FRC wants corporate reporting improvements to increase trust
30 Oct 2019
The FRC (Financial Reporting Council) has written to all audit committee chairs and finance directors, following its annual review of corporate reporting, calling for improvements in order to enhance public trust in business and ensure companies address the issues which matter for investors
30 Oct 2019
The letter reflects findings from the regulator’s annual review of corporate reporting, which highlighted a number of areas of concern. These include how companies present forward looking information, the potential impact of known and emerging risks and opportunities on future business strategy and the carrying value of assets and the recognition of liabilities.
The FRC warns that failure to report on these crucial areas undermines trust in business and can lead to the conclusion that management is either unaware of their potential impact, is being opaque, or is not managing them effectively.
In the report, the FRC noted that while it is unsatisfactory that its most frequent enquiries in the year cover the same topics as 2017/18 and 2016/17, there has been some improvement in the quality of the disclosures made in these areas.
The report stated: ‘Our challenges around judgements and estimates – still the most frequent area of questioning – were more nuanced this year. Most companies are now adequately distinguishing between judgements and estimates; our probing sought a better articulation of the disclosures and how they can best inform investors.’
However, the FRC said it continued to see errors within cash flow statements and related disclosures, many of which inflated cash generated from operating activities at the expense of investing or financing activities.
The report stated: ‘As these errors can be identified from a desk top review of the accounts, it remains a concern that companies’ own quality control procedures and those of their auditors are failing to spot such matters.’
The report also highlighted concerns raised by the FRC ‘s financial lab about the presentation of cash holdings.
The report stated: ‘We continue to see basic errors, many of which were misclassification of cash flows which were evident from the face of the financial statements and which could have been identified through robust pre-issuance review.
‘We expect companies to follow the detailed requirements of IAS 7 (International Accounting Standard) to assist investors’ comparability between companies. Where a genuine material judgement has been made on presentation, we expect that judgement to be disclosed and explained.
‘We continue to have particular concerns about the level of disclosure around supplier financing arrangements as featured in the lab report. We will ask companies direct questions on whether and, if so, the extent to which, they enter into this type of arrangement where their usage is common place in their industry and there is no reference to the matter in their report or accounts.’
The FRC’s thematic reviews, which form the basis of the annual report along with 207 reviews of annual and interim statements, included consideration of the first-time mandatory application of two new accounting standards (IFRS 9 Financial Instruments and IFRS 15 Revenue from Contracts with Customer).
It said it had identified plenty of scope for improvement in the clarity of disclosures around both loan loss provisions, particularly in respect of smaller banks, and the comprehensiveness of the accounting policies for revenue recognition.
The FRC has also written to a number of companies about their disclosure of contingent liabilities or provisions due either to missing or unclear disclosures, or instances where the information disclosed in the provisions note appeared inconsistent with information provided elsewhere.
The report stated: ‘We continued to challenge companies about the completeness of the principal risks and uncertainties disclosed in their strategic reports, particularly where matters disclosed elsewhere in the annual report, or externally, indicated a significant risk that was not identified in the strategic report.
‘We wrote to some companies whose business models would appear to give rise to significant climate risk, but which was not disclosed in the annual report. We expect disclosure of significant physical or transitional risks.’
There were also frequent instances of strategic reports which in the FRC’s view did not appear to provide a fair, balanced and comprehensive analysis of the development and performance of the business during the year. Examples included business reviews that failed to discuss the performance of acquisitions, the progress of transformation programmes or significant changes or concentrations of credit risk.
In addition, the FRC said it was still seeing too many cases of absent or unclear definitions of alternative performance measures (APMs) and their reconciliation to the closest equivalent IFRS line item.
Paul George, executive director of corporate governance & reporting at the FRC, said: ‘Investors and the general public rightly expect financial reports to be fair, balanced and understandable.
‘This is particularly important in periods of uncertainty where heightened transparency is expected.
‘High-quality reporting by companies, including candid disclosure of the risks they face, supports trust in business.’