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FRC publishes year-end advice to preparers in advance of the 2018/19 reporting season

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25 Oct 2018

The Financial Reporting Council (FRC) has published a letter to Audit Committee Chairs and Finance Directors, in advance of the 2018/19 reporting season, highlighting changes to reporting requirements and key matters which should be considered in the preparation of forthcoming annual reports and accounts.

The year-end advice covers the following key areas:

New Accounting Standards

The letter draws the reader’s attention to two new accounting standards - IFRS 9 Financial Instruments and IFRS 15 Revenue from Contracts with Customers, which will be effective for December 2018 year-end reporters.

The FRC has performed thematic reviews looking at the disclosures on the impact of both standards within the June 2018 interim reports of a sample of companies. The results of the thematic reviews will be published in November 2018 but in advance of those the FRC sets out the disclosures that it expects to see at year-end relating to these new standards.

IFRS 15

Companies are encouraged to invest sufficient time during their year-end preparation to ensure that:

  • explanations of the impact of transition are comprehensive and linked to other relevant information in the annual report and accounts;
  • changes to revenue policies are clearly described and explained, reflecting company specific information – as are any associated management judgements;
  • performance obligations are identified and explained, with a focus on how they have been determined and the timing of delivery to the customer; and
  • the impact of the standard on the balance sheet is also addressed, including accounting policies for contract assets and liabilities.

IFRS 9

The main impact of IFRS 9 will be felt by banks and the FRC thematic review will focus on how banks have implemented the new requirements. Although the effect may not be as significant for non-banking companies, the FRC indicates that it still expects companies to:

  • have updated their hedging documentation and assessed the effectiveness of existing hedges on application of the new requirements;
  • explain and, where possible, quantify material differences between IAS 39 Financial Instruments: Recognition and Measurement and IFRS 9, including key assumptions adopted on implementation;
  • remember that the scope of the impairment requirements has been extended to include, for example, IFRS 15 contract assets, lease receivables and will also apply to loans to subsidiaries and other undertakings in individual parent company accounts;
  • take particular care when considering the application of the standard to embedded derivatives and the different treatment required where the host contract is a financial asset compared to where it is a financial liability;
  • reconsider the accounting for previous debt modifications, such as refinancing, that did not result in derecognition;
  • reflect the additional disclosure requirements of IFRS 7 Financial Instruments: Disclosures; and
  • if relevant, explain why the impact is not material, particularly where significant financial instruments are recognised in the accounts.

The FRC has also conducted a ‘light touch’ thematic review of the disclosures relating to IFRS 16 Leases in June 2018 interim reports. Although only mandatorily effective for accounting periods beginning on or after 1 January 2019, the FRC does indicates that it expects companies to be “in a position to provide specific disclosure in their December 2018 reports and accounts explaining the impact of the new requirements on their business”. Specifically the FRC expects companies to:

  • provide meaningful information about the application of the standard with a focus on their specific facts and circumstances;
  • disclose qualitative and quantitative information, identifying any lease portfolios that are significantly impacted by the new requirements;
  • explain the specific judgements and policy changes prompted by the new model and provided detail about the structure of their implementation projects; and  
  • identify the exemptions that companies intend to apply.

Findings from its monitoring work

The FRC’s monitoring work, as detailed in its Annual Review of Corporate Governance and Reporting published concurrently with the letter to Audit Committee Chairs and Finance Directors, highlights areas where the FRC still sees areas for improvement. The most significant areas are:

Critical judgements and estimates

The FRC indicates that whilst it has seen some better disclosures in this area “there is still significant scope for further 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 the FRC expects:

  • a clear distinction to be made between judgements and estimates as different disclosure requirements apply;
  • clear disclosure of the sensitivity of carrying amounts to the assumptions and estimates underlying a measurement calculation, or, if more meaningful, disclosure of the range of reasonably possible outcomes within the next year in respect of the carrying amounts of the relevant assets and liabilities; and
  • identification of any voluntary additional disclosures provided in respect of estimation uncertainty, for example, where the impact of any possible material change in estimate is not anticipated to have effect until a period outside the twelve-month window required by the standard.

Control environment

The FRC highlights what it sees as an increase in “basic” errors and non-compliance in areas of reporting caused by a poor control environment. The FRC indicates that management “need to have effective procedures in place to ensure compliance with the basic reporting requirements of IFRS, which investors take as a given in audited reports and accounts”.

Topical areas in corporate reporting

Brexit

The FRC indicates that it has seen “companies take a variety of approaches to reporting on the risks associated with Brexit” with the nature and depth of disclosure, in part, dependent on the potential impact of Brexit on the business and the mitigating actions that the company had been able to put in place. As there are still uncertainties surrounding Britain exiting the EU, the FRC recognises that this poses particular challenges for Boards as they prepare December year-end reports ahead of the March 2019 deadline. Specific areas of focus for the FRC include:

  • Impact on business models: Companies are encouraged to provide disclosure which distinguishes between the specific and direct challenges to their business model and operations from the broader economic uncertainties which may affect them.
  • Sensitivity disclosures:   The broad uncertainties that may still attach to Brexit when companies report will require disclosure of sufficient information to help users understand the degree of sensitivity of assets and liabilities to changes in management’s assumptions. The FRC expects that many companies will want to consider a wider range of reasonably possible outcomes when performing sensitivity analysis on their cash flow projections and which should be disclosed and explained.
  • Viability and going concern: It will be up to companies to decide whether Brexit uncertainties impact their statements on viability and even their ability to continue as a going concern.
  • Post balance sheet events: The situation is likely to change between the balance sheet date and the date of signing the financial statements. Companies should ensure that they incorporate a comprehensive post balance sheet events review in their year-end reporting plan to identify both adjusting and non-adjusting events and to make the relevant disclosures.

Complex supplier 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.

Risk and viability reporting

The FRC indicates that this remains a key area of focus for investors. It highlights that “viability reporting should be based upon a robust risk assessment of the principal risks that would threaten the business model, future performance, solvency and liquidity of the company”.   It encourages Boards to apply apply a two-stage process to the viability statement: firstly, assessing the future prospects of the company; and secondly, stating whether directors have a reasonable expectation that the company will be able to continue to operate and meet its liabilities as they fall due (potentially over a shorter period). The FRC draw attention to the Financial Reporting Lab’s implementation study issued in October 2018.

Strategic report

The strategic report remains an area that the FRC continually challenges in its monitoring work. It expects companies to ensure that their reports include a fair review of the company’s business that is a balanced and comprehensive analysis of both performance and position paying particular attention to:

  • Alternative Performance Measures (APM’s). The FRC expects all companies that report alternative performance measures to apply the Guidelines produced by the European Securities and Markets Authority (ESMA). Specifically it expects to see:
    • definitions for all APMs used;
    • good explanations for their use;
    • reconciliations to IFRS amounts appearing in the financial statements;
    • no greater prominence for APMs than measures directly stemming from the financial statements; and
    • explanations for changes in APMs to be provided, which may include how they are defined or calculated.

The FRC draws attention to the Corporate Reporting Review’s thematic report in this area and also the Lab’s report, Reporting on Performance Metrics which provide insights as to what investors expect to see in this area.

  • Non-financial information statement. The FRC highlights the new non-financial reporting disclosure requirements, incorporated in their updated guidance on the strategic report, which are effective for the 2017/18 reporting season. It indicates that for those companies within scope, the Strategic Report should include a non-financial information statement covering information (or references to where that information is disclosed in the strategic report) relating to environmental matters, employees, social matters, respect for human rights and anti-corruption and anti-bribery matters. For companies within scope, the FRC expects disclosures to focus on the impact of these activities in respect of these matters, the policies it has in place, any due diligence processes introduced through which it assesse and tracks their effectiveness and the related outcomes.  

The press release and full letter are available on the FRC website.  Our Governance in brief publication is here.

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