FRC publishes findings on the quality of corporate reporting in 2015/2016

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21 Oct, 2016

The Financial Reporting Council (FRC) has published its Annual Review of Corporate Reporting 2015/2016, which provides the FRC's assessment of corporate reporting in the UK based on evidence from a variety of sources, including the work of the FRC's own Corporate Reporting Review (CRR) team.

The report opens by setting out nine characteristics of good corporate reporting, which the FRC believes make for a good annual report. It then discusses the FRC's detailed findings on the overall quality of corporate reporting and in relation to two key elements of the annual report - the financial statements and the strategic report. Overall the FRC has found that the quality of financial reporting is generally good but that companies have room for improvement in some areas. 

Characteristics of good corporate reporting

The nine characteristics identified by the FRC in their report are as follows.

  1. A single story - making sure that the narrative is consistent with the financial statements, with no 'hidden surprises' lurking in the accounts.
  2. How the money is made - clearly explaining the business model and giving a balanced account of the company's performance, good and bad.
  3. What worries the board - making sure that the principal risks disclosed in the report are genuinely those that concern the board, with clear and specific descriptions of the risks themselves and mitigating actions taken, as well as links to accounting estimates and judgements where appropriate.
  4. Consistency - clearly reconcile any alternative performance measures (APMs) to the financial statements and explain why adjusting items have been identified.
  5. Cut the clutter - highlight important messages and remove immaterial detail, using effective cross-referencing to avoid repetition.
  6. Clarity - use precise, clear language, avoiding jargon and boilerplate.
  7. Summarise - aggregate information appropriately, using tables supported by consistent accompanying narrative.
  8. Explain change - properly explain accounting policy changes from the prior period.
  9. True and fair - follow the spirit as well as the letter of accounting standards, assisting compliance with the legal requirement to present a true and fair view. 

The quality of corporate reporting

Overall the FRC believes that compliance with accounting requirements is generally good, particularly by larger public companies, and that the introduction of the strategic report has improved the quality of narrative reporting. However, in its view there is room for further improvement, particularly with regard to the acknowledgement of when things have not gone so well and the erosion of trust caused by inappropriate use of APMs.

In relation to its inspections of annual reports in 2015/16 (a total of 192 annual and interim reports were reviewed), the FRC noted significant findings in relation to the following financial statement areas.

  • Accounting policies.
    For many companies accounting policies still need to be more specific and granular, particularly as regards revenue recognition and the linkage between this and the business model. Accounting for complex long-term contracts is a particular area of concern.
  • Judgements and estimates
    Too many companies give generic descriptions of judgements or estimates that could be replaced by more concise explanations that clearly identify the specific judgment made or how uncertainty could affect next year's accounts. Quantified information regarding estimates, such as sensitivities or ranges of possible outcomes, should be provided.
  • Tax reporting
    The FRC pre-warned 33 companies that they would be conducting a thematic review of the tax disclosures in their 2015/16 accounts, which prompted improvements to the quality of their tax reporting. However, there is still scope for better articulation of how tax uncertainties are accounted for and the FRC will continue to challenge companies that do not make sufficient disclosure in this area.
  • Pension disclosures
    The FRC has written to companies where the disclosure of their pension funding strategy does not adequately explain the risks to which the company is exposed, as well as in relation to the nature and valuation of plan assets.

Regarding the strategic report, the FRC identified the following topics of significance.

  • Whether the report is sufficiently balanced. For example, whether it includes information of interest to investors, such as discussion of effective tax rates or non-financial key performance indicators (KPIs), or whether there is sufficient focus on the balance sheet and cash flow information rather than just financial performance.
  • The approach taken to the new viability statement. The FRC has reviewed 100 FTSE 350 viability statements and found that 75% of them used a three-year lookout period, although this does not mean that three years should be seen as a default. Directors are expected to give adequate thought to their company's particular circumstances and explain how the viability analysis has been carried out.
  • Clear articulation of the business model and principal risks gives valuable insight to users. The ongoing Financial Reporting Lab project on business model disclosures is expected to be published shortly and is likely to confirm the importance of business model disclosures to investors.
  • Giving too much emphasis to APMs or pro-forma non-IFRS financial information and failing to adequately discuss IFRS results. The FRC is currently undertaking a thematic review on the use of APMs in companies' interim financial reports, expected to report in November 2016.
  • Disclosures regarding dividend policy and practice, following on from the report produced by the Financial Reporting Lab in November 2015. The FRC believe that there is room for further improvement in this area.
  • Transparency on a broad range of topics such as increased tax transparency, climate-related matters and culture.

The FRC has also indicated that IFRS reporters should plan well ahead for the implementation of IFRS 9 Financial Instruments, IFRS 15 Revenue from Contracts with Customers and IFRS 16 Leases, ensuring that appropriate disclosures are made regarding their expected impact. Any UK GAAP reporters that are yet to transition to the new UK GAAP framework should start planning for this as soon as possible. Finally, all companies should consider the impact of Brexit both in terms of their risk assessment processes and also the potential impact that it could have on the UK corporate reporting landscape.

Alongside the Annual Review of Corporate Reporting 2015/2016, the FRC has also published a slide deck of technical findings (see link below) from the Conduct Committee's Financial Reporting Review Panel during the year, which gives more detail on the areas challenged by the Panel. 

The press releasefull report and Technical findings of the Conduct Committee’s Financial Reporting Review Panel: 2015-16 can be obtained from the FRC website.

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