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21 Oct 2016 12:33pm

Brexit may lead to divergence between EU and UK accounting frameworks

Brexit could have “significant implications” for the future adoption of international financial reporting standards, the Financial Reporting Council (FRC) has warned

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Caption: FRC warns exit may lead to divergence between UK and EU corporate reporting

Just what these implications will be will depend on the exit terms the UK government negotiates with the EU, but one of the most likely changes is that the UK will end up taking back the assessment of new standards prior to adoption.

As the UK will no longer be bound by EU regulation, it will be able to adopt its own version of IFRS which could end up differing from the EU’s. This would also have major consequences for UK listed companies that report using IFRS.

“After leaving the EU the UK won’t, it’s fair to assume, use EU-adapted IFRS,” an FRC spokesperson explained. 

“If we did take back approval of IFRS, it would mean there would be a different regulatory structure, there would be a UK process for responding to new or amended IFRS separate from that in Europe though, clearly, at this stage the exact form of such a process is unknown.

If the FRC is finding reason to raise queries with so many sets of accounts, could companies be missing a trick here?

RSM’s head of financial reporting Danielle Stewart

“The FRC has always shown its commitment to influencing international debate to promote high quality global standards – both quality and international consistency will continue to be important.”

The potential consequences of Brexit are highlighted in the FRC’s 2015/16 annual review of corporate reporting in the UK, which was published today.

Paul George, the FRC’s executive director for corporate governance and reporting, made it clear that the regulator continues to support the use of a single set of high quality global standards by UK listed companies. “Investors have told us they want comparability when reading company accounts,” he said.

Nevertheless, he stressed that any standards adopted in the UK post Brexit would have to be “of the requisite quality and capable of implementation at an appropriate cost”.

Nigel Sleigh-Johnson, head of the ICAEW Financial Reporting Faculty, agreed. “What may or may not happen is very uncertain for now,” he said.

“What isn’t in doubt is the significance of the use by UK-listed companies of high quality international standards, given the status of London as a global financial centre.”

The FRC’s review, which covers UK corporate reporting in the year to 31 March 2016, concludes that while compliance with the accounting framework is “generally good” and the introduction of the strategic review has led to better narrative reporting, there is still room for improvement.

Companies, it says, prefer to tell their story in a positive light and don’t like to admit when things have gone wrong. They rely on “excessive use” of underlying profit figures and “inappropriate use” of alternative performance measures. These practices result in an unbalanced picture and “erode trust and undermine the quality of corporate reporting”.

Despite this, a YouGov survey of 224 stakeholders, commissioned by the FRC, showed that more than 90% of directors and auditors and 73% of investors have a high level of confidence in annual report and accounts.

They do, however, remain concerned about the length and accessibility of the annual report and accounts.

The FRC admits that companies face a growing challenge to ensure that their reports remain clear and concise while answering calls for transparency on a broader range of issues and reporting to a wider group of stakeholders.

“While the primary audience for the annual report and accounts remains existing shareholders, the FRC recognises the validity of wider stakeholder interest in corporate reporting,” the review says.

“Companies need to recognise that the concerns of stakeholders will have a bearing on their reputation and could materially affect their profitability and the interests of shareholders.”

Tax arrangements, dividend disclosures and the impact of Brexit are three obvious areas that companies should pay attention to but the review also mentions environmental, social and governance issues, including climate-related matters and corporate culture.

“It is worth noting that shareholders themselves are interested in how broader non-financial matters may have an impact on the development, performance and position of the business over the longer term and are looking for more disclosure in relation to public interest matters,” it adds.

This year, the review also contains a nine-point guide to the characteristics of good corporate reporting, over and above basic compliance with the requirements of the law and accounting standards and the need for complete and accurate accounting information.

They are:

  • A single story
  • How the money is made
  • What worries the board
  • Consistency
  • Cut the clutter
  • Clarity
  • Summarise
  • Explain change
  • And true and fair.

In compiling the review, the FRC drew on its monitoring work during the year. It reviewed the reports of 192 companies, raising queries about issues in around one third of them. Most of these have now been settled with the companies agreeing to remedy their reporting in future.

Sleigh-Johnson welcomed the report’s conclusions and reiterated ICAEW’s support for the FRC’s efforts to improve the quality of narrative and non-financial reporting by large organisations.

“Those efforts have resulted in considerable improvement in the quality of such reporting in recent years,” he said. “It is especially welcome in this context that the call from ICAEW for the EU and the UK government to no longer use the annual report as the repository of choice for new disclosures of a regulatory or public policy nature appears to have been heeded.” 

He also welcomed evidence of the high level of confidence in corporate reporting among directors, auditors and investors but warned there was no room for complacency.

“Technological change, the question of public trust in business and the increasing interest of a wider group of stakeholders in corporate reporting means that there will be pressure for radical change to corporate reporting in coming years.

“The challenge is to ensure that the hard fought for effectiveness of the current regime for reporting to investors, which plays a critical role in encouraging investment in the UK, is maintained.”

RSM’s head of financial reporting Danielle Stewart pointed out that the headline finding that most accounts were compliant “disguises the fact that the FRC’s review team raised queries with approximately one in three accounts they reviewed”.

“If the FRC is finding reason to raise queries with so many sets of accounts, could companies be missing a trick here?” she asked.

“The annual accounts are a key opportunity to really connect with investors and potential investors. However, the FRC’s survey data shows that investors have significantly less confidence in the quality of financial reporting than either auditors or directors.

"Those companies who are falling short not only risk non-compliance with IFRS, they are also damaging their future investment prospects. This is particularly true for AIM-listed and smaller mid-market companies.”

Julia Irvine

 

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