Julia Irvine 30 Oct 2019 03:18pm

Companies need to think beyond the financials, FRC says

The new chief executive of the Financial Reporting Council (FRC) has written to audit committee chairs and finance directors setting out the regulator’s perspective on key matters ahead of the 2019/20 reporting season

In this year’s six-page letter, Sir Jon Thompson highlights the recent changes to reporting requirements that address wider matters of interest to investors and other stakeholders than just the financials, such as s172 reports and climate change risk disclosures.

And he warns companies of mistakes that they are continuing to make, in particular around disclosures that relate to critical judgments and estimates, reporting of cash and alternative performance measurements (APMs).

As far as s172 reports are concerned, since 1 January this year, boards have been required to include a statement in the strategic report which explains how they have taken various factors – including the likely consequences of any decision for the company in the long term, employees’ interests, the impact of the company’s activities on the environment and the need to foster business relationships, among others – into account in working to promote the success of their business.

Sir Jon points out that, although this is not a new duty, the reporting requirement is and boards will be expected to comply. His suggestions for disclosure include: those issues, factors and stakeholders the board considers relevant to s172 and the reasons it came to that view; the main methods it has used to engage with stakeholders and to understand the issues to which it must have regard; and information about the effect of that regard on the company’s decisions and strategies during the financial year.

On environmental disclosures, Sir Jon reminds large asset owners and listed companies that they are expected to report in accordance with the requirements of the Task Force on Climate-Related Financial Disclosures (TCFD) by 2022. He also refers them to the FRC’s statement setting out what it expects companies’ climate change reports to contain.

“Neither the requirements of the non-financial information statement nor the s172 report specifically require companies to disclose the impact of climate change on their operations. However, consistent with the UK Corporate Governance Code’s focus on emerging risks, and after considering the likely consequences, companies should, where relevant, report on the effects of climate change on their business (both direct and indirect),” he writes.

“To be clear, we expect companies to disclose risks that extend beyond the period covered in their viability statement.”

The letter goes on to detail findings from the FRC’s monitoring work on corporate reporting that have given the regulator cause for concern.

For instance, it welcomed the increase over the year in the number of companies which clearly distinguished between the critical judgments they made in preparing their accounts and those that involved the making of estimates and which lead to different disclosure requirements. But it also discovered some companies were providing insufficient disclosures to explain estimation uncertainties, especially where a particular judgment had a significant impact on their reporting.

Over the year, the FRC also saw a rise in the number of times it had to challenge companies about their cash flow statements and related disclosures. “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,” Sir Jon says.

“We expect companies to follow the detailed requirements of IAS 7 to assist investors’ comparability between companies. Where a genuine material judgment has been made on presentation, we expect that judgement to be disclosed and explained.”

The FRC remains concerned about the level of disclosure around supplier financing arrangements, he adds. Companies must expect to face questions about 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 says it will continue to monitor companies’ disclosures around APMs especially where they appear to have failed to comply with ESMA guidelines. “Any apparent reluctance to identify and highlight the audited IFRS numbers from which APMs are derived is a cause for concern,” it warns.

The FRC is broadly satisfied with the way in which companies have implemented IFRS 9, Financial Instruments, and IFRS 15, Revenue from Contracts with Customers, both of which were effective for December 2018 year ends.

This year companies are having to contend with implementation of  IFRS 16, Leases, and the FRC sets out what disclosures it expects to see.

The FRC also warns companies that in times of uncertainty, like now, investors will be looking for greater transparency in corporate reports to help inform their decisions.

“We expect companies to consider carefully the detail provided in those areas of their reports which are exposed to heightened levels of risk; for example, descriptions of how they have approached going concern considerations, the impact of Brexit and all areas of material estimation uncertainty,” it says.

Another area that needs careful consideration relates to the global reforms of interest rate benchmarks, such as LIBOR, and the published amendments to IFRS 9 and IAS 39.The FRC is keen for companies to start planning now for the transition to new rates, including early consideration of the need to re-negotiate relevant contracts and agreements.