On April 12, 2017 the Financial Reporting Council (FRC) wrote to investors ahead of the 2017 shareholder meeting season to highlight some recent changes and developments in reporting which it hopes will be helpful. The letter encourages investors to engage with companies to provide a steer on what information they believe is relevant for inclusion in the annual report and to challenge where reporting falls short of expectations.
Business model reporting in the strategic report
The letter reminds investors about the Financial Reporting Lab report, published in October 2016, which identified room for improvement in the clarity with which many companies explain how they make money and what differentiates them from their peers.
Alternative performance measures in the strategic report
The FRC continues to monitor how alternative performance measures (‘APMs’ or ‘non-GAAP’ measures) are used to report performance. The letter comments that this year will be the first in which the European Securities and Markets Authority (ESMA) ‘Guidelines on Alternative Performance Measures’ apply to annual reports. Investors should expect to see disclosures that give a clear and complete understanding of the APMs presented, how they are calculated and why they are useful and, where relevant, reconciliation to amounts presented in the financial statements.
Risk reporting and viability statements in the strategic report
The letter notes that the FRC’s initial assessment of viability statements suggests that there is little variation in disclosures between business sectors. This year, the FRC has encouraged companies to provide clear disclosure of why the period of assessment selected is appropriate for the particular circumstances of the company, what qualifications and assumptions were made, and how the underlying analysis was performed.
Brexit and the strategic report
Companies will need to consider the consequential risks and uncertainties in the political and economic environment and the impacts of those risks and uncertainties on their business. As the economic and political effects are developed and become more certain in the medium and longer term, the FRC would expect boards to provide increasingly company specific disclosures with, ultimately, quantification of the effects.
The letter reminds investors that the UK Corporate Governance Code operates on a comply or explain basis. Where companies elect not to comply with key provisions of the Corporate Governance Code, they should provide specific explanations. This means setting out the background, providing a clear rationale for the action being taken and describing any mitigating activities. The FRC encourages investors to challenge companies where they do not believe that explanations given are sufficiently persuasive.
Audit committee report
In 2015, the FRC issued its ‘Audit Quality Practice Aid for Audit Committees’ to assist audit committees in evaluating and reporting on audit quality in their assessment of the effectiveness of the external audit process. The FRC notes that investors should expect to see this reporting in the context of the company’s business model and strategy, the business risks it faces, and it’s perception of the reasonable expectations of the company’s investors and other stakeholders.
The FRC’s thematic study of tax reporting identified areas for improved disclosure. More companies are expected to disclose the amount of their tax provisions than in previous years.
In light of the 2015 Financial Reporting Lab report on best practice in dividend disclosures, the FRC has already noted examples of improved disclosure, and expects to see more over the coming reporting period. The FRC suggests investors may wish to challenge companies that provide insufficient information in this area.
Low interest rates
The FRC has reminded companies that they should consider the impact of low interest rates on the amounts reported in their financial statements. In particular, careful consideration should be given to the valuation of long term assets and liabilities and companies may need to provide sensitivity analysis to highlight the potential impacts.
Accounting policies, significant accounting judgements and estimates
Companies should explain significant judgements and accounting policy choices, particularly where there is diversity of treatment, in pension reporting, for example. However, the FRC notes that there continues to be room for improvement in the disclosure of accounting policies, particularly in relation to revenue recognition. Investors should be able to see a clear link between the sources of income described in the business model and revenue recognition policies. Companies should also identify the precise nature of the judgements they make rather than merely repeat the accounting standards so investors can assess the quality of management’s policy decisions. Clear descriptions of sources of estimation uncertainty should explain the extent to which the values of assets and liabilities have the potential to change materially in the next year.
Developments in IFRS
The FRC notes that the International Accounting Standards Board has published three major standards that will become effective in the next few years: IFRS 15 Revenue from Contracts with Customers (effective for periods beginning 1 January 2018), IFRS 9 Financial Instruments (effective 1 January 2018), and IFRS 16 Leases (effective 1 January 2019). It expects that most companies that apply IFRS will have made substantial progress in their implementation of these standards. Investors should expect to see companies provide information on this progress and disclose the likely impacts of each of the new standards once they can be reasonably estimated.
(FRC, Letter to investors, 12.04.17)