadoption periods that were retrospectively adjusted. IFRS 15 defines a completed contract as one for which an entity has transferred all goods or services identified in accordance with existing IFRS. IFRS 15 also provides an additional practical expedient that permits an entity electing the full retrospective method to apply IFRS 15 retrospectively only to contracts that are not completed contracts as of the beginning of the earliest period presented. No such expedient is included in Topic 606.

Last month, the IASB published final clarifications to its revenue standard, IFRS 15. The FASB’s ASU states:

Although the amendments in this Update are not identical, and some are incremental, to the amendments the IASB decided to make to its final standard, Clarifications to IFRS 15, the FASB expects that the amendments generally will maintain the convergence that was achieved with the issuance of Update 2014-09 and IFRS 15 by reducing the potential for diversity arising in practice. Significant diversity in application could substantially reduce the benefits achieved by converged guidance.

The amendments in this Update do not change the core principle for revenue recognition in Topic 606. Instead, the amendments provide clarifying guidance in a few narrow areas and add some practical expedients to the guidance. The amendments are expected to reduce the degree of judgment necessary to comply with Topic 606, which the FASB expects will reduce the potential for diversity arising in practice and reduce the cost and complexity of applying the guidance.

The ASU’s effective date and transition provisions are aligned with the requirements in the new revenue standard, which is not yet effective. For more information, see the ASU on the FASB’s website.

Recent sustainability reporting developments

10 May, 2016

A summary of recent developments at the CDSB & CDP and GRI.

The Climate Disclosure Standards Board (CDSB) and the CDP (previously the ' Carbon Disclosure Project') have commented on the Phase I report of the Task Force on Climate-related Financial Disclosures (TCFD) set up by the Financial Stability Board (FSB). In their joint response CDSB and CDP highlight among other things new accounting rules by the IASB, which may be relevant to reporting climate-related transition risks as well as IFRS 9 requires entities to measure expected credit losses of a financial instrument using factors that are specific to the entity, general economic conditions and an assessment of both the current and forecasted direction of conditions at the reporting date. Please click to access the full response on the CDSB website.

The Global Reporting Initiative (GRI) has published questions and answers about transitioning from the GRI G4 Guidelines to the modular, interrelated GRI Sustainability Reporting Standards (GRI Standards): the new format, the public comment process, and ultimately how the transition will benefit reporting organisations and report users. Please click to access the Q&A document on the GRI website.

FRC appoints Director of Audit Quality

09 May, 2016

The Financial Reporting Council (FRC) has announced the appointment of Mike Suffield as Director of Audit Quality.

Mike Suffield will lead the FRC’s Audit Quality Review (AQR) team in its work to monitor the quality of UK audit firms’ audits of Public Interest and large AIM entities.  He will join the FRC in July.

The press release is available on the FRC website.

May 2016 IASB meeting agenda posted

09 May, 2016

The IASB has posted the agenda for its next meeting, which will be held at its offices in London on 17–19 May 2016.

Again, a large part of the meeting will be dedicated to the agenda consultation with over seven hours of discussion spread over all three days. Other major topics on the agenda are Insurance/IFRS 9 and financial instruments with characteristics of equity (both on Tuesday afternoon) and the Consceptual Framework (Wednesday morning).

The full agenda for the meeting and first pre-meeting summaries can be found here. We will post any updates to the agenda, as well as the remaining pre-meeting summaries as well as observer notes from the meeting, on this page as they become available.

IASB posts sixth webinar on insurance contracts standard

06 May, 2016

The IASB has posted the sixth instalment of its weekly webinar series on the upcoming insurance contracts standard.

The series, hosted by IASB member Darrel Scott, will discuss the following topics related to the upcoming insurance contracts standard:

  • The need for change and the history of the project. (issued 1 April)
  • What is an insurance contract? (issued 8 April)
  • Initial mea­sure­ment of insurance contracts. (issued 15 April)
  • Sub­se­quent mea­sure­ment of insurance contracts. (issued 22 April)
  • Mod­i­fi­ca­tions to the general model: variable fee contracts. (issued 29 April)
  • Other mod­i­fi­ca­tions to the general model. (issued 6 May)
  • Pre­sen­ta­tion and dis­clo­sure.
  • Applying the Standard for the first time.

For more in­for­ma­tion as well as pre­sen­ta­tion slides, see the webinar page on the IASB’s website.

Charity Commission and OSCR launch new SORP research consultation

05 May, 2016

The Charity Commission for England and Wales (“Charity Commission”) and the Office of the Scottish Charity Regulator (OSCR) are seeking views on how the Charities Statement of Recommended Practice (“Charities SORP”) can be improved.

The research exercise focuses on the Charities SORP (FRS 102) with the consultation period running until 11 December 2016. It is intended to inform the development of the next Exposure Draft of the SORP which itself is likely to be consulted upon in 2018.

In particular views are being sought on:

  • the SORP’s structure, format and accessibility;
  • implementation issues that require improvements to the SORP;
  • SORP Committee members’ suggestions for changes to the SORP:
  • charity regulator themes for making changes to the SORP; and
  • ideas for items to remove, change or add to improve the SORP.

For the press release on the Charity Commission website see here.

Further information, including the consultation document itself, can be viewed via the dedicated SORP site (link to Charity Commission website).

FRC completes implementation of the EU Audit Regulation and Directive

04 May, 2016

The Financial Reporting Council (FRC) has issued “final drafts” of the 2016 UK Corporate Governance Code ("the Code"), the revised Guidance on Audit Committees, the Ethical Standard 2016 and revised International Standards on Auditing (UK and Ireland). These complete the FRC’s implementation of the EU Audit Regulation and Directive, together with parts of the Competition & Markets Authority’s (CMA’s) final Order.

Both the FRC and The Department for Business, Innovation and Skills (BIS) consulted on matters requiring changes to the Code, Guidance on Audit Committees, the standards for auditors and changes to legislation respectively during 2015. BIS is expected to lay updated legislation in Parliament soon.

Although the 2016 UK Corporate Governance Code, Guidance on Audit Committees, ISAs (UK & Ireland) and Ethical Standard are marked as “final draft”, no further changes other than minor errata are anticipated before they take final effect.

2016 UK Corporate Governance Code

There are few changes to the Code and those are restricted to the Preface and to section C.3 (Audit Committee and Auditors). There is now a provision indicating that the audit committee as a whole will need competence relevant to the sector in which the company operates. In addition, the audit committee report within the annual report is now required to provide advance notice of any plans to retender the external audit, whilst the previous provision on FTSE 350 companies tendering the external audit every ten years has been removed.

Guidance on Audit Committees

More extensive changes to the Guidance on Audit Committees bring the Guidance up to date, reflecting the updates to the Code since this Guidance was last published and the FRC’s Financial Reporting Lab’s work on the Reporting of Audit Committees.

The changes affect both the activities of the audit committee and the disclosure in the audit committee report within the annual report.

The key revisions affect: the role and composition of the audit committee; the interaction with internal audit; the relationship with the external auditor regarding the audit and non-audit services; the disclosures on areas relating to those changes and disclosures around the FRC’s interaction with the company’s financial reporting or external audit.

Ethical Standard

There is now one FRC Ethical Standard which covers the independence requirements for auditors as well as reporting accountants (previously in the Ethical Standard for Reporting Accountants) and for engagements to report to the Financial Conduct Authority (FCA) on client assets.

The Ethical Standard incorporates the EU reforms as well as certain areas where the FRC wanted to align more closely with the Code set by the International Ethics Standards Board for Accountants (IESBA) or where they felt changes were needed.

This is a principles-based standard, which nevertheless contains a lot of detailed rules. Auditors are required to consider the broad principles even if they think they have complied with all of the rules.

Key revisions to the Ethical Standard relate to incorporating the EU reforms for public interest entities (PIEs) for non-audit services. A “PIE” is a public interest entity, defined in EU law as being an entity governed by Member State law with securities (debt or equity) admitted to trading on an EEA regulated market (including those with a Premium or Standard Listing on the main market of the London Stock Exchange but excluding those traded on AIM), a credit institution (in the UK, a bank or building society) or insurance undertaking (those insurance companies, friendly societies and Lloyd’s syndicates that apply the Solvency II regime). There are additional changes over and above the EU changes affecting existing rules on providing tax services to listed entities on a contingent fee basis – a term covering a listing on any exchange worldwide – as well as a general clarification of the principles relating to advocacy in respect of tax.

In addition, the new EU rules on applying a cap of 70% cap on fees for non-audit services when compared to a three year history of statutory audit fees are explained in detail.Care will be needed in applying the Ethical Standard to multi-jurisdictional group situations as the rules around extraterritoriality are complex.

In addition to changes relating to non-audit services, there are also changes for auditors relating to personal independence – a broadening in scope of “covered persons” and persons connected to engagement team members who cannot have certain prohibited financial, business or employment relationships, and a clarified rule on gifts and hospitality offered to or accepted by the auditor. .

ISAs (UK & Ireland)

The FRC has made changes to reflect the EU reforms throughout their standards and has also implemented three major IAASB projects – the disclosures project (which stresses the importance of the audit of disclosures), auditor reporting, and the auditor’s responsibilities for other information accompanying financial statements.

Key changes include the requirement for enhanced auditor reporting for all PIEs and all listed companies; this is a change from the existing UK enhanced auditor reporting regime which only applied to those companies required to or choosing to comply with the Code. The change will affect UK and Irish companies with listings outside the UK and Ireland, including entities with listed debt, together with unlisted banks, building societies and insurance undertakings.

There will also be some changes to the contents of the enhanced audit report which may add to the length of reports, including:

  • An expansion of the auditor’s description of significant risks and their response to include key observations, where necessary;
  • a description of the extent to which the audit was considered capable of detecting irregularities including fraud;
  • disclosure of the auditor’s tenure, including previous reappointments and renewals; and
  • a declaration of the auditor’s independence including confirmation that no prohibited services were provided.

Some changes are also made to auditor’s reports on all entities, whether listed, PIE and/or neither:

  • an amendment to the auditor’s reporting on the going concern basis of accounting;
  • a revised description of the scope of an audit; and
  • for statutory audits, an opinion as to whether the directors’ report and any strategic report have been prepared in accordance with the legal requirements. This is not an audit of the content of these reports and is limited to confirming that the relevant information has been produced.

Click for:

ICAEW Financial Reporting Faculty publishes report on whether financial reporting encourages short-termism

04 May, 2016

The Financial Reporting Faculty of the Institute of Chartered Accountants in England and Wales (ICAEW) has published a Public Policy Paper on ‘Long-Term Investment and Accounting: Overcoming Short-Term Bias’, as part of its information for Better Markets thought leadership initiative.

The report examines the evidence as to whether financial reporting encourages short-termism and questions whether financial reporting could provide better information to its users on long-term performance. It looks in particular at five areas in which current financial reporting has been accused of encouraging short-termism;

  • through the effects of using fair values;
  • by not providing information on long-term performance;
  • through excessive frequency of reporting;
  • by writing off rather than capitalising spending on long-term assets such as intangibles; and
  • by ignoring long-run effects on the natural world or on society as a whole.

The paper concludes that current evidence does not suggest that current financial reporting practices impedes long-term investment, except in relation to the frequency of reporting where there can be a trade-off between the benefits of transparency and the costs of ensuring that investors’ expectations of performance are met at the frequent intervals required.

An executive summary and the full research paper are available from the ICAEW website.

Correction list for hyphenation

These words serve as exceptions. Once entered, they are only hyphenated at the specified hyphenation points. Each word should be on a separate line.