Julia Irvine 10 Oct 2017 04:31pm

Companies put on warning by FRC letter

The implementation of three major new international accounting standards are likely to have a significant impact on many companies’ results and their financial position, the Financial Reporting Council (FRC) has warned

In its annual letter to company audit committee chairs and finance directors highlighting key developments ahead of the 2017/18 reporting season, the regulator stresses the importance of companies disclosing the likely impact of IFRS 9, Financial Instruments, IFRS 15, Revenue from Contracts with Customers, and IFRS 16, Leases, as soon as this can be reliably measured.

“In the last set of financial statements before the implementation date we expect to see detailed, quantitative disclosure regarding the effects of the new standards,” Paul George, the FRC’s executive director of corporate governance and reporting, said in the letter.

“We expect companies to have made a step change in the quality of their disclosures this year, particularly in respect of IFRS 15 and IFRS 9.”

Companies will be in the process of implementing both these standards. However, IFRS 16, which is  operational for accounting periods starting on or after 1 January 2019, is still awaiting endorsement. The FRC expects it to be approved by the end of 2017 in time for companies to adopt it early so they can implement it at the same time as IFRS 15.

The letter also highlights the need for companies to improve the quality of their communications in the strategic report, to ensure what they said was effective, “fair, balanced and understandable”.

The FRC reveals that the strategic report remains one of the areas most frequently challenged by its monitoring team. Some companies clearly prepare theirs with an eye on compliance rather than on communicating the whole story while others produce reports that appear to lack balance.

George says companies should explain the relationships  and linkage between different pieces of information, “For example, explaining the linkages between key performance indicators (KPIs) and remuneration policies can provide valuable context for investors’ assessment of management stewardship.”

Despite Brexit, the European Union continues to drive changes in UK reporting, including new regulations for non-financial reporting which implement the EU Directive on Non-Financial and Diversity Information.

The regulations require certain large companies to provide enhanced disclosures on issues ranging from human rights to anti-corruption and bribery, for financial years beginning on or after 1 January 2017.

The FRC says that it is revising its guidance, but until this is completed in 2018 it has provided a fact sheet on the new regulations.

The new guidance will encourage companies to improve information on how their boards have complied with the requirement under s172 of the Companies Act 2006 to take the interests of a wide group of stakeholders into account when taking business decisions.

The FRC also wants companies to consider the broader drivers of value that are integral to their long-term future but are not recognised in the financial statements. For example, companies should disclose how they manage, sustain and develop, say, their intellectual property or internally-generated intangible assets where these are relevant to understanding company performance.

Another area the FRC letter highlights is the viability statement. Most companies have opted for a three-year period, largely to reflect their medium-term business plan. However, the regulator says that other factors such as investment and planning periods, the board’s stewardship responsibilities, the nature of the business and its stage of development, and previous statements made (especially in raising capital) should also be considered.

It would like to see companies developing the viability statement in two separate stages. The first would involve reporting on the company’s prospects over a period reflecting its business and investment cycles, while the second would cover the board’s reasonable expectation that the company should be able to continue in operation and meet its liabilities as they fall due over the period of the assessment.

The FRC also focuses on improvements that are needed in smaller company accounts. It reports a significant increase in the amount of companies reporting on their distributable profits/reserves, particularly among the FTSE 100. However, it says that progress in the FTSE 250 has been “less significant” with only 30% making the disclosures.

George also addressed how smaller listed companies use accounting policies that are often “out of date, irrelevant, immaterial or based on boilerplate text taken from the standard”.

“Companies should ensure that their disclosures are sufficiently tailored to their circumstances,” he it says. “For example, revenue accounting policy disclosures should cover each significant business stream.”

Finally, with its audit regulator hat on, the FRC warns auditors and audit committee chairs that during its monitoring of 2017/18 year end audits, it would be taking some of the areas it has raised in the letter and seeking evidence that the auditors have challenged management on them and reported clearly to the audit committee.

Critical judgments, estimates and pensions are three of the target areas, it adds.