The best ideas are the simple ones, and the operating and financial review (OFR) is an example of such a theory. But now it seems likely it will be ruined by the desire of politicians and civil servants to fix something that isn’t broken and to turn annual reports into a series of puerile statements addressing the clamour of every lobby group or corporate reporting fad. And parts of the accounting profession are conniving at this imminent demise.
The purpose of the OFR as conceived by the Accounting Standards Board in the early 1990s was for boards of directors to give a straightforward, spin-free account of their company’s past performance and likely prospects.
That was more or less it. It wasn’t even mandatory, but in the years following its introduction it gained credibility as a report that sat alongside the numbers and filled in some of the details that figures alone could not tell.
No doubt some OFRs were better than others. Some would have been sexed up and would have wilted under a Hutton-style inquiry but, on the whole, they did the job. In fact, they did the job to such an extent that the Company Law Review decided to give the OFR the ultimate accolade and make it a legal requirement for larger companies. The ensuing white paper made clear that directors would decide precisely what information is material to their particular business and thus should be published in their OFR.
It also states that the government intends to devolve to a standards board the task of drawing up detailed rules for the compilation of the OFR, but that, as a first step, an independent group would be asked to provide guidance to directors on the key issue of materiality in the context of the OFR. And that was where the rot really started to show.
That independent group, more commonly known as the Working Group on Materiality, produced a 30-odd page interim report discussing the concept of materiality, the principles and the process. Sadly, it’s a safe bet that the final report, due in a few weeks, won’t say what it ought to say, which is: ‘Oops – made a terrible mistake in trying to define materiality. We recognise that experienced and well-paid directors with a reasonable knowledge of the key drivers of their business will be too sensible to fill up the OFR with drivel. So we can’t really see the need for guidance from us or, indeed, from this still mysterious ‘standards board’. However if the directors are stuck, we suggest they refer to the ASB’s statement on the OFR, which was updated and reissued in January 2003.’
Sadly, working groups don’t operate like that. The Institute of Chartered Accountants of Scotland has voiced many of these doubts about the direction in which the OFR is being pushed. For instance, it says it is not obvious that the guidance is necessary. Instead, it suggests that the working group should ask the ASB to extend its own statement to pick up the “relatively small” number of key points from the consultation and to include a definition of materiality.
This would avoid two problems that ICAS identified. First it claims that the OFR is being dragged in contrary directions, trying to be all things to all people. More seriously, the ICAS argues that the proposed guidance seems to require more forward-looking information than companies are likely to be able to give without prejudicing commercial interest and perhaps destabilising their competitive position. It is particularly miffed because the legislation offers no safe harbour rules, which might encourage FDs to be more forthcoming about the future. The final criticism from ICAS is that the working group is out of touch with reality. It told the DTI: “In relation to the composition of the group, it could be suggested that there was a lack of visible input from those who deal with the day-to-day aspect of running a business.”
Will sense, as expressed by the Scots, prevail? Doubtful. The OFR regime is being changed; it has been set down on a track where, far from being the dynamic flexible report in which directors actually say what’s going on, it will become ossified and increasingly irrelevant.
Moreover, there is an emerging thought which suggests that the OFR would be better sat alongside the preliminary results rather than the annual report on the grounds that it’s the prelims that actually move the share price, not the annual report. But it’s hard to see how that idea will progress now that the OFR is set in the stone of legislation. And that is to the detriment of financial reporting in the UK, not its improvement.