Peter Williams

Finance directors who fail to ensure that their companies’ business review is up to scratch could find themselves up before the Financial Reporting Review Panel. This may be a remote possibility, but the Accounting Standards Board has warned finance directors that while the requirement to disclose key performance indicators is a matter of judgement for the directors, the lack of inclusion of any KPIs in a business review in the future will provide the FRRP with a possible indicator that the review may not be compliant with the law.

If the threat of the FRRP seems a little over the top, then it does at least illustrate how seriously the financial reporting establishment is taking the subject of narrative reporting. The words in the annual report have been pushed down the agenda over the past couple of years while the focus has been on the numbers being cranked out under international financial reporting standards. Even so, the ASB has been persistent in its pursuit of narrative reporting, carrying on with its Reporting Statement on the operating and financial review despite the setback of Chancellor Gordon Brown withdrawing statutory backing for it.

Even without the legislative support of the prime minister-in-waiting, companies have been working at their narrative reporting. The ASB is satisfied that companies are generally complying with the legal requirements, when measured against the best practice recommendations set out in its Reporting Statement, but it is determined to raise the bar.

In terms of narrative reporting, companies are measured against two interlinked yardsticks. First, best practice – the degree to which companies are adopting the ASB’s Reporting Statement, which is the most complete and authoritative source of best practice guidance; and second, how companies are performing in the light of the requirement under the EU Accounts Modernisation Directive for companies to provide a business review in the directors’ report.

The greatest area of difficulty for companies is the disclosure of forward-looking information. The pressure on directors to say more about the future will grow, especially as the proposed safe harbour provisions in the Companies Act 2006 may encourage companies to provide greater detail as directors will receive certain protection from liability for statement or omissions in inter alia the directors’ report.

At the moment, the legislative imperative is vague so the ASB is keen to dispel confusion and
spell out to corporates what it expects. Companies should be assessing, discussing and disclosing their key indicators of performance and principal risk and uncertainties and improve their description of the resources available – in particular, intangible items such as brand strength, corporate reputation and natural resources not portrayed in the balance sheet. At the same time companies need to report on the approach they have taken to the management and mitigation of principal risk.

The study by the ASB found that the number of risks and uncertainties in its sample ranged from four to 33. As the ASB put it: “We question whether a company can really have 33 principal risks and uncertainties.”

In context of the current legal requirement, the business review should be a balanced and comprehensive analysis “of the development and performance of the business of the company during the financial year and the position of the company at the end of the year, consistent with the size and complexity of the business”.

The law requires that “to the extent necessary for an understanding of the development and position of the business” and “where appropriate” the business review must include analysis using non-financial KPIs. In the absence of any guidelines on preparing a statutory business review, the principles outlined in the reporting statement are being widely adopted by quoted companies as best practice in narrative reporting when preparing their annual report. Companies that ignore the reporting statement could find themselves tangling with the FRRP.

Non-financial KPIs are the stumbling blocks for UK corporates at the moment. The evidence from the independent surveys suggest that a little over half of companies do specifically identify financial KPIs, while other surveys suggest that many companies fail to distinguish between financial and non-financial KPIs and over half fail to identify any non-financial information.

All the evidence suggests that narrative reporting is still evolving and that there is a
willingness among many companies to go beyond the strict legal requirements. Companies are good at describing their business and markets together with strategies and objectives and are keen to report on environmental and social issues. Where they are genuinely struggling is how to report on the future – measures and indicators, risks and intangibles. Companies have to continue to engage with these areas as part of the process of achieving transparent and open communication with shareholders.