Capital Quarter: “Could do better”
Read time: 6 mins
Errors and failings the FRC wants to see preparers of corporate reports and accounts avoid in next year’s corporate reporting.
Every year the Financial Reporting Council (FRC) randomly selects a handful of company report and accounts for review and publishes its findings in an Annual Review of Corporate Reporting on the FRC website, in an effort to promote best practice. The best and worst examples of reporting are highlighted for praise and damnation.
The FRC’s Corporate Reporting Review team looked at 246 reports to produce its 2021/22 Annual Review published in October last year, a 14 percent increase in the number of reports reviewed compared to the previous year which demonstrates the expanding resources the FRC is now dedicating to review and its growing emphasis on better quality reporting.
Having effectively marked the homework of those responsible for preparing corporate reports and accounts, the FRC has drawn-up a list of the top ten most persistent problems that need to be high on the agenda for improvement and where preparers of corporate reports and accounts, and auditors, “could do better”.
This top ten should not be ignored! The list gives an insight into the areas of focus for the FRC in future, and where it will be trouble-spotting for poor practice in forthcoming reviews of corporate reports. Typically, they include aspects of reports and accounts that are overly complicated, or deliberately obfuscatory.
Failure to come-up to scratch could result in a request for further explanation and additional information from the FRC, and potentially spark the launch of a deeper investigation. Either way, it means extra work to respond to the FRC’s questions, time to research and prepare answers, and a significant increase in worry and stress for all concerned.
Ultimately, the FRC’s goal is greater clarity to help corporate report users better understand the company. This aim is one that should be shared by preparers of corporate reports and auditors: the more effectively a company can communicate its story, the more useful and comprehensible its reporting, then the more attractive it will be to potential investors. To this end, companies should give serious consideration to adopting the FRC’s recommendations.
The 52 page Annual Review of Corporate Reporting 2021/22, doesn’t make for light reading, so PKF has distilled the FRC’s top ten common errors and areas for improvement into a practical checklist, to get the ball rolling…
Estimates and Judgements
This area tops the list for 2021/22. It has become of increased importance because of the uncertainty around the future impact of Covid-19 on the economy.
1. Critical Judgements: tailored disclosures that explain the impact of the judgements made and identify the amounts at risk of material misstatement.
2. Sources of estimation uncertainty:
a. quantify through sensitivity analysis; and
b. assign values to key inputs and assumptions
1. Repeat the standard; and
2. Give limited information
Revenue recognition policies and related disclosures continue to be problematic and are one of the top areas requiring additional queries.
- Revenue recognised over time: give the basis for choosing this method and how performance obligations are monitored over time;
- Revenue recognised at a point in time: give a clear explanation e.g., why the dispatch of goods coincides with the transfer of control;
- Arrangements with multiple elements: explain the significant judgements made in identifying relevant performance obligations; and
- Variable consideration: explain the nature of any variable considerations and how it is estimated.
Give insufficient explanations. Common unexplained areas include:
- Contract modifications;
- Contract assets and liabilities; and
- Acting as a principal vs. agent.
- Disclose the recoverability of other financial assets and the methodology used to assess this;
- When estimating ECL provisions and credit risk, quantify the weightings used in any forward looking scenario and quantify any variables. Explain the factors considered wherever there is a change in risk.
- As we come out of the Covid-19 pandemic, clear explanations are expected regarding companies’ positions and the liquidity available to them;
- Show the impact of factoring and reverse factoring on the balance sheet and cash flows, the accounting policies applied and impact on covenants.
Give a boilerplate commentary with no disclosures around the impact of changes in year on year risk and the considerations made.
Alternative Performance Measures (APMs)
Reconciliations and calculations continue to be poorly dealt with and disclosed within financial statements.
- Provide reconciliations to known GAAP measures for all APMs including ratios;
- Any adjustments made should include gains and losses where relevant;
- Provide descriptions of APMs, but these should not be similar to IFRS measures, to avoid confusion;
- Rationale for making use of APMs should be clearly explained;
- Definitions should be provided for all APMs.
Give APMs undue prominence – there needs to be a balance between IFRS and APM measures;
Give an unfair view eg., adjusting for costs that are part of normal operations.
Impairment of Assets
An area of particular focus in light of Covid-19 uncertainty. Disclosures are key.
- Provide indicators of impairments e.g., outcome of judgements, basis for assumptions and sensitivities;
- Explain how cash generating units are identified and any year on year changes;
- Explain future cash flow selection, quantify assumptions and the sensitivity of those assumptions;
- Values should be assigned to sensitivity analysis, along with headroom;
- Explain how discount rates have been set;
- Give information about impairment losses, the recoverable amount and the reason for the impairment.
Give boilerplate explanations.
Statement of cashflows
An area of significant that may require some companies to restate their cash flow statements. Robust pre-issue reviews by companies could avoid many problems.
- Provide reporting which is consistent e.g., with the strategic report;
- Ensure that cashflow expenses are added back and income deducted;
- Focus on key areas:
- Dividends received;
- net cash paid on acquisitions;
- cashflows from acquisitions of NCI (financing);
- cashflows from derivatives (operating where operational hedges or investing where net investment hedges).
- Present non-cash items:
- Focus on net basis reporting e.g., new borrowings and payments.
Strategic Report and Companies Act
An area which has improved, but companies were challenged where significant matters were not addressed.
- Provide a fair, balanced and comprehensive view;
- Outline performance and position, including information on all of the primary statements and other key matters e.g., debt, tax, etc;
- Include both positive and negative matters;
- Ensure that matters are comparable on a like for like basis.
- Omit risks e.g., climate;
- Focus solely on the good, or the future and omit comment on the negative – be consistent.
Provisions and contingencies:
A frequently raised topic triggered by inconsistent or unclear information.
- Explain the basis for recognition;
- Include judgements about those taken to both recognise and not recognise provisions;
- Disclose the nature of provisions, linked uncertainties and potential timing of cashflows;
- Say why disclosure is not provided: information is still required about the general nature of the dispute and the reason why the information is not disclosed due to it being seriously prejudicial.
Recognise provisions on a net basis when covered in part by insurance.
- Provide the rationale for transactions outside the scope of IFRS 16 and full disclosure for all transactions falling either in or out of scope e.g., sale and leaseback, lease incentives;
- Disclose and explain variable payment features;
- Provide quantitative and qualitative disclosures about lease extension or termination options and ensure identification of these is disclosed as a significant judgement.
- Give a clear maturity analysis;
- Give a clear maturity analysis;
Significant accounting judgements and sources of estimation uncertainty are required.
- Disclose the amount and expiry date (where relevant) of deferred tax assets (DTA) recognised, and any movement in P&L;
- Provide judgements around key sources of estimation uncertainty including carrying amounts impacted and any changes in assumption on the DTAs.
Fail to provide evidence about why the DTA is being recognised. This should pay heed to the current economic environment.