“Corporate reporting standard improving, though quality not as high as it should be,” says the headline of a recent news release from the UK’s Financial Reporting Council.
This summarizes the findings of the FRC’s Annual Review of Corporate Reporting. Although the report covers a range of topics, we’ll focus here on some of the items relating to applying IFRS. Overall, what follows falls much more into the category of reinforcing past messages than of identifying new ones:
Judgments and estimates “Investors tell us that they value disclosures of judgments and estimates that enable them to evaluate a company’s financial position and results and their sensitivities to changes in assumptions….The better quality reports (in the FRC’s sample) identified a smaller number of judgments and estimates but provided much richer information about the supporting assumptions and sensitivities. Users of these reports would have a clearer picture of which decisions taken by the board had a significant impact on the company’s performance. It was particularly helpful when companies explained the reasons for changes in the list of judgements and estimates considered to be key from those disclosed in the previous year…it was disappointing that a significant minority still used elements of boiler-plate text, which could apply to any company and gave no additional useful information to users of the accounts….”
This could have been issued verbatim by Canadian regulators, and more or less has been in the past…
Business combinations “Our reviews include consideration of the accounting for business combinations as, by their nature, such transactions can be complex and the accounting issues may differ from those that applied to a company’s previous acquisitions. There may also be a finely balanced judgement as to whether a business or a group of assets has been acquired. Some transactions include complex contingent and deferred consideration arrangements. We have questioned the accounting for these arrangements where the disclosures of the treatment adopted and its effect are unclear … We continue to challenge companies where it is unclear why few or no intangible assets other than goodwill are recognized in accounting for an acquisition; for example, when disclosure elsewhere in the report and accounts suggests the company has acquired leases on favourable terms…”
Again, that should all be familiar to connoisseurs of Canadian regulatory bulletins – I think I’ve encountered all those issues in practice even within the past year…
Revenue “We challenge companies where there is an apparent disconnect between the description of revenue streams in the narrative sections of the annual report and the accounting policies disclosed in the financial statements. Questions most frequently raised with companies concerned the lack of clarity of communication of the policy and any areas of complexity…”
This too is an extremely long-standing issue of course – Canadian regulators have commented again and again on the inadequacy of revenue-related disclosures. The implementation of IFRS 15 provides an obvious opportunity for a fresh start in this respect – among much else, the new standard contains additional requirements for disaggregating revenue into categories reflecting different exposure to economic factors. The focus will no doubt be on preventing those disclosures from descending into excessive and unilluminating technical detail (something the relevant sections of IFRS 15 might certainly inadvertently encourage).
Cash flow statements “Investors consider reported operating cash flows to be an important indicator of a company’s current, and potential future, performance. It is, therefore, important for cash flows to be accurately presented as ‘operating’, ‘investing’ or ‘financing’. This year we identified a number of companies where cash flows relating to operating income had been classified as ‘investing’ rather than ‘operating’ such as the purchase of assets rented out to customers and business acquisition expenses included in the income statement….”
The report goes on to cite some other examples of questionable cash flow treatment, relating to transactions with shareholders and to amounts received from factoring arrangements. Although it seems clear enough that the two items mentioned above are indeed operating cash flows, it’s not hard to see why some might regard them otherwise based on their strategic purpose, or how it might lead in the direction of thoughts about reporting subtotals of operating cash flow. We talked about some other issues in cash flow reporting here.
Some aspects of the report, although only strictly relevant in a UK regulatory context, set out ideas which might stimulate Canadian preparers in building a better MD&A. For instance the FRC is placing a greater emphasis on:
- …information relating to sources of value that have not been recognized in the financial statements and how those sources of value are managed, sustained and developed, for example a highly trained workforce, intellectual property or internally-generated intangible assets, as these are relevant to an understanding of the company’s development, performance, position or impact of its activity.
- We are also encouraging companies to describe how their allocation of resources will support the achievement of their strategy and impact on stakeholders, for example what proportion of resource is directed to investing in research and development, to capital investment, or to dividends. This information could be provided using qualitative and quantitative analysis and we are aware that a few companies are already providing this kind of information in their annual reports.
The report also covers a range of broader topics, many of which we’ve touched on here in the past – from disclosures of alternative performance measures to Brexit to risk reporting to the FRC’s research into the future of financial reporting as a whole, so it’s certainly worth a look.
The opinions expressed are solely those of the author