Essential Corporate News: Week ending 6 October 2023

FRC: Annual Review of Corporate Reporting 2022/23

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.

Top ten issues in corporate reports

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.

Key matters for 2023/24 annual reports and accounts

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:

• High inflation and rising interest rates may drive significant changes to discount rates and expected future cash flows which can have effects ranging from additional impairments to a reduction in pension scheme liabilities and the potential recognition of a surplus. 
• The range of uncertainty over a number of economic factors, including inflation, has increased. This may increase the degree of judgement required by management in determining inputs to the financial statements, and require disclosure of sensitivities to a wider range of reasonably possible outcomes. 

FRC’s key disclosure expectations for 2023/24

The FRC expects companies to do the following: 

• Ensure disclosures about uncertainty are sufficient to meet the relevant requirements and for users to understand the positions taken in the financial statements. In particular: 
  • The values of key assumptions and sensitivities or a range of reasonably possible outcomes, must be provided, where required for impairment tests and major sources of estimation uncertainty. 
  • Significant accounting judgements must be described. 
  • Disclosures should be re-assessed each year to ensure they remain relevant and assumptions, and the range of outcomes used for sensitivity disclosures, remain appropriate. 
  • Better disclosure helps users understand the linkage between narrative reporting on uncertainties such as inflation and climate change, and the assumptions made in the financial statements. 
• Give a clear description in the strategic report of risks facing the business, their impact on strategy, business model, going concern and viability, cross-referenced to 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; concentrations of risks and information about covenants (where material). 
• Provide a clear statement of consistency with the TCFD Recommendations and framework which explains, unambiguously, whether management considers they have given sufficient information to comply with the framework in the current year. 
• Perform sufficient critical review of the annual report and accounts, including taking a step back to consider whether the report as a whole is clear, concise and understandable, omits immaterial information and whether additional information, beyond the requirements of specific standards, is required to understand particular transactions, events or circumstances.

(FRC, Annual Review of Corporate Reporting 2022/23, 05.10.2023)

(FRC, FRC sets out reporting expectations amidst ongoing economic uncertainty, 05.10.2023)