CapitalQuarter – Spring 2024
The FRC has recently published its Annual Review of Corporate Reporting 2022/23. We look back at the key points and also forward to the 2023/24 review to guide companies in their approach.
This review sets out the top 10 issues on which the FRC has raised questions with companies, as well as its findings from thematic and other specific reviews. There’s also a focus on its overall expectations for 2023/2024 and on aspects that are likely to present reporting challenges for companies.
The top 10 issues
The FRC’s Annual Review found that the general quality of corporate reporting among FTSE350 companies has been maintained. The number of substantive questions was similar to previous years and these were resolved through open and constructive engagement – a positive outcome in a challenging trading and reporting environment.
There were a few improvements, with alternative performance measures (APMs) dropping out of the top 10 for the first time in several years.
Impairments
The issues most frequently raised in the latest Annual Review were related to impairments, including the disclosure of judgements and estimates. This may reflect the heightened economic uncertainties companies have had to factor into their financial reporting.
Reduced headroom in impairment tests may trigger additional disclosure requirements for assumptions and sensitivities. Estimates, such as discount rates, may need to reflect a wider range of possible outcomes than in previous reporting periods. Reasonably possible changes in assumptions that would result in a recoverable amount below the carrying amount are required to be disclosed. Quantitative disclosures about the amount of headroom in the recoverable amount over the carrying amount, the key assumptions, or the sensitivity of the headroom to changes in the key assumptions are required to be disclosed if change in assumptions would result in impairment. Companies have not always provided sufficiently transparent disclosures for users to understand the view taken by management on these points, and the FRC believes these will remain areas of risk for the coming reporting season.
Cash flow statements
As for cash flow statements, there were fewer major errors than previously noted, but there were still many issues arising from basic consistency checks, comparing the cash flow statement to other information in the financial statements. Other common errors related to classification, netting off and reporting on non-cash movements in the cash flow statements.
Further challenges included:
- Strategic reporting requirements and other issues relating to requirements of the Companies Act 2006
- Financial instruments
- Income tax
- Revenue recognition
- Provisions and contingencies
- Presentation of financial statements
- Fair value measurement
What to beware of for 2023/24 annual reports and accounts
The FRC also highlighted the main obstacles in the current trading or reporting environment likely to present reporting challenges for companies.
One is high inflation and rising interest rates that may drive significant changes to discount rates. These, in turn, could result in additional impairments or a reduction in pension scheme liabilities and potential recognition of a surplus.
The range of estimation uncertainty over a number of economic factors, including inflation, has increased. This may mean more judgement calls by management to determine inputs to the financial statements, and disclosure of sensitivities to a wider range of reasonably possible outcomes.
Companies should consider the effect of uncertainty and high inflation on the recognition and measurement of assets and liabilities, and related disclosures, and to ensure that the key assumptions and range of sensitivity disclosures remain appropriate.
Changes to IFRS accounting standards for the coming reporting season are relatively minor, except for the implementation of IFRS 17.
What does the FRC expect of companies?
The FRC set out its key disclosure expectations for 2023/24:
- Ensure disclosures about uncertainty meet the relevant requirements and are sufficient for users to understand the positions taken in the financial statements.
- Give a clear description in the strategic report of risks facing the business, their impact on strategy, business model, and going concern, cross-referenced with relevant detail in the reports and accounts.
- Provide transparent disclosure of the nature and extent of material risks arising from financial instruments, including: changes in investing, financing and hedging arrangements; the use of factoring and reverse factoring in working capital financing; the approach to, and significant assumptions made in, the measurement of expected credit losses; and concentrations of risks and information about covenants (where relevant).
- Provide a clear statement of consistency with Task Force on Climate-related Financial Disclosures (TCFD) (where required by the stock market listing rules), or an explanation of the reasons for not doing so, which explains clearly whether management believes it has given sufficient information to comply with the framework in the current year.
- Carry out a sufficiently critical review of the annual report and accounts.
What are the thematic focuses for 2023/24?
The FRC has started its next review cycle and is carrying out four thematic reviews:
- Fair value measurement
- TCFD – metrics and targets
- Large private companies
- Insurance contracts.
Fair value measurement is required or permitted by many IFRSs. Companies are facing greater estimation uncertainty and a high level of judgement in this area, given the risks posed by the challenging economic environment and by climate change. This means clear and transparent disclosures of fair value measurements will become increasingly important.
Another thematic review focused on the quality of companies’ disclosures of TCFD metrics and targets. There has been a gradual improvement in this aspect of reporting since the 2022 review. Most companies have set net zero or other climate-related targets and interim emissions targets, but these have not always been well explained. Likewise, the review found there has been some commonality between companies in the same sectors, but different methodologies have made direct comparison difficult and challenging.
The FRC published its review of reporting by the UK’s largest private companies in January 2024. The reporting quality was mixed in terms of how clearly companies explained material matters that were complex or judgemental. All companies included in the review were substantial entities in respect of revenues and employees, many of which have complex structures, business models and operations.
Key findings that companies should take into account for future annual reports include:
- The strategic report should explain the key matters in a clear, concise and understandable way that is consistent with other disclosures in the financial statements
- Details of the specific judgment involved and rationale for the conclusion must be explained clearly
- Quantitative disclosures should be included to provide clarity on the significance of estimation uncertainty
- Accounting policies for complex transactions and balances should be entity specific.
The thematic review was based on the disclosures regarding the impact of the new standard IFRS 17 Insurance contracts on a sample of companies for the June 2023 interim reports. Overall, the FRC was pleased with the quality of IFRS 17 disclosures in the sample interim accounts. But it also identified areas for improvement:
- Companies must provide high quality disclosures about complex or subjective areas
- Accounting policies should be company-specific
- Disclosures of significant judgements and estimates must be sufficiently detailed
- Companies should explain the transition approach they adopt.
The 2022/23 FRC Annual Review can be found here. For further information or guidance, please contact Wendy Liang.
