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M&A hub: Developments driving and shaping M&A
Key legal and regulatory developments driving and shaping M&A
United Kingdom | Publication | October 2023
On 5 October 2023, the Financial Reporting Council (FRC) published its Annual Review of Corporate Reporting, which describes the activity and findings of its Corporate Reporting Review function for the 12 months to 31 March 2023. Its aim is to help companies improve their corporate reporting by highlighting key improvement areas and matters on which companies should focus in the coming year, with a particular focus on those areas where the FRC has challenged companies most frequently, or where the requirements are complex or changing.
The ten topics that resulted in the most substantive questions to companies in the past year were the following:
Impairment of assets
The FRC points out that companies need to disclose and explain key inputs and assumptions applied in impairment testing, including the relevant values and sensitivity analysis, where required. Additional disclosures will be required where headroom is low, and heightened uncertainties over inflation, consumer demand and interest rates may drive a wider range of reasonably possible outcomes for future cashflows and discount rates. Users should be able to understand how assumptions are consistent with discussion of uncertainties elsewhere in the report. In addition, impairment testing methodology should comply with IFRS.
Judgements and estimates
All significant judgements, including those applied in performing the going concern assessment, must be described. It is not sufficient to list the matters requiring judgement. Disclosures about estimates should include values, sensitivities and explain significant changes. Sources of estimation uncertainty with a significant risk of resulting in a material adjustment within one year should be clearly distinguished from other estimates. Disclosures should be reassessed every year to confirm all relevant matters are captured, immaterial issues are not rolled forward, and the assumptions and ranges of reasonably possible outcomes remain appropriate in the company’s current circumstances.
Cash flow statements
A robust pre-issuance review should be performed. The FRC comments that it continues to identify many issues from basic consistency checks, comparing the cash flow statement to other information in the financial statements.
Strategic Report and other Companies Act 2006 matters
The strategic report should include unbiased discussion of positive and negative aspects of performance, a clear articulation of the effects of economic uncertainty on the business, and should address significant movements in the financial statements, including those in the cash flow and balance sheet. Companies should also ensure that all statutory requirements for the payment of dividends have been met, including the requirements to file interim accounts where distributions are not supported by the most recent audited accounts.
Financial instruments
All material risks arising from financial instruments must be adequately disclosed, along with how these are managed, including risks driven by inflation and rising interest rates, and related hedging arrangements. In addition, information about banking covenants should be provided unless the likelihood of any breach is considered remote.
Income taxes
Forward-looking assessments to support the recovery of deferred tax assets must be based on appropriate assumptions about future taxable profits. Where companies have been loss-making, the nature of the convincing evidence supporting recognition of the assets must be disclosed. More generally, tax-related disclosures throughout the report and accounts must be consistent, and material reconciling items in the effective tax rate reconciliation adequately explained.
Revenue
Companies need to ensure that accounting policies are provided for all significant revenue streams and that the methodology applied is described, including the timing of revenue recognition, the basis for recognising any revenue over time, and any significant judgements made in applying or those policies. Companies should also describe inflationary features in customer contracts and the corresponding accounting treatment.
Provisions and contingencies
Companies must provide clear and specific descriptions of the relevant exposure, including the basis for determining the best estimate of the relevant outflow, and the timeframe over which it is expected to crystalise. In addition, the calculation and presentation should comply with IFRS. Provisions should not be presented net of any reimbursement asset and a consistent approach should be taken in reflecting the effects of inflation in cash flows and discount rates.
Presentation of financial statements
Company-specific information about material accounting policies and transactions must be disclosed, with an explanation of how the policies apply to the company’s particular circumstances.
Fair value measurement
The FRC notes that fair value measurements are market participants’ assumptions and provide high quality disclosures. The FRC finds most issues in the disclosure of recurring Level 3 measurements, for which significant unobservable inputs should be quantified and a sensitivity analysis given. Companies should consider the need for specialist third party advice where no internal expertise exists.
The FRC, as well as expecting companies to take account of the top ten issues above, also expects companies to carefully consider how current economic conditions may impact on financial and narrative reporting in 2023/24. The report summarises the potential implications of reporting in an uncertain and inflationary environment and it provides detail on the reporting implications of high inflation and rising interest rates. In particular, it notes as follows:
The FRC expects companies to do the following:
(FRC, Annual Review of Corporate Reporting 2022/23, 05.10.2023)
(FRC, FRC sets out reporting expectations amidst ongoing economic uncertainty, 05.10.2023)
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