FRC publishes findings on the quality of corporate reporting in 2017/2018

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24 Oct, 2018

The Financial Reporting Council (FRC) has published its Annual Review of Corporate Governance and Reporting 2017/2018, 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 also includes information on the level of compliance with the provisions of the UK Corporate Governance Code (“the Code”) as well as the quality of explanations and reporting provided by companies in their governance statements and committee reports.

The report is structured around the FRC’s overall review of corporate reporting and in particular focuses on those areas which fall within the remit of the FRC’s reviews; the financial statements and the strategic report.

Annual review of Corporate Reporting

Financial statements

Overall the FRC indicates that “while there are strengths in corporate reporting there is clearly room for improvement in some areas”. The most significant findings of the FRC relating to financial statements include:

  • Judgements and estimates companies make in the preparation of their accounts requires major improvement. The FRC draws attention to its thematic reviews which indicate what ‘good’ looks like in respect of key judgements and estimates reporting, APMs and pension disclosures. Improvements are expected when the December 2017 reports and accounts are reviewed. Specifically:
    • Judgements
      • Companies were challenged where disclosure of significant judgements did not explain the significant judgements made or the basis for conclusion.
      • Some companies disclosed that judgements had been made in circumstances where the accounting was straightforward and no judgements had been required to be made at all.
      • For some companies it appeared that significant judgements had been made but that the required disclosures of IAS 1 Presentation of Financial Statements had not been given.
  • Estimation uncertainty.  The FRC continues to see poor disclosure of the sensitivity of assets and liabilities to the assumptions and estimates on which they are based. The FRC indicates that “clear disclosure is needed…to help investors understand the effect and timing of any possible changes to management estimates”.
  • a rise in what the FRC sees as “basic” errors and non-compliance in areas of reporting including misclassification of cash flows in the cash flow statement and errors in the calculation of basic earnings per share. The FRC expresses its disappointment that some accounting requirements have been “overlooked” especially as “the accounting standards set out a clear requirement for direction” for those specific areas. The FRC highlights that such errors should have been picked up in company’s review processes prior to the accounts being made public. It notes “while boards and audit committees focus on material matters affecting the company’s performance and the reporting of significant events and transactions, they must also put effective procedures in place to ensure that the basic rules and requirements embedded in reporting standards, and which investors are entitled to assume have been complied with, are observes”.
  • Income taxes. The FRC indicates that “this year there were relatively more issues identified” relating to income tax than in previous years. The challenges principally related to the reconciliation of the effective tax rate and the basis for the recognition of deferred tax assets for losses. Specifically:
    • The FRC frequently raised questions where significant reconciling items were not explained in the effective tax rate reconciliation.
    • Challenges were made where the basis for recognising a deferred tax asset for losses was not adequately explained.
    • Companies were also questioned where it was unclear whether tax relating to share-based payments had been appropriately allocated between equity and the income statement.
  • Revenue. The FRC challenged companies where the accounting policies did not provide a clear explanation of how revenue is recognised for each revenue stream. It also frequently raised questions of companies where it was not clear how the company had assessed whether it acts as principal or agent in transactions with customers. The FRC has performed a thematic review on the disclosures on the impact of IFRS 15 Revenue from Contracts with Customers within the June interim reports of a sample of companies. The purpose of the review was to identify any weaknesses in interim disclosures which can then be communicated to companies when considering the completeness of their IFRS 15 disclosures in their year-end accounts. The results of the thematic review which will be published in November 2018, indicate that whilst there were a number of good examples of transitional disclosures, there were also a number of weaknesses identified including generic disclosures about performance obligations or no disclosure at all.
  • Supplier financing arrangements. The FRC indicates that it expects the strategic report and the disclosures in the financial statements to describe the nature and amount of any material supplier financing arrangements and the impact on the company’s liquidity. It draws attention to its December 2014 press release on complex supplier arrangements which company’s should still refer to.  Our news item on the FRC's reminders to Boards of companies in the construction and business support services sectors of their reporting obligations is available here
  • Effect of IFRS 16 Leases. The FRC conducted a ‘light touch’ thematic review of the disclosures relating to IFRS 16. The aim was to set out the FRC’s expectations in respect of December 2018 disclosures. Findings indicated that:
    • Whilst there were examples of good disclosure, most companies have work to do in order to provide meaningful information in the 2018 year end reports and accounts.
    • Most of the disclosures provided were boiler-plate and not specific.

The FRC indicates that it expects companies to “significantly improve the quality of their disclosures at year end by providing company specific detail about the standard”. This will include qualitative and quantitative information, clarification of the exemptions they intend applying and the policy choices they have made.

  • Thematic reviews. As well as the thematic review of IFRS 15 (as above), the FRC, at the same time, will also be publishing the results of its thematic review on the quality of the disclosures on the impact of IFRS 9 Financial Instruments within the June interim reports of a sample of companies. The report, published today, includes preliminary findings from those reviews which the FRC highlights that preparers and their advisors should take note of to inform future reporting under these two new standards. Additionally, in November the results of a thematic review targeting various aspects of smaller listed and AIM-quoted companies’ reports and accounts will be published. Whilst the FRC has identified good examples of disclosures relating to such companies it indicates that there is still scope for improvement.

Strategic reports

The FRC’s specific challenges to companies in this area were principally on:

  • the description and disclosures relating to APMs; and
  • whether the strategic report was sufficiently balances and comprehensive.

In relation to APMs the FRC encourages all companies to comply with the European Security and Market Authority’s (ESMA’s) Guidelines on Alternative Performance Measures. It indicates that common areas of challenge are in relation to:

  • undue prominence given to APMs, such as alternative measures of profit, over the equivalent IFRS measures;
  • unclear, cursory or boiler-plate explanations, or a simple statement that adjusted measures are superior to the equivalent IFRS measures;
  • items excluded from ‘underlying’ profit when their inclusion would appear to be warranted as part of normal trading;
  • unclear reconciliations to relevant IFRS numbers – including ratios such as return on capital and cash conversion;
  • inappropriate labelling of ‘recurring’ items as ‘non-recurring’;
  • costs of multi-year restructuring programmes that are charged in successive years without reporting on overall progress; and
  • adjustments that appear inconsistent with the stated accounting policy.

Other key areas of FRC focus include:

  • Business reviews - the FRC challenges companies where the Strategic report is insufficiently balanced and comprehensive to meet the Companies Act requirements or where the disclosures or principal risks and uncertainties are missing or incomplete.
  • Risks associated with Brexit - the FRC indicates that the development of focused disclosures in this area has been “patchy”.
  • Materiality – the FRC will challenge strategic reports that do not include a discussion of all material aspects of a company’s reported performance such as foreign exchange movements or a material reduction in the cash generated in the period.
  • Key performance indicators – the FRC expects management to identify and report on the most relevant metrics they use to monitor their performance, clearly explaining their purpose and the basis on which they are calculated.
  • Dividends and distributable reserves - the FRC indicates that the availability of dividend resources within companies and their strategy regarding the payment of dividends continues to be an area of interest to investors.  It highlights that reporting on the interaction between the requirement to have regard to wider stakeholders (under s172) and dividend policy and payment is not yet common practice and that it would expect this to be an area where reporting develops.

Compliance with the provisions of the UK Corporate Governance Code/quality of explanations

The report indicates that:

  • Compliance with all but one or two of the Code provisions by FTSE 350 companies is high at 95%. It also highlights that Code provision B1.2 has the lowest levels of compliance.
  • Companies remain reluctant to explain non-compliance with Code Provisions and are not providing sufficient detail to allow shareholders (and other interested parties) to understand the company’s decision to depart from a provision.

Additionally the report covers information on the development of reporting by those companies using UK GAAP and the FRC’s views on significant future developments.

Alongside the Annual Review the FRC has also published a letter to Audit Committee Chairs and Finance Directors in advance of the 2018/19 reporting season on key areas that need to be considered in the preparation of forthcoming annual reports and accounts. Those key areas are drawn from, and are consistent with, the findings included in the FRC’s Annual Review of Corporate Governance and Reporting.

A slide deck of technical findings (see link below) from the Conduct Committee's Financial Reporting Review function during the year has also been published, which gives more detail on the areas challenged by the Panel.

The press release, full report and Technical findings 2017/18 can be obtained from the FRC website.  Our Need to know publication on judgements and estimates disclosures is available here.  Our Governance in brief publication is here.

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