Essential Corporate News - Week ending May 20, 2022

FRC: Thematic Review – Discount Rates

On May 16, 2022 the Financial Reporting Council (FRC) published a report which summarises the key findings in relation to discounting in financial reporting arising from both a thematic review conducted by the FRC and its routine monitoring of corporate reporting. 

The report notes that while discounted cash flows, and discount rates themselves, are commonly used when applying International Financial Reporting Standards (IFRS), determining an appropriate discount rate is a complex area of financial reporting, which can also be a source of significant estimation uncertainty. This is partly because the reporting requirements relating to discount rates differ across IFRS Accounting Standards, some do not include any explicit requirements, and many require judgement to be applied in determining the construction of the appropriate discount rate.

As a result, discount rates can be a source of errors which the FRC believes could have been avoided if companies had sought specialist third party advice at an appropriate point in their reporting cycle and so the FRC encourages companies to make a point of including this in their annual planning process, where no internal expertise exists. The FRC also believes that there is general scope for improvement in the usefulness of the disclosures provided by many companies, particularly in the current interest rate environment of low nominal interest rates and relatively high inflation, which may impact reporting by many companies. 

The FRC states that the report aims to help preparers, auditors and investors better appreciate the reporting implications of sustained negative real interest rates. Its findings include the following:

• Assumptions used for discount rates and cash flows should be internally consistent, and care should be taken to avoid double-counting risks. When nominal rates are used, the effects of inflation on the cash flows should not be overlooked, particularly in the current interest rate environment of low nominal interest rates and relatively high inflation.
• There is general scope for improvement in the usefulness of the disclosures provided by many companies, with high quality disclosures needed, including both the discount rate used, and an explanation of how it was determined.
• Companies may need to consider whether specialist third party advice is required when valuing a material item, and where there is no internal expertise.
  A number of examples of better disclosure and opportunities for improvement are included in the report, together with some case studies, based on issues the FRC sees in routine reviews, to illustrate some of the challenges which companies may face in this area.
  (FRC, Thematic Review – Discount Rates, 16.06.2022)

A number of examples of better disclosure and opportunities for improvement are included in the report, together with some case studies, based on issues the FRC sees in routine reviews, to illustrate some of the challenges which companies may face in the area.