This update is the final part of the FRC’s two year review of the Code and response to the Sharman report. It follows earlier consultations on directors’ remuneration and risk management, internal control and the going concern basis of accounting. The key changes to the Code cover three principal areas:

• Going concern, risk management and internal control;
• Remuneration; and
• Shareholder engagement.

The updates also include some changes to the Preface to the Code, highlighting the importance of diversity on the board and setting the correct 'tone from the top' regarding standards of behaviour. In particular the Preface notes that, in addition to gender and race:

Diversity is as much about differences of approach and experience, and it is very important to ensure effective engagement with key stakeholders in order to deliver the business strategy.

As well as the updated Code itself, the FRC has also published two guidance documents:

• Guidance on Risk Management, Internal Control and Related Financial and Business Reporting, which revises, integrates and replaces the current documents Internal Control: Revised Guidance for Directors on the Combined Code and Going Concern and Liquidity Risk: Guidance for Directors of UK Companies (the "Guidance"); and
• Guidance for Directors of Banks on Solvency and Liquidity Risk Management and the Going Concern Basis of Accounting, which addresses supplementary considerations for the banking sector and should be read in conjunction with the above.

Furthermore, revised versions of ISA 260 Communication with those charged with governance, ISA 570 Going concern and ISA 700 The independent auditor’s report on financial statements (all links to FRC website) have been published. These reflect consequential amendments to the responsibilities of auditors as a result of the changes to the Code, in particular the fact that the auditors will now have a responsibility to state in their report whether they have anything material to add or draw attention to in relation to the directors' assessment of principal risks, the going concern statement and the statement about the prospects of the entity. 

Going concern

As set out in the proposals in the consultation paper issued in April 2014, going forward boards will need to provide two statements as follows:

1)     In annual and half-yearly financial statements, the directors should state whether they considered it appropriate to adopt the going concern basis of accounting in preparing them, and identify any material uncertainties to the company’s ability to continue to do so over a period of at least twelve months from the date of approval of the financial statements (Code Provision C.1.3); and

2)     The directors should state whether, taking account of the company’s current position and principal risks, 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 (Code Provision C.2.2). 

Risk management and internal control

There has continued to be broad support for the FRC’s proposals on principal risks and monitoring the risk management system and, as such, there are no amendments to the April 2014 proposals.  The Code has been amended to include a new provision C.2.1 requiring the directors to:

confirm in the annual report that they have carried out a robust assessment of the principal risks facing the company, including those that would threaten its business model, future performance, solvency or liquidity.

It also requires them to describe those risks and explain how they are being managed or mitigated.

As well as this, provision C.2.3 has been amended to refer to specifically refer to a responsibility for the board to monitor the company’s risk management and internal control systems.

Although concerns were raised during the consultation process about the recommendation in the draft Guidance that the board should explain actions that have been or are being taken to remedy any significant failings or weaknesses in risk management or internal controls, this has been retained in the final Guidance document as the FRC believes that it is of legitimate stewardship interest to shareholders. However supplementary guidance has been included to make it clear that the board

would not be expected to disclose information which, in its opinion, would be prejudicial to its interests. 

Remuneration

Section D of the Code now emphasises that the overall objective of the remuneration policy should be to deliver long-term benefit to the company. Principle D.1 now states that

Executive directors’ remuneration should be designed to promote the long-term success of the company. Performance-related elements should be transparent, stretching and rigorously applied.

This is supported by a requirement to avoid paying more than necessary and changes to Schedule A in relation to the design of performance-related remuneration schemes. The supporting principle also emphasises the need to be cautious about using comparisons with other companies and the danger of upward ratcheting with no corresponding improvement in performance.

Provision D.1.1 has been amended to include a specific reference to recovering or withholding performance-related payments, also know as 'clawback', including the circumstances in which this is considered appropriate.

The supporting principle in provision D.2 has also been amended to remove any potential ambiguity in relation to conflicts of interest when the remuneration consults the chief executive about the remuneration of other executive directors. 

Shareholder engagement

Section E of the Code now includes a new provision requiring companies to explain what action they intend to take in response to situations where a significant proportion of votes have been cast against a resolution at any general meeting. This is likely to be particularly relevant to resolutions on directors' remuneration.

Click here to view:

• The FRC's press release (link to FRC website).
• The updated Code (link to FRC website).
• The Guidance on Risk Management, Internal Control and Related Financial and Business Reporting (link to FRC website).
• The supplementary guidance for directors of banks (link to FRC website).
• Extracts from the revised ISAs (link to FRC website).
• Our Governance in brief publication discussing these changes
• Our previous UK Accounting Plus news item on the April consultation

In recent discussions, one of the factors often mentioned in connection with long-term finance has been accounting and especially fair value accounting. A Green Paper consultation on the long-term financing of the European economy published by the European Commission (EC) in March 2013 had suggested that the fair value might lead to short-termism in investor behaviour. This had solicited, among others reactions, a statement by the IASB that "the IASB does not believe that fair value accounting principles have of themselves led to short-termism in investment behaviour". In an earlier speech the IASB Chairman had noted that even long-term investors require shorter-term, reliable and unbiased performance measures to keep track of their investments and to hold management to account. Nevertheless, the EC later adopted a package of measures on long-term financing that included considering whether the use of fair value in especially in IFRS 9 Financial instruments "is appropriate, in particular regarding long term investing business models".

The FSB report reflects some of the concerns regarding fair value accounting that were voiced in the member survey (the EC is a member of the FSB). The two main concerns voiced were that:

• the use of fair value accounting for financial instruments increases volatility in measures of income and capital and so could provoke adverse reactions from investors and
• fair value does not reflect the business model of long-term investors, as it can mean that short term changes in value of instruments are given undue weight.

The second concern was especially raised for insurers, whose business model involves matching assets and liabilities, and for holders of strategic equity investments. Nevertheless, the members also noted that the insurance contract project is still under development, and that the introduction of expected loss accounting for loan provisions through the impairment project will greatly enhance transparency.

All in all, the FSB finds that it is too early to fully assess whether the concerns are justified and what the impact of the changes on the provision of long-term finance or changes in market behaviour in response to these changes might be, but promises that the regulatory community "will remain vigilant to avoid material unintended consequences and to analyse potential impacts as implementation proceeds". For the time being, however, the FSB concludes:

The FSB's monitoring continues to find little tangible evidence or data to suggest that global financial regulatory reforms have had adverse consequences on the provision of long-term finance. The reforms are intended to be proportionate to risks and to support financial stability. They are not designed to encourage or discourage particular types of finance.

Please click for access to the full report on the FSB's website.

After the report was released, the FSB held a plenary meeting in Cairns, Australia, that looked at vulnerabilities affecting the global financial system and reviewed work plans for completing core financial reforms. Among other topics, the plenary discussed work by the International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB) on new standards for the financial sector that take account of the lessons of the financial crisis and introduce forward-looking expected loss provisions for loan losses. Members welcomed this work and reaffirmed the continuing relevance of the objective of achieving a single set of high-quality global accounting standards. The FSB also encouraged the IASB and FASB to monitor the consistent implementation of their respective standards and to continue to seek opportunities for further convergence.

Please click for the press release on the FSB's website.

The future of audit and assurance is an important corollary of the wider debate on corporate reporting of financial and non-financial matters. In the medium and long term, we support the development of a holistic, forward-looking and strategy oriented approach to corporate reporting. This will help provide users with a longer-term and broader perspective, complementing the financial statements. It is important that the development of this reporting and associated assurance models are driven by users' legitimate and reasonable needs, taking into consideration both the costs and benefits.

The discussion paper itself is available from the FEE website and the full comment letter can be downloaded from our publications pages.

Background

In developing IFRS 13 Fair Value Measurement, the IASB intended to prioritise Level 1 inputs into the fair value hierarchy but did not expressly state that Level 1 inputs should be prioritised even when those inputs to not correspond to the unit of account of the asset measured (the investment as a whole). Therefore, questions arose on the unit of account for investments in subsidiaries, joint ventures and associates and on their fair value measurement when those investments are quoted in an active market. Similarly, the IASB also received questions on the measurement of the recoverable amount of cash-generating units (CGUs) on the basis of fair value less costs of disposal when they correspond to entities that are quoted in an active market.

Therefore, the IASB has now published proposed amendments that would confirm that the unit of account for investments in subsidiaries, joint ventures and associates is the investment as a whole, but that the fair value measurement of quoted investments in subsidiaries, joint ventures and associates should be the product of the quoted price multiplied by the quantity of financial instruments held, without adjustments. The IASB also proposes to align the fair value measurement of a quoted CGU to the fair value measurement of a quoted investment. Lastly, the proposed amendments also include an addition to the Illustrative Examples for IFRS 13 to illustrate the application of paragraph 48 of that standard to a net risk exposure of Level 1 financial assets and financial liabilities.

Suggested changes

The IASB proposes amendments to six standards in ED/2014/4 Measuring Quoted Investments in Subsidiaries, Joint Ventures and Associates at Fair Value (Proposed amendments to IFRS 10, IFRS 12, IAS 27, IAS 28 and IAS 36 and Illustrative Examples for IFRS 13):

Dissenting opinion

One IASB member voted against the publication of the ED. This member believes that using the product of the quoted price multiplied by the quantity of the financial instruments is neither appropriate for the fair value measurement of investments nor for determining the recoverable amount of CGUs. If the IASB concludes conclusion that the unit of account is the investment as a whole instead of the individual financial instruments that make up the investment, this board member believes that the unit of account used for the fair value measurement should also be the investment as a whole and not the underlying financial instruments. According to this board member, the investment's fair value should either be measured using another valuation technique or by adjusting the Level 1 input to reflect the price differences between the investment as a whole and the underlying individual financial instruments.

Effective date and transition requirements

The ED does not contain a proposed effective date. For the proposed amendments related to quoted investments the IASB suggests mandatory application from the beginning of the year the amendment is first applied; for the proposed amendments related to the measurement of CGUs the IASB suggests prospective application.

Additional information

Please click for:

• IASB press release (link to IASB website)
• Access to the exposure draft on the IASB website
• Deloitte's Need to Know newsletter explaining the proposed amendments
• Our UK Accounting Plus project page on IFRS 13 — Unit of account

The report is based on disclosures made to CDP by companies around the world. It presents breakdowns of the companies that have disclosed the use of an internal price on carbon, both by geography and sector. It also provides excerpts from the disclosures made that provide insight into the use of carbon pricing by businesses as well as the implications of carbon pricing and associated policies.

The research shows that, in many jurisdictions, companies are ahead of their governments in planning for climate change risks, costs and opportunities. They are prepared for a global carbon market and would welcome more regulatory certainty with respect to climate change policy and carbon pricing.

The full report can be downloaded from the CDP website.

These taxonomies have been developed to enable accounts to be filed electronically and to help users of annual reports extract and analyse data from them. They follow a similar approach in content, design and style to the existing UK GAAP and IFRS taxonomies already in use and are expected to be adopted by HMRC and Companies House in due course. The  Irish Revenue Commissioners are also expected to implement them once appropriate extensions have been made to incorporate Irish requirements.

As well as the taxonomies themselves, the FRC has published a Developer Guide and a Tagging Guide to help preparers implement the new taxonomies.

Click for:

• The FRC's XBRL site, where the new taxonomies and supporting resources can be accessed.
• The FRC's press release on this topic.
• Our previous UK Accounting Plus news article.

We are concerned that two of the three proposals in the Exposure Draft result in arrangements being differentiated on a basis other than the relevance of the resulting information:

• A subsidiary providing services that relate to the parent's investment activities. We believe that the proposals to subsume a service providing entity into a single fair value number will, for some arrangements, result in an inappropriate lack of transparency and that they will allow structuring opportunities.
• Application of the equity method by a non-investment entity investor to an investment entity investee. We believe that an assumed difference in the ease of obtaining information is not sufficient reason to introduce a difference in the equity method of accounting for associates and joint ventures.

Click for the full comment letter.

As the IASB concluded that diversity in practice around the recognition of a deferred tax asset that is related to a debt instrument measured at fair value is mainly attributable to uncertainty about the application of some of the principles in IAS 12, the proposed amendments consist of some clarifying paragraphs and an illustrating example.

EFRAG in its draft comment letter agrees with most of the proposals but has some concerns or wording suggestions as EFRAG believes that some of the amendments are difficult to read or would need further clarification. In relation to the new paragraph 29A the IASB proposes to add, EFRAG explicitly asks constituents for their view (should EFRAG agree or disagree) and presents two alternative answers as EFRAG is aware that there are significant different views on the issue.

Comments on the draft comment letter are due by 28 November 2014. It is available on the EFRAG website.