The quality of financial reporting has improved but concerns about the creep of seemingly unproductive and irrelevant content remain, writes Veronica Poole.
TO many, it seems that the pace of change in today’s corporate reporting world never lets up. This may be true but real progress has accompanied the ever-increasing requirements and expectations of annual reports in recent years. Deloitte has been undertaking surveys of UK listed companies’ annual reports for about 20 years and the reports we see now are very different to those that were written when we started. For one thing, they’re about three times as long, averaging 135 pages.
Part of this change has been brought about by demands for more information from investors, the primary user of a company’s annual report. Sometimes it can seem like investors have an insatiable appetite for more and more information and the task of preparing an annual report is no mean feat.
According to a survey of UK investment professionals by the CFA Society, the annual report is the most popular source of information for financial analysis. Most respondents to that survey agreed the quality of financial reporting has improved over the past decade. But a recurring concern about the “creep of seemingly unproductive and irrelevant content” in financial reports was revealed, as was a feeling that important information was omitted.
Mechanisms to collate and communicate such concerns have been strengthened in recent years, with institutions such as the Financial Reporting Council’s (FRC) financial reporting lab liaising with the investor community to develop an understanding of what they want to see in reports. To an extent, materiality is in the eye of the beholder and inevitably there will always be room for improvement and requests for information that hasn’t been provided. But there is an unmistakable appetite in the preparer community to develop useful, and not just compliant, annual reports.
For example, this year almost half of the companies in the survey provided net debt reconciliations or similar and 40% provided insight on the level of distributable reserves despite there being no legal requirement to do so. Both these pieces of information have been cited as useful by investors.
Admittedly, there is a spectrum, with some preparers still aiming to achieve little more than a technically compliant report. This tends to be more of an issue in smaller companies, which have fewer resources to devote to report preparation and, in some cases, believe that investors pay little attention to their reports. The FRC has repeatedly sought to encourage smaller quoted companies to improve their reporting in recent years, acknowledging that generally they achieve a good standard. However, the areas where they fall short tend to be areas that investors are particularly interested in. For example, talking about the good and the bad in the strategic report.
Endeavouring to provide all the information that anyone might ever find useful is a fool’s errand, and this is where materiality and the FRC’s umbrella initiative of clear and concise reporting comes in. Regulators have been promoting the idea of cutting immaterial disclosures throughout the report for some time now, but preparers tend to be cautious and would often rather not have to justify omissions. Interestingly, this year’s survey saw 16% of companies undertaking pre-emptive strikes, explicitly stating that certain disclosures had been omitted on the grounds of immateriality.
One bank’s annual report this year stated that, among other items, it had rationalised its notes on lease commitments and staff costs and removed a separate note on property, plant and equipment, incorporating any relevant information into other notes. Another company decided not to provide all the disclosures required for some of their unquoted equity investments as they only amounted to £8m out of £4bn total assets.
The result of these efforts? Well, annual reports still got longer this year but, interestingly, financial statements dropped in length by two pages – it was the narrative that was driving the increase, perhaps because preparers find it more difficult to apply the concept of materiality to words, rather than numbers?
Another challenge with all this information is linking it together and avoiding the “silo” treatment. When we say “linkage”, we’re talking about more than a table of contents and some cross-references at the bottom of the business model telling a reader to “see page 20 for key performance indicators”. We’re talking about true integration of these different aspects of the report – this isn’t something that you’ll achieve by working your way through a checklist.
Disappointingly, only 10% of the companies we looked at achieved what we deemed to be “comprehensive” linkage, pulling together all the different strands of the report. A good start in demonstrating this linkage is to provide a table, mapping strategies and KPIs to the company’s different objectives, and showing how the principal risks and uncertainties threaten the company’s achievement of those objectives.
We also saw two-thirds of companies include directors’ remuneration schemes with performance measures that include at least some of their KPIs, demonstrating clearer alignment of directors’ pay with company performance. Consistency between front and back is vital too – if a company pulls something out in its P&L that is “exceptional”, one would expect to see that discussed with suitable prominence in the front end. Indeed, non-GAAP measures’ popularity has continued, with 81% of companies using them in the summary section of their reports and 54% presenting them more prominently than the associated GAAP measures. This remains an area of focus for regulators, with ESMA having recently published related guidance.
One of the new challenges for reporting this year is the requirement for a statement on longer-term viability. The viability statement requires directors to state that they have a “reasonable” expectation that the company will be able to continue, and meet its liabilities for a period they have specified. We’ve only seen a handful of companies adopting this requirement early. Again, there’s a balance to be struck between investors wanting as much assurance as possible and directors feeling nervous about going too far.
The question on everyone’s lips tends to be what length of time they should consider. It is expected, except in rare circumstances, that the period will significantly exceed 12 months. We’ve seen that most companies going early tend to look at three to five years, reflecting their medium-term plans, but it does depend on factors such as the financing arrangements in place, the maturity of the company and the nature of the industry. Including the statement in the strategic report or the directors’ report affords directors the safe-harbour provisions of the Companies Act.
There’s also new recommendations for risk reporting, which is obviously of very real interest to investors. The latest guidance calls for insight on what risks are new in the year, what their potential impact would be, and what is the likelihood of their occurrence. About one-third of companies are currently showing changes to risks in the year, typically through the use of up and down arrows, but not many have been giving insight on likelihood and impact. This means that most companies will need to enhance their disclosures in this area this year.
In terms of what the future holds, the journey will continue – clear and concise is the name of the game at the moment and it seems that there genuinely are collaborative efforts between investors, preparers, regulators and auditors to strengthen and improve the UK corporate reporting scene.
Of particular interest here is integrated reporting, which is an international initiative, but one that resonates with the existing UK reporting framework. Some of the ideas it contains are taking hold in the UK: seven companies surveyed made explicit reference to integrated reporting. More than half talked about relationships or resources used as inputs or outputs in business model descriptions – termed “capitals” under the integrated reporting framework. Of course, a truly integrated report is an output of integrated thinking; it flows naturally from the integration of business processes and behaviours. Further embracing these concepts will help ensure that the UK remains one of the most advanced corporate reporting regimes in the world. ■
Veronica Poole is Deloitte’s Global IFRS Leader and UK National Head of Accounting and Corporate Reporting