The revisions to the standard are designed to provide increased clarity as to the auditor's obligations.  They include enhancements to the requirements for the identification and assessment of risk of material misstatement due to fraud and the procedures to respond to those risks.
 
The revised UK standard is effective for audits of periods beginning on or after 15 December 2021 with early adoption permitted.

A press release, the revised standard and the feedback statement on the consultation are available at FRC website.

Background

At its meeting in March 2017, the IASB generally agreed that they should be playing a more active role in wider corporate reporting. At the meeting in November 2017, the Board members decided preliminarily that being the specialists in financial reporting they are best placed to provide the link between financial and non-financial information and the best way forward would be to revise the Management Commentary Practice Statement so that it could serve as an anchoring point for other frameworks. One of the key points to address would be to promote alignment between financial and ‘other’ information disclosed by an entity.

Since the IASB's decision to revise the Practice Statement, reporting on sustainability and ESG aspects has gained a lot of traction and the information needs of investors and creditors have evolved. Independently of the IASB’s work on management commentary, the Trustees of the IFRS Foundation have taken up an initiative on sustainability reporting and are currently considering setting up a board for setting IFRS sustainability standards. The IASB's project on management commentary and the initiative of the IFRS Foundation are connected in that entities would be able to apply standards issued by the new sustainability standards Board for complying with the revised Practice Statement.

Key proposals

The proposals in ED/2021/6 Management Commentary are divided into three parts, each of which has several subsections:

• Part A — General requirements. This part specifies requirements for identifying management commentary and the related financial statements, for authorising management commentary and for including a statement of compliance. It also sets out the objective of management commentary. Key proposals are:
  
  • Management commentary identifies the financial statements to which it relates. If the related financial statements are not prepared in accordance with IFRSs, the management commentary would disclose the basis on which the financial statements are prepared.
  • Management commentary that complies with all requirements of the Practice Statement includes an explicit and unqualified statement of compliance.
  • Management commentary that complies with some, but not all, of the requirements of the Practice Statement may include a qualified statement of compliance that identifies the departures from the requirements of the Practice Statement and gives the reasons for those departures.
  • The objective of management commentary is to provide information that enhances investors' and creditors’ understanding of the entity’s financial performance and financial position reported in its financial statements and provides insight into factors that could affect the entity’s ability to create value and generate cash flows across all time horizons, including in the long term.
• Part B — Areas of content. This part specifies six areas of content for management commentary, and requires management commentary to provide information that meets disclosure objectives for each of those areas of content. It also includes the requirement that management commentary should focus on key matters. Key proposals are:
  
  • The proposed six areas of content are:
    
    • the entity’s business model,
    • management’s strategy for sustaining and developing the entity’s business model,
    • the entity’s resources and relationships,
    • risks to which the entity is exposed,
    • the entity’s external environment, and
    • the entity’s financial performance and financial position.
  • The proposed disclosure objectives for the areas of content are:
    • a headline objective describing the overall information needs of investors and creditors for the area of content,
    • assessment objectives describing the assessments that rely on information provided for the area of content, and
    • specific objectives describing the detailed information needs of investors and creditors for the area of content.
  • Key matters that management commentary should focus on are:
    • key features of the entity’s business model,
    • key aspects of management’s strategy,
    • key resources and relationships,
    • key risks,
    • key factors and trends in the external environment, and
    • key aspects of financial performance and financial position.
  • Generally, an entity would report on matters that could affect the entity’s long-term prospects, on intangible resources and relationships, and on environmental and social matters.
• Part C — Selection and presentation of information. This part contains guidance on the selection of information to include in management commentary and the presentation of that information. Key proposals are:
  • In the context of management commentary, information is material if omitting, misstating or obscuring it could reasonably be expected to influence decisions that investors and creditors make on the basis of the management commentary and of the related financial statements.
  • Identifying material information requires management to apply judgement.
  • Information about a matter may be material because of the nature or magnitude of that matter, or a combination of both.
  • Information about possible future events that have not yet affected the entity’s financial performance or financial position may be material depending on the potential effects of the events on the amount and timing of the entity’s future cash flows.
  • Materiality judgements need to be reassessed each reporting period.
  • Information provided in management commentary must be complete, balanced, accurate as well as clear and concise.
  • Information in management commentary is more useful if it is comparable, verifiable, and coherent.
  • Metrics used to describe material information in management commentary should be derived from metrics that management uses to monitor key matters and to measure progress in managing those matters.

The deadline for submitting comments on these proposals is 23 November 2021.

Effective date and status of the Practice Statement

The exposure draft proposes that the Practice Statement would supersede IFRS Practice Statement 1 Management Commentary for annual reporting periods beginning on or after the date of its issue. The Practice Statement is not an IFRS and its application is not mandatory. Financial statements can comply with IFRSs even if they are not accompanied by management commentary or if they are accompanied by management commentary that does not comply with the Practice Statement.

Additional information

The following additional information is available on the IASB website and on IAS Plus:

• IASB press release (includes a short introductory video)
• Access to the exposure draft
• Access to the basis for inclusions
• IASB Snapshot document summarising the proposals
• Deloitte's Need to know publication
• Our UK Accounting Plus Project page on Management commentary (Wider corporate reporting)

The paper is a follow-up to the perspectives paper ESG and Business Valuation released in March 2021 which began to explore how ESG characteristics are, or can be, incorporated into the value measurement process. Please click to access A Framework to Assess ESG Value Creation on the IVSC website.

The original agenda paper analysed feedback from some insurers and recommended the Board make a narrow-scope amendment to IFRS 17 to address the issue of accounting mismatches arising from financial assets derecognised in the comparative period. After releasing the paper, the staff received subsequent information provided by insurers that suggested that the staff recommendation included in that agenda paper was too narrow, not sufficiently clear and would not completely address the issue of concern for those insurers. It was also stated that implementing the recommended amendment would cause operational challenges.

Based on that information, the staff prepared the updated agenda paper to analyse and clarify additional aspects concerning the presentation of comparative information on initial application of IFRS 9 and IFRS 17 and updated the question for Board members accordingly.

Please click to access the updated agenda paper on the IASB website. A detailed summary of the new paper has been added to our meeting note page. As noted earlier, the session is now scheduled for Thursday 27 May 2021, 13:30-14:30.

The report aims to provide a deeper understanding of the current intersection of corporate governance with employee voice, in the light of requirements in the 2018 UK Corporate Governance Code for boards to ensure effective workforce engagement. The research conducted includes analysis of company reports, a survey of FTSE 350 firms, and a series of interviews with directors, executives and workforce representatives.  It explores approaches companies have taken to providing a workforce voice in the boardroom, why different approaches have been chosen, what these changes have meant in practice and how effective they have been both from a managament and workforce perspective. 

The report suggests a number of key lessons which companies should consider.  They include the following:

• Representativeness and breadth of coverage - ensuring that the employee voice reflects the geography and demography of the workforce.
• Depth of coverage - properly integrating different engagement and voice channels with each other, including collective forms of employee representation.
• Providing for regular and structured input from the workforce, especially during periods of rapid change.
• Workforce representatives, whether sitting on a panel or as worker directors, should be chosen with some input from the workforce.
• Energies should be focused principally on the substance of workforce engagement, not the process.
• Agenda setting is best when there is a balance between topics of management interest and topics of workforce interest.
• A meaningful dialogue with the workforce also requires an effective feedback loop, based on informed employee voice.

The report stresses that in order to make workforce engagement effective, boards first need to reflect on the purpose they want that engagement to serve.  Whilst the report indicates that there is innovation and fresh thinking in this area it does indicate that many FTSE 350 companies appear to downplay the importance of workforce engagement and in many cases "relegating it to boilerplate language in a formulaic table of stakeholders". 

The press release, report and a podcast are available on the FRC website.

The FRC will also host a webinar on this topic on the 10th June.  

The Amendments, which were consulted upon in Financial Reporting Exposure Draft (FRED) 77:

• provide a disclosure exemption in relation to IAS 16 Property, Plant and Equipment and maintain consistency with IAS 1 Presentation of Financial Statements; and
• remove a reference to paragraphs 39 and 40 of IAS 1. These paragraphs were deleted by Annual Improvements to IFRSs 2009–2011 Cycle, and therefore were only applicable for accounting periods beginning before 1 January 2013.

Please click below for (all links to FRC website):

• Press release
• Amendments to FRS 101 – 2020/21 cycle
• Impact Assessment and Feedback Statement – Amendments to FRS 101 Reduced Disclosure Framework – 2020/21 cycle 
• FRS 101 Reduced Disclosure Framework 

More information about the issues is set out below:

Click to access all our comment letters to the IASB, IFRS Foundation, and IFRS Interpretations Committee.

Cash flow statement errors remain a recurring issue in Constructive Engagement cases.  The FRC indicates that cash flow statement cases made up 9% of the cases that it resolved through constructive engagement during 2019/20 and this rose to 17% in 2020/21.  The FRC highlights that whilst audit firms have taken appropriate steps where errors have been identified, this increase in cases suggests that further action is needed to prevent the need for restatements and errors occuring.

As indicated in the FRC's Annual Review of Corporate Reporting and latest cash flow thematic review, the FRC have frequently identified what it calls as 'basic' errors in cash flow statements.  Many of these relate to misclassification errors between operating, investing and financing activities. 

The Thematic Briefing indicates that a common root cause of these errors is that the internal consistency checks being performed by audit teams across the financial statements are not picking up the basic cash flow statement errors.  Other root causes identified include:

• The audit team may not have always adequately challenged management on the accounting policies applied and disclosures made affecting the cash flow statement.
• Guidance available to the audit team to deal with technical and complex judgements is not always sufficient or embedded through staff awareness methods and training.
• The review process does not always identify and adequately respond to matters identified in the audit.
• The use of spreadsheets and the manual nature of cash flow workings by companies increases the complexity of auditing the consolidated cash flow statement.

The Thematic Briefing contains case examples and enhancement actions taken by audit firms arising in cash flow statement cases.  The Thematic Briefing also includes a summary of how audit firms have enhanced the audit of cash flow statements.

A press release and the Thematic Briefing document are available on the FRC website.

The review, which was conducted against the backdrop of COVID-19, analysed the reports of 20 companies listed on the main market of the London Stock Exchange, whose interim period ended between June 2020 and September 2020.  The sample of companies selected was across a range of industries, consistent with the FRC’s priority areas.  The thematic review includes extracts from those reports and accounts sampled to highlight useful disclosures.  The key areas of focus for the review were:

• Management commentary and the use of APMs
• Going concern disclosures
• Impairments
• Cash flow information
• Significant judgements and estimates
• Financial instruments
• Fair value measurements
• Related parties
• Defined benefit obligations

Overall, the FRC was pleased with the quality of interim reports, with most companies taking into account the FRC COVID-19 recommendations to enhance their disclosures, particularly in relation to going concern and the statement of cash flows and related notes. However, an area of improvement was identified with regards to providing better explanations on balance sheet movements.

The thematic review’s key observations show that:

• Management commentaries provided an overview of the key events in the first half of the year and how these had affected operations and results. The best examples differentiated the impact that the various stages of the COVID-19 pandemic had on the financial statements.  However, explanations of significant balance sheet movements were not provided in all cases (for example, net pension obligations and lease liabilities). The FRC has noted this as an area of improvement for companies.
• Where necessary, companies provided an update of the risks and uncertainties for the remaining six months of the financial year.
• The majority of the companies in the sample provided detailed explanations for their use of Alternative Performance Measures (APMs) and reconciliations to GAAP measures.  However, whilst some companies gave such explanations, a number of companies had not updated their definitions from the annual report and did not explain why some items were treated as exceptional whilst other similar items were not, for example, the impairment of assets.  The FRC expects to see companies provide specific, rather than general, explanations for all material classes of adjusting or exceptional items.
• Better disclosures of impairments included reasons for the impairments and quantified the key assumptions used in the impairment assessments. In line with the expectation set out in the FRC’s COVID-19 thematic review, several companies considered COVID-19 to be an indicator of impairment at the half year because of the adverse effect it had had on their businesses, market capitalisation and the markets in which they operated within.  However the FRC indicated that in some companies’ interim accounts unclear information was provided around whether an impairment assessment had been conducted or the reason for the impairment.  The FRC expects companies to provide an explanation of material impairments or reversals of impairments recognised in the interim period.  Good explanations include sufficient information about the events and circumstances that lead to the impairment and its impact on the company’s financial position and performance. 
• The best examples of changes in estimates disclosures included an update of the IAS 1 ‘Presentation of Financial Statements’ estimation uncertainty disclosures where relevant, in addition to disclosing the nature and amount of the changes in estimate.
• Better disclosures of significant changes in current and deferred tax balances included a breakdown of the components of the tax charge and the deferred tax balance by category of temporary difference.  However, in some instances it was noted that explanations disclosed by companies of the treatment of tax events were unclear, in particular around annual expected tax credits, one-off tax events taking place during the interim period and the utilisation of unrecognised tax losses carried forward.
• When an event or transaction is significant to an understanding of the changes in financial position and performance of the company since the last annual reporting period, better disclosures followed the disclosure guidance of individual IFRSs to provide updated relevant information.
• Where directors and other members of senior management had waived fees, or agreed to a pay reduction in light of the COVID-19 pandemic, the impact of these was typically not disclosed in the related party section of the financial statements, despite directors and possibly senior management being classed as a related party by virtue of being key management personnel as defined in IAS 24 ‘Related Party Disclosures’.

Whilst the FRC saw many examples of good disclosure, it highlights that there is still room for improvement.   For the 2021 interim reporting season, the FRC highlights that a good interim report should:

• Ensure that management commentaries detail important events that have occurred during the first six months of the financial year, and their impact on the financial statements.
• Provide a comprehensive update of the principal risks and uncertainties for the remaining six months of the financial year.
• Make sure APMs are explained, reconciled to IFRS measures and not given undue prominence.
• Give going concern disclosures that explain the basis of any significant judgements, including whether there are any associated material uncertainties, and the matters considered when confirming the preparation of the financial statements on a going concern basis.
• Detail changes to key judgements and estimates with reasons that enable users to understand management’s views about the future, and their impact on the interim financial statements.
• Explain in sufficient detail, events and transactions that have a material impact on the financial position and performance of the company, such as impairments. Better disclosures update relevant information disclosed in the last annual report by following the applicable disclosure guidance of individual IFRSs, such as IAS 36 for impairment disclosures.
• Focus on providing material disclosures that are clear and concise.

The press release and thematic review are on the FRC website.  A webinar on the thematic review will be held on 16 June.  Further information and details of how to register are available on the FRC website here.

The revised standard provides additional clarity on auditor responsibilities, strengthens the review procedures required on management’s going concern assessment and strengthens reporting requirements in relation to going concern. 

A press release, the revised standard and the feedback statement are available at FRC website.