The FRC has announced its latest guidance on how and where companies can improve their annual reports.
The Financial Reporting Council has come out with its latest guidance on how and where companies can improve their annual reports in the forthcoming reporting season. In general the FRC believes that there are points of strength in UK corporate reporting. Companies try to "do the right thing" and tend to react well to its recommendations (even those that the FRC acknowledges go beyond strict requirements).
However, the FRC makes clear its frustration with slow progress on a number of reporting issues, notably transparency of judgements and estimates, and expresses disappointment at the number of basic errors it finds, notably in cash flow statements and EPS calculations from smaller-listed companies in particular; expressing concern that these failings may indicate control weaknesses.
Improving confidence in corporate reporting and governance is a key objective for the FRC as clear and transparent presentation of relevant and material information can significantly affect how companies are perceived and can build trust. The FRC has written an open letter to Audit Committee Chairs and Finance Directors to set out its expectations.
Based on the FRC’s latest guidance, here’s what you should be paying particular attention to this season:
The FRC expects management to give investors sufficient information to understand how and why significant estimates made might be materially different from future outcomes and it said it was disappointed at the challenge it received from some on the need to improve disclosures. In particular, disclosures should include the range of outcomes or sensitivities for items where there is a significant risk that a company will need to make a material adjustment in the next year. Specifically, it calls out inadequate disclosure regarding significantly uncertain tax positions.
The report also notes a tendency for some to make “overly optimistic” judgments, or fail to explain the degree of uncertainty, which undermines credibility.
The FRC will continue to challenge annual reports that give undue prominence to APMs, fail to justify why some items are excluded, do not define all APMs or reconcile them, mislabel APMs or do not explain why the company is using that specific alternative performance measure.
The FRC’s 2017 APM thematic review sets out how companies should and should not use APMs.
The adoption of the new requirements on Revenue (IFRS 15), means that related disclosures will be a particular emphasis for FRC scrutiny. The FRC wants to see comprehensive explanations of how the transition to IFRS 15 has impacted revenue, company-specific accounting policies covering contract assets and liabilities (and what has changed), as well as how companies have identified revenue generating performance obligations and timing of revenue recognition.
In addition, the FRC wants to see improvement in the way companies explain deferred revenue, the judgements they make regarding agent versus principal and how companies assess the stage of completion on long term contracts.
Basic errors in accounts are under renewed focus. The FRC expects companies to have effective procedures to make sure they are compliant.
The FRC required seven companies to refer to discussions they had with it to correct cash flow statements because of classification errors. These errors included the inclusion of restructuring cash flows within investing cash flows and JV funding cash flows being classified as financing. Two companies omitted to restate earnings per share where required for changes in capital.
In the coming year the FRC will focus on how companies are disclosing the effects of material supplier financing arrangements in Strategic reports, balance sheet disclosures of financial instruments and cash flow statements.
The FRC acknowledges that the effect of IFRS 9 will vary between companies. Common issues, however, could include the following:
- Updating hedging documentation and reassessing its effectiveness
- Consideration of the updated and extended approach to financial asset impairment
- Revisiting the treatment of embedded derivatives; and
- Reassessing previous debt modification accounting.
With Brexit due at the end of this next reporting season, the FRC expects companies to acknowledge the company specific risks and uncertainties arising, particularly in the areas of viability, going concern, impairment testing and taxation. Consideration should be given to including sensitivity analysis with respect to reasonably possible outcomes.
The FRC has a new policy to disclose the names of those companies whose accounts it has reviewed. This is in addition to cases where it publishes press releases and / or requires companies to refer to the FRC’s review if significant changes to accounts are the result.
The FRC is considering toughening up its policies regarding how companies report an interaction with it, in particular in reports of the Audit Committee. The regulator notes that there was “significant variation as to whether such references provided a fair and balanced summary of the nature of the exchange” and were in many instances bland and uninformative. As a result, it is considering making more direct disclosures about the outcome of its reviews.
Further detail on the FRC’s reviews and expectations on a number of the above topics can be found in the Thematic reviews released in early November covering IFRS 9, IFRS 15 and smaller listed companies.