On December 17, 2015 the Financial Reporting Council (FRC) published a report examining the steps companies have taken towards clear and concise reporting, whereby annual reports provide relevant and easily understandable information for investors. The report highlights emerging best practice in narrative reporting and considers developments in the reporting framework.
The report is in three sections as follows:
Clear and concise reporting
The report sets out steps that can be taken to help achieve clear and concise reporting, including starting the annual reporting process early, applying materiality, considering the audience for the annual report and engaging with the board early in the planning process. It points out that companies do not need to provide every disclosure set out in standards or regulations and that only material and relevant disclosures need to be included. It confirms that complementary information that is not required by law or regulation to be included in the annual report can be published separately and it sets out questions to consider when deciding whether information can be removed or moved from the annual report.
Impact of the strategic report
The FRC has collated the findings of reports produced by a number of organisations on the quality of UK corporate reporting and supplemented that with a detailed review of a sample of 2013/14 and 2014/15 strategic reports of FTSE 350 companies.
In terms of communication, it notes that many companies have improved how they communicate in their annual reports, particularly in their strategic reports, by making important information more accessible. Steps to help communication include the following:
- Giving sufficient prominence to changes in strategy, significant acquisitions or disposals and key developments for each segment, market or core product range is considered particularly helpful.
- The best strategic reports communicate to investors the effectiveness of the board’s stewardship both in terms of capitalising on opportunities and managing the impact of less favourable events, trends and conditions. They also avoid jargon and explain acronyms and industry specific terms.
- The FRC believes there is scope for companies to go further in providing a longer-term forward-looking analysis and suggests companies may wish to consider the alignment between time horizons applied to their forward-looking information, strategic review, impairment reviews and viability statement and/or clarify why it is appropriate to consider different time periods in each context.
- The FRC sees good linkage as essential for the annual report to communicate a holistic story to investors and strategic reports which explain the nature of the linkage between disclosures are more useful than those that simply highlight the location of related information. The report provides examples of where companies have used linkage effectively.
- Boilerplate disclosures should be avoided. Principal risk disclosures and reporting on environmental, employee. Social, community and human rights matters (EESCH) tend to be more generic than company specific.
The report also considers the placement of information and urges innovation with structure and presentation in the strategic report. The FRC has found that companies are generally striking a good balance in the proportions of summarised information and more detailed narrative explanation providing analysis and context. However, it believes companies can be more ambitious in their use of cross-referencing and an increased use of signposting to complementary information inside or outside the annual report should enable companies to streamline strategic reports further and communicate more clearly and succinctly.
In terms of the content of the strategic report, the FRC comments include the following:
- Business model disclosures that focus on the main drivers of value generation are more informative than those that primarily focus on describing the company’s broad objectives or mission statement. Placing business model disclosures near the front of the strategic report, followed by strategy disclosures, is the most logical approach as these disclosures underpin the other disclosures in the strategic report.
- There are a variety of approaches to disclosure of strategy. Best practice reports explain the relationship between strategy and principal risks and some link key performance indicators (KPIs) to specific strategy objectives. The clearest explain why these KPIs have been selected as the most appropriate measures for quantifying progress towards those strategic objectives.
- Some companies still report a large number of principal risks which makes it difficult for investors to identify and understand which are the most significant for the business. The clearest reports identify as principal risks only those that have a high likelihood of occurrence or have the potential to have an effect on the entity of high magnitude, or both.
- In terms of KPIs, the FRC notes that it considers strategic reports which contain a limited number of KPIs that are clearly linked to the company’s strategy are the most informative.
- The quality of reporting on EESCH matters has generally improved but the relevance of EESCH matters disclosed is clearer when the EESCH reporting is linked to the business model, principal risks or KPIs, highlighting the impact of EESCH matters on the business and how the company operates. Positive EESCH matters should be balanced with sufficient discussion of the negative impacts of the business on EESCH matters.
In addition, in terms of materiality, the FRC believes there is scope for companies to go further in the application of materiality to certain areas of the strategic report, particularly in relation to disclosures of principal risks and KPIs.
The FRC discusses a number of developments in the pipeline that will impact on corporate reporting in the future. These are:
- Non-financial reporting – the UK will soon be implementing the requirements of the EU Directive on the disclosure of non-financial and diversity information. The Department for Business, Innovation and Skills is shortly to consult on implementation and the FRC will update its 2014 Guidance on the Strategic Report once regulations are in place.
- New disclosure requirements – there are likely to be new reporting requirements in 2016 on prompt payment of suppliers, closing the gender pay gap, tax transparency and transparency in supply chains (through the annual slavery and human trafficking statement under the Modern Slavery Act 2015).
- Risks and going concern – in 2016 the FRC will publish its non-mandatory simplified Guidance on the going concern basis of accounting and reporting on solvency risk and liquidity risk for non-Code companies which it published for consultation in October 2015.
- APMs - In 2016 there will be more focus on alternative performance measures.
- IASB disclosure initiative - The International Accounting Standards Board is progressing an initiative aimed at improving the quality of disclosures in financial statements that could contribute to clear and concise disclosures in financial statements.
- Digital reporting – The FRC’s Financial Reporting Lab will work on the next phase of its digital project in 2016, following its 2015 report, Digital Present.
(FRC, Clear & Concise: Developments in Narrative Reporting, 17.12.15)