FRC publishes findings on the quality of corporate reporting in 2016/2017

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23 Oct, 2017

The Financial Reporting Council (FRC) has published its Annual Review of Corporate Reporting 2016/2017, 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 “beyond basic compliance with the fundamental requirements of the law and accounting standards and the need for complete and accurate publication of accounting information”. It then discusses other developments in corporate reporting which have come to the fore over the last year.

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, in the strategic report, 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 and uncertainties disclosed in the strategic report are genuinely those that concern the board, with clear and specific descriptions of the risks themselves and mitigating actions taken by the Board to manage their impact, as well as links to accounting estimates and judgements where appropriate.
  4. Consistency - clearly reconcile any alternative performance measures (APMs), referred to in the strategic report, 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 changes from the prior period, whether matters of policy of presentation.
  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 the standard of corporate reporting remains “generally good” especially by the largest listed companies. However it indicates that “even so, the quality of reporting is not always as high as it could be”. Whilst the FRC finds that there have been “some improvements” in strategic reports, “findings in respect of the financial statements are broadly consistent with last year” with “room for improvement in the clarity and completeness of explanations companies provide”.

Financial Statements

In relation to its inspections of annual reports in 2016/17 (a total of 203 annual and interim reports were reviewed), the most significant findings of the FRC include:

  • Judgements and estimates

    • The FRC highlights that in recent years, many companies have given generic descriptions of judgements or estimates that did not describe the specific judgements a Board had made or that failed to explain the extent to which changes in estimates could have a material effect on the following year’s accounts. Whilst this year, the FRC has seen improved disclosures from a sample of 20 companies that were pre-informed of a review, it still found that “boiler-plate text still lingered”. The FRC advises that companies should avoid boilerplate disclosure and encourages more granular disclosure about a smaller set of judgements and estimates that had a significant impact on results.
  • Accounting Policy Disclosures 

    • A focussed review in relation to assess disclosures made by companies of the likely impact of IFRS 9 Financial Instruments and IFRS 15 Revenue from Contracts with Customers identified that there were “significant variations” in the information provided. The FRC encourages companies to provide disclosures that are “tailored to their specific circumstances and transactions” and that include “any key judgements that management would need to make in complying with the new standards”.
  • Pensions 

    • A thematic review was conducted by the FRC as a result of concerns about the need for increased transparency in pensions reporting. A sample of 20 companies who were pre-informed that their pension disclosures would be reviewed. The FRC found that many had improved their reporting and in its letter to Audit Committee Chairs and Financial Directors it highlights that companies should seek to further improve transparency including around the nature and risks to which the schemes expose the company to; and explanations of deficit funding arrangements, risk management strategies and scheme assets.
  • Business Combinations 

    • It was not clear to the FRC why some companies had only recognised few or no intangible assets, other than goodwill, in acquisition accounting. The FRC indicates that judgements and decisions in this area will be challenged.

Strategic Reports

The FRC explains that the strategic report is one of the areas which is most frequently challenged by the corporate reporting review team (CRR) and that “companies can expect to be questioned and encouraged to improve where the report is lacking in balance”.

The FRC identified the following topics of significance:

  • Reports where it appeared that not all key aspects of performance had been considered for example changes in KPIs being reported but no explanation of the reason for the changes of their impact. The FRC found that descriptions were vague or not specific enough to inform a proper assessment.
  • Most companies that had been pre-informed that their use of APMs would be reviewed, enhanced the quality of these disclosures.
  • The majority of companies reported on continuing uncertainties of the risks and ongoing uncertainties regarding the effects of the EU referendum. Many reported that it was too early to measure the longer-term effects and how business strategies would be effected although some companies are now starting to provide greater detail of the likely risks.
  • There has been a “slight improvement” in the quality of narrative reporting particularly around risk reporting. The Financial Reporting Lab will be providing a report on risk and viability reporting towards the end of the year to provide practical guidance for companies. Investors are calling for greater differentiation of the time periods used by different companies and sectors.
  • As indicated in its letter to Audit Committee Chairs and Financial Directors, the FRC encourages companies to consider developing their viability statements in two stages – first, to consider and report on the prospects of the company over a period reflecting its business and investment cycles, and second to state whether they have a reasonable expectation that the company will be able to continue in operation and meet its liabilities as they fall due over the period of their assessment, drawing attention to any qualifications or assumptions as necessary.
  • There have been “further improvements” in how companies are reporting their dividend policies and level of distributable reserves. The Financial Reporting Lab has recently published an updated report into disclosure of dividend policy and practice by companies. This continues to be an area of investor focus and the FRC encourages further adoption of the recommendations included in the Lab report. In particular the FRC encourages further reporting on the capacity to pay dividends, including the extent to which profits can be distributed by subsidiary companies and the extent of any restrictions.

Other developments

 The report highlights that “the corporate reporting environment is shifting and expectations of corporate reporting are rising”. Two particular areas of change include:

  • the need for companies to be more transparent about relationships with employees, customers, suppliers and other stakeholders – as these are important for the longer-term success of a company. The FRC notes that some companies are already disclosing such relationships and some are referring explicitly as to how boards have fulfilled their duty under s172 when taking decisions to promote the long term success of the company; and
  • the need to communicate how a company generates and preserves value. The FRC believes that “companies need to be transparent as to what they consider to be the key sources of value, how they are managed and how value is likely to be generated in the future”.

The report also:

  • Includes current FRC work in relation to UK GAAP and highlights that the transition to FRS 102 has created challenges for many companies and their auditors. These challenges are explained in a dedicated section of the report.
  • Highlights the recently published consultation on Guidance on the Strategic Report published in August 2017.
  • References to the FRC’s letter to Audit Committee Chairs and Finance Directors, in advance of the 2017/18 reporting season on key areas of focus for annual reports published in October 2017.

Alongside the Annual Review of Corporate Reporting 2016/2017, 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 release, full report and Technical findings of the Conduct Committee’s Financial Reporting Review Panel: 2016-17 can be obtained from the FRC website.

Our related Governance in brief publication is available here.

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