Disclosure reporting at small listed companies under fire
Smaller listed companies must improve the quality of disclosures about significant accounting judgments and errors, and provide more transparency about their cash flow and tax arrangements
7 Nov 2018
The latest thematic review from the Financial Reporting Council (FRC) analysed the reports and accounts of 40 smaller listed and AIM quoted companies, highlighting problems with the quality of financial reporting in annual reports and accounts, including on alternative performance measures (APMs) and the quality of Strategic Reports; pension disclosures; accounting policies, including critical judgments and estimates; tax disclosures; and cash flow statements.
Around 40% of the companies reviewed in the FRC's Reporting by smaller listed and AIM quoted companies (smaller companies) report, were picked up on the quality of their financials and told to refer to correspondence with the FRC following a restatement of one of their primary statements, underlining that basic errors in compliance with accounting standards are more common in smaller companies. Over half of all the restatements related to misclassifications in cash flow statements.
The FRC also said that companies needed to do more to ensure that the classification of cash flows complies with IAS 7 Statement of Cash Flows and that all sections of the report present APMs in a balanced and transparent manner.
Widespread problems with a lack of tax transparency were also highlighted in the review, with FRC criticising the absence of reporting ‘where significant movements in the tax charge were labelled “other”, reducing the usefulness of the analysis of the charge (or credit) for the period or the reconciliation to a standard applicable rate’.
A quarter of the reviewed companies did not disaggregate types of temporary differences included in the deferred tax charge (or credit) to profit and loss. There were also examples where significant amounts of deferred tax assets and liabilities were disclosed as ‘other’ temporary differences, potentially concealing significant individual items that would require separate disclosure in the balance sheet notes.
None of the companies’ APM disclosures or accounting policies described the treatment of unusual tax items such as the impact of tax reforms on post-tax adjusted earnings per share (EPS).
Only one company in the sample referred to the non-financial reporting (NFR) regulations and provided cross-references to demonstrate how the new requirements had been integrated into its strategic report.
The FRC highlighted poor reporting on cash flow issues, stating that ‘the weaker narratives failed to present a comprehensive view of the cash position or showed inconsistencies with the financial statements. Better examples specifically addressed the effect on cash flows of individually significant transactions separately from ongoing trends and provided supplemental information to support the analysis where required, such as that concerning deferred consideration’.
Paul George, FRC’s executive director for corporate governance and reporting, said: ‘There is scope for companies to provide stakeholders with more tailored information about the areas of their accounts subject to most judgment and the potential effect of material changes in estimates and assumptions.’
Annual reporting checklist
In a bid to improve the quality and transparency of small company reporting, the FRC has also produced a checklist of issues to consider when preparing annual reports and accounts. These are some of the key issues to consider:
These should contain a fair review of the business, be balanced and comprehensive analysis of performance and the position at the end of the year, with commentary on the income statement, balance sheet and cash flow statement.
Presentation of APMs
These should be transparent, reliable and understandable, with clear signposting of APMs versus International Financial Reporting Standard (IFRS) measures when discussing financial performance and position. In addition, companies must take care to only label items as ‘non-recurring’ when the items will genuinely not recur.
Reporting on pensions needs to explain the pension risk, potential impacts and risk mitigation strategies, enabling users to understand the relationship between the pension expense, cash payments to the scheme and the surplus or deficit. Plan assets also need to be categorised into sub-classes with differing characteristics.
The application of different accounting principles need to be explained, taking into account revenue recognition policies that align with the business model, covering all material sources of revenue, an area highlighted as a significant area of concern for a number of years. It is also important to take account of the impact of upcoming standard changes, such as IFRS Leases on the entity.
Judgments and estimates
It is important to make a clear distinction between judgments and estimates, with relevant disclosures for each category, including identification of those estimates with a significant risk of a material adjustment in the next year, with quantification of the relevant amounts.
Cash flow statements
Cash flow reporting needs to be taken seriously by companies and should be separately presented as operating, investing and financing activities to allow users to assess their impact on the financial position of the entity and the amount of its cash and cash equivalents.
Reporting on tax needs to show the current and future tax consequences of the recovery (settlement) of the carrying amount of recognised assets (liabilities), as well as the current and future tax consequences of current period transactions and other events. It is also important to include explanations for the recognition of deferred tax assets where there is a history of losses, and explanation of the reported and future effective tax rates.
The companies reviewed included 22 listed companies outside the FTSE 350 and 18 AIM quoted companies, with year ends ranging from 31 December 2017 to 31 March 2018.
The 48-page FRC Corporate reporting thematic review: Reporting by smaller listed and AIM quoted companies (smaller companies), was issued 6 November 2018.
Report by Sara White