In an open letter to finance directors and audit committee chairs, the regulator says companies need to do more to improve key accounting judgements and estimates, and demonstrate how they have applied the principles of the UK corporate governance code.

The letter states: ‘This year, we identified an increase in the number of basic errors in the reports and accounts we reviewed.

‘In times of change and uncertainty - whether due to new accounting standards or broader economic events like the UK exiting the EU - management’s attention will rightly be focused on ensuring that there is quality disclosure around the key judgements and estimates they make in determining material matters in their reports and accounts.

‘However, management also need to have effective procedures in place to ensure compliance with the basic reporting requirements of IFRS, which investors take as a given in audited reports and accounts. These need to be sufficiently robust to ensure that reporting remains free of basic errors which can detract both from the integrity of the company’s report and accounts and trust in management.’

Brexit

The letter highlights particular challenges for boards as they prepare for their December 2018 report and accounts, many of which will be published shortly ahead of the March deadline for the UK’s departure from the EU.

It states: ‘We encourage companies to provide disclosure which distinguishes between the specific and direct challenges to their business model and operations from the broader economic uncertainties which may still attach to the UK’s position when they report.

‘The situation may well change between the balance sheet date and the date of signing the accounts. We remind companies to ensure that they incorporate a comprehensive post balance sheet events review in their year-end reporting plan, in order to identify both adjusting and non-adjusting events and to make the necessary disclosures required by IAS 10 events after the reporting period’.

Monitoring

The FRC reviewed 220 annual and interim reports for its 2017/18 monitoring activity predominantly with December 2016 year ends. Disclosure of judgements and estimates and alternative performance measures (APMs) were the most common areas of concern, arising in a large proportion of the 46% of companies the FRC wrote to seeking further explanation.

The regulator also said that while viability statements have brought a greater focus on risk management, they could be enhanced to show more clearly how companies have assessed their prospects and viability.

In its report the FRC noted: ‘We were disappointed that the reporting of the significant judgements and estimates companies made in the preparation of their accounts was, again, a major area for improvement.

‘We were also disappointed to see a rise in basic errors and non-compliance in a few areas of reporting, including misclassification of cash flows in the primary statement, where the accounting standards set out a clear requirement or direction which appeared to have been overlooked. A number of these points were readily evident and, in our view, should have been identified by a robust pre-publication review process.’

One press notice was issued in relation to Mitie Group, concerning its impairment testing of the goodwill allocated to the healthcare cash generating unit in its 2016 accounts. In its 2017 annual report and accounts, Mitie recorded a prior year adjustment to goodwill of £26m and explained that there was a material disclosure deficiency in its 2016 annual report and accounts relating to a failure to disclose certain of the significant judgements that it had made in its impairment testing.

In addition, 15 companies (2016/17: three; 2015/16: two) were required to refer to the corrective action taken.

They included two companies which should have restated their comparative earnings per share to reflect changes to the share structure that took place in the current year (Accrol Group Holdings and Harworth Group). Amongst other corrections, The Restaurant Group was pulled up for restructuring cash outflow incorrectly classified as investing activities rather than operating activities; Revolution Bars Group should have corrected a material prior period error by retrospective restatement rather than including the correction in the income statement for the year in which the error was discovered; and Kier corrected the reporting of a profit on the sale of a subsidiary which had incorrectly been disclosed as continuing, rather than discontinued, operations.

Governance

As regards governance, the FRC said reported compliance with the code is high with 95% of FTSE 350 companies reporting that they comply with all but one or two of the 55 provisions.

However, it said reporting on how companies have applied the principles in the code has been inadequately covered due to an excessive reliance on compliance with the provisions. Companies remain reluctant to explain clearly when they do not comply with code provisions. and the FRC said the quality of explanations is disappointing.

Paul George, executive director of corporate governance and reporting at the FRC, said: ‘A lack of transparency in financial and governance reporting, undermines trust in business. More accurate reporting and better governance practices are needed to reverse this trend.

‘The UK faces challenges with corporate reporting after EU Exit. Companies should therefore do more to meet the expectations of the market and society in order for the UK to maintain its position as an attractive home for global capital.

‘Recent developments in narrative reporting have raised fundamental questions about the purpose of companies’ annual reports. Reporting will need to evolve as a result and the FRC will begin a project to address the future of corporate reporting in response to these developments.’

FRC letter to FDs and audit committee chairs is here

FRC annual review of corporate governance and reporting 2017/2018 is here 

Corporate Reporting Review Technical Findings 2017/18 is here

Report by Pat Sweet