Uncertain Times - The Reporting Challenge
Financial Reporting Brief: December 2020
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Uncertain Times – The Reporting Challenge
With the end of the year firmly in sight, calendar year reporters are busily engaged in the process of finalising key decisions on how they present their annual reports and tell their story to all those that have an interest in their performance, financial condition and future prospects.
Has there ever been a time of greater uncertainty in which to report? While good news is appearing regarding vaccines, the COVID-19 pandemic continues to be globally pervasive and there is still some way to go. Uncertainties abound and the Brexit position leaves Ireland facing additional risks of a daunting nature. Environmental, Social and Governance (ESG) risks have grown in prominence, with climate risk to the fore, and investors are unhappy with corporate disclosures, and what they see as their inadequacy.
The peculiarities of 2020 has seen a vast abundance of guidance and commentary from various sources on how to cope with the demands on reporting in times of such great uncertainty. It is perhaps noteworthy that, other than some changes to the leasing standard, there has been no move towards amending standards to deal with changing conditions. This is to be expected if the standards do what they proclaim as being sufficient to deal with all circumstances and conditions. To do anything else would undermine the consistency and comparability of reporting, which are key pillars of providing reliable information to stakeholders. What is needed is to ensure that the necessary qualities of clarity, consistency, relevance and transparency of disclosures are fully promoted and safeguarded. It should be borne fully in mind that while the standards have minimum levels of disclosure requirements, there is no maximum if companies consider that providing additional disclosure will assist in providing a more complete story to stakeholders.
Recent guidance has included:
- IAASA Information Note: Reporting the Impact of COVID-19
- FRC Letter to CEOs, CFOs and Audit Committee Chairs: Company Reporting
Expectations for 2020/21
While the primary focus of the IAASA report is COVID-19, both cover similar ground consistently and provide valuable guidance to all involved in the corporate reporting process.
IAASA has observed diversity in the quality of reporting by issuers of the impact of the pandemic:
- Higher quality disclosures were those that clearly explained to users, in issuer specific terms, the critical judgements and sources of estimation uncertainty and any sensitivities associated with those judgements.
- Lower quality disclosures were characterised by boilerplate references to the pandemic and instances where entities remain silent or vague in explaining some of the key judgements and an absence of issuer specific information.
The IAASA observations clearly underline the fully justifiable expectation that all
stakeholders will be told the company’s ‘own story’ – highs and lows in a balanced manner – and not given some generic script.
The FRC emphasises that it expects increased disclosure of relevant sensitivities or ranges of possible outcomes to help users understand the assumptions underlying significant estimates and the extent of the changes that might be reasonably possible in the next twelve months.
The FRC has also published a review of corporate reporting in relation to IAS 7 ‘Statement of Cash Flows’ and the liquidity disclosure requirements in IFRS 7 ‘Financial Instruments: Disclosures’. The FRC will continue to challenge companies where there is an apparent material inconsistency between the cash flow statement and the notes, or where cash flows are incorrectly classified, together with a focus on improvement to disclosures of accounting policies and judgements in relation to the cash flow statement. The review also comments on the current hot topic of liquidity disclosure requirements.
Deloitte has continued its series of Need to know publications on the Accounting Considerations relating to the Corona Virus Pandemic. The November update includes clarifications on disclosures for ‘Going concern’ and ‘Liquidity risk management’, new subsections on ‘Dividends and capital management’ and ‘Contracts to buy/sell commodities’, and added guidance for idle assets in ‘Acquisitions and disposals’, as well as clarifications on ‘Share-based payments’, ‘Government assistance’ and ‘Breach of covenants’.
Report to Whom?
The question of to whom companies report has seen the sands shift considerably in recent times from the shareholder focus of profitability and return to the wider impact of the activity of a company on society, the environment and the values it creates and protects.
The growing awareness of the relationship between purpose and profit and
growing recognition by companies of the need to deliver sustained value to a
range of stakeholders is redefining the social contract between business and
society. ESG factors now feature prominently in boardrooms and gain ever more
attention from investors and other stakeholders.
Over the longer term, international standards may be expected to provide the optimum solution for non-financial reporting. Until then, existing frameworks can be used to meet stakeholder demands, such as for climate reporting, and improve the quality and consistency of corporate reporting. There is an urgent need to improve the consistency and comparability in sustainability reporting which will allow businesses to build public trust through greater transparency of
their sustainability initiatives.
The recent status report published by the Task Force for Climate-related Financial Disclosure (TCFD) found that the percentage of companies disclosing the resilience of their strategies for dealing with climate-related risk was significantly lower than that of any other recommended disclosure. This further highlights that it is not sufficient to just disclose information on climate and other ESG risks. Companies need to disclose their risk mitigation strategies, and how they are embraced in their business plans.
The FRC has published the results of its thematic review of climate-related considerations by boards, companies, auditors and professional bodies and investors. One of the many findings includes that disclosure of climate change in the financial statements lags behind narrative reporting. The FRC review identified areas of potential non-compliance with the requirements of generally accepted accounting practice.
A Different Perspective
The Deloitte report Annual Report Insights 2020 - Surveying FTSE Reporting provides a fresh approach to the growing evidence which suggests that companies that embed ESG factors and purpose can outperform those that don’t. Areas inherent in this are referred to as the four Ps – Purpose, People, Planet and Profit. In dealing with the four Ps throughout the report, it provides insight and inspiration, accompanied by examples of better practice as companies prepare for their next reporting season. In the times we are in, the Pandemic is pervasive to all – a fifth P!
Given comments earlier in this article, it is interesting to note in relation to Planet that while 90% of companies surveyed made reference in their reports to climate change and 64% referred to TCFD recommendations, only 22% made fulsome disclosures in line with TCFD recommendations and only 25% had a KPI clearly linked to climate-related risk.
Of great help are those parts of the Report on ‘what to watch out for’, providing practical tips and guidance on how to present relevant features in the Annual Report.
‘What to watch out for’ on Planet includes the following recommendations:
- The integration of a company’s response to climate change risk within
its broader strategy and processes which is fundamental to driving action
should be reflected in the disclosures in the annual report;
- If the processes in place for identifying, assessing and managing climate-related risks are separate from the broader risk management process, that should be explained;
- When describing the climate-related risk and explaining the company’s strategic response to it, be sure to outline which issues impact the short, medium and long term, as well as the time horizons of each; and
- Where climate-related risks are deemed ‘principal’ or otherwise significant, the connection between the risk and the metric in place to measure the impact on or the outcomes from the company should be communicated.
The Report notes that it was disappointing to see the chasm between the communications in the narrative reports of the climate-related impact and that in the financial statements. There was little linkage with only two companies referring explicitly to climate change impacts in their financial statements, both in respect of impairment testing.
Telling the story in a clear manner through the financial statements and management commentary is important to investors’ information needs and confidence. Issuers should not limit disclosures to ‘boilerplate’ discussion on COVID-19 itself, but to explain - (i) how COVID-19 impacted and/or is expected to impact the financial performance, financial position and cash flows of the company, (ii) how the strategy and targets of the companies have been modified to address the effects of COVID-19, and (iii) measures taken to address and mitigate the impacts of the pandemic on the company.
An annual report continues to provide a unique opportunity for a company to tell its story across the four Ps, to explain their interaction and to demonstrate ‘integrated thinking’.
Monthly Reporting Pack - November 2020
Irish/UK GAAP & Related Developments
IFRS & Related Developments
Legal and Regulatory Developments