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Financial Reporting Brief - September 2014

This months article: The Financial Reporting Lab – An experiment that works?

Welcome to our financial reporting brief for September, our opportunity to update you on recent developments with our featured article which discusses "The Financial Reporting Lab – An experiment that works?".

The Financial Reporting Lab – An experiment that works?

The Financial Reporting Lab (the Lab) continues to progress with its collaborative approach to improving corporate reporting so that it better meets the needs of companies and the investment community.

Set up by the Financial Reporting Council (FRC) in late 2011, the Lab works with companies, investors and analysts to understand which areas of corporate reporting they want to improve and then works with project participants to test practical improvements

The Lab offers an unbiased and safe environment for companies, investors and analysts to discuss innovative reporting solutions that better meet the needs of all.  The Lab is designed to identify how disclosures could be improved in the current framework and where the regulatory framework needs to change in the future.  Clarifying what investors and analysts actually want is a powerful influence on change.

The work being carried out by the Lab is consistent with a number of projects which the International Accounting Standards Board (IASB) is currently engaged in, including those on a) Proposed amendments to IAS1: Presentation of financial statements, b) Materiality, and c) Principles of disclosure.  

The Lab Work Programme
To date the Lab has published nine reports which cover a range of governance and financial reporting topics.  These are:

June 2012:  A single figure for remuneration
September 2012: Net debt reconciliation
November 2012: Debt terms and maturity tables
November 2012: Operating and investing cash flows
February 2013: Presentation of market risk disclosures
March 2013: Reporting of pay and performance
October 2013: Reporting of audit committees
July 2014: Accounting policies and integration of related financial information
August 2014: Towards clear and concise reporting

In addition, the Lab has commenced two other projects, which are: (1) disclosure of dividend policy and capacity, and (2) corporate reporting in a digital world.

In May 2014 the Lab launched a survey seeking feedback from all those involved in corporate reporting to assist with maintaining focus on issues important to the reporting community.  The survey is focused on what the priorities of the Lab should be going forward and providing feedback on its activities to date.  The survey closed in June and the Lab is working on developing its future plans.

Clear and concise reporting
The FRC is committed to promoting clear and concise corporate reporting and the two most recent Lab reports are designed to support this.

Accounting policies and integration of related financial information:

This Lab report considers the views of investors and companies in relation to developing reporting practices and looks at:

  • Accounting policies: which policies are disclosed, the content of what is disclosed and their placement
  • Notes to the financial statements:  wording, grouping and combined notes
  • Financial reviews:  integration with the primary financial statements

In relation to accounting policies, some clear messages from investors for companies to improve the presentation of significant accounting policies and enhance the quality of their disclosure include:

  • Judgements on which accounting policies are significant  including materiality, policies for all distinct revenue streams, decisions where there is a choice of policy under IFRS and where there is a need for significant estimation or judgement in applying the policy.
  • Articulate qualities of good policy disclosures – plain understandable language, judgements made in selection and the rationale, describe the application of policies.
  • Prioritise the need for improvements in quality ahead of placement.

Common issues with the quality of policy disclosure are a) including reference to immaterial policies which can obscure key information, and b) use of boilerplate text such as extracts from standards or model accounts.

Investors strongly emphasise that accounting policy disclosure should be company specific, making clear the relevance to the company’s own business transactions and consequences for reported amounts.

Towards clear & concise reporting
This insight report is based on observations that the Lab made during a review of 2013 year end reporting.  It highlights progress made by companies towards clearer and more concise reporting and provides ideas on change in reporting practices.

Examples of what companies have done to aid clarity and conciseness include:

  • The communication channels they use and how to match information to users’ needs, enabling the targeting of information to specific user group needs with effective signposting of different information in the annual report
  • How to focus content on what is most important to investors, including improved focus on what committees, such as the audit committee and risk committee, do during the year rather than just process description.
  • Materiality criteria - removing immaterial disclosures and focusing on significant  accounting  policies, including (a) removing elements which are no longer relevant, (b) encouraging companies to avoid inertia in reporting, (c) improving the quality, and relevance of accounting policy disclosures, and (d) removing immaterial notes in the financial statements
  • Layout to improve clarity , and cross-referencing to reduce duplication including making effective use of the reports of the chairman, chief executive and financial director, effective  use of layout to improve conciseness and using cross-referencing and signposting to improve accessibility of information.

Good corporate reporting
The Financial Reporting Review Panel, which has now become the Conduct Committee of the FRC, set out in its annual reports for 2011 and 2012 the characteristics of corporate reporting which it is believed make for a good annual report.  The characteristics are consistent with the FRC’s initiative for clear and concise reporting and continue to provide a useful guide for companies.  The nine characteristics of good corporate reporting are:

1. A single story – the narrative in the front end is consistent with the back end accounts

2. How the money is made – a clear and balanced explanation of the company’s business model and the salient features  of the company’s performance and position, good and bad 

3. What worries the board – sufficiently specific descriptions of the principal risks and uncertainties that the Boards are concerned about?

4. Consistency – key performance indicators (KPIs) and non-GAAP measurers are clearly reconciled to the relevant amounts in the accounts and any adjustments are adequately explained.

5. Cut the clutter – important messages, policies and transactions are highlighted and not obscured by immaterial detail.

6. Clarity – the language used is precise and explains complex accounting and reporting issues clearly, with jargon and boiler-plate avoided.

7. Summarise – items are reported at an appropriate level of aggregation and tables are supported by and consistent with the accompanying narrative.

8. Explain change – significant changes from the prior period are adequately explained

9. True and fair – the spirit as well as the letter of accounting standards is followed.

Plans for improved reporting
The Lab has researched the experiences of those companies who have undertaken a process of corporate reporting improvement, and identified various steps which are fundamental to the process.

 These may be summarised as follows:

  • Plan the change – build momentum, get leadership from the top and decide on the scope
  • Manage the process – identify  who will make the changes, set targets and get agreement from the board
  • Do what is needed – start with a blank page, ensure that changes in business and regulation are reflected and make sure the auditors are brought into the changes
  • Evaluate the process – debrief early, ask for feedback from investors, and reflect on how to make improvement continuous.

The Lab Report also highlights how two companies, Prudential and BP, have managed the process of change.

Conclusion 
The answer to the question of whether the experiment of the Financial Reporting Lab is a success must be a resounding yes if it is contributing significantly to improving corporate reporting.

With half year reporting now over and done with for most companies they can now focus on year end reporting and the process of continuing improvement therein.  It is never too early to commence the process and change happens when action is prioritised.  Investment of time and resources will assist in achieving more clear and consistent reporting delivering key measures in a relevant and understandable manner to investors and other stakeholders.

No time like now – for identifying change and implementing improvements.

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