INVESTORS want companies to be more transparent about their dividend policy and ability to pay dividends, now and in the future. This call prompted the FRC’s financial reporting lab (FRC Lab) to embark on a project to gain views from a broad population of investors and preparers. The findings were published at the end of last year.
A group of investors and the UK Shareholders Association wrote to all FTSE 100 Audit Committee Chairs asking for clarity over the split between distributable reserves and those that cannot be distributed. However, companies do not have to identify on their balance sheet separately distributable profits. It is not required by law – something the FRC and BIS recently reconfirmed.
However, investors and companies consider dividend disclosures to be relevant when evaluating investment decisions and assessing management’s stewardship. While dividends are only one way of using a company’s cash, for investors, information on dividend policy reveals how a company balances its capital expenditure needs with returns to its shareholders.
Current company reporting practice in this area is diverse. Deloitte’s annual reporting survey, Annual Report Insights 2015 – The reporting landscape, found that, out of 100 listed companies reviewed, 10 clearly set out the level of distributable reserves available and another 30 included some disclosure – for example, highlighting certain amounts that are not distributable or discussing transactions designed to improve the company’s level of distributable reserves.
Some companies are providing information, but understanding this information can be a challenge. The FRC Lab report, Disclosure of dividend and practice, points out that it can be difficult to piece information together as it tends to be scattered throughout company communications, including the annual report, preliminary announcement and presentations.
The FRC Lab report provides useful guidance for all listed companies, irrespective of size, by reflecting the view of investors on disclosures. It recognises the practical issues in determining the level of profits a company can legally distribute and that the type of disclosure will depend on the level of resources a company has compared with its proposed dividends.
Explaining the issues clearly and concisely may prove a challenge for some groups. However, it is important to remember the objective of the disclosures and avoid excessive detail. As the FRC Lab report explains, the extent of the disclosure should depend on the margin between available reserves and the expected level of dividends: the smaller the margin, the more disclosure is likely to be needed to achieve the objective. As the report also mentions, the availability of cash will often be a greater constraint than the level of distributable reserves.
So what are some of the practical things for companies to think about? The FRC highlights:
1. Dividend policy
Investors want to know why a policy has been chosen and how it is implemented in practice. Also, what is the likelihood an investor might not get the return they are expecting? Explaining any discretion inherent in the policy and the risks that the company might not be able to stick to its policy is important.
One solution, the FRC suggests, may be to collect information disclosed over the years and so provide a type of trend information which, over time, could build into a means of long-term assessment.
2. Group situations
Distributable reserves are based on the separate financial statements of a parent company. Amounts disclosed in the consolidated financial statements have no relevance to the amount which may lawfully be distributed to shareholders as dividends. However, in all but the simplest situations, investors are likely to be interested in more than just the amount of distributable reserves in the parent company.
For complex international groups, the parent’s own reserves will be only part of the story. Investors will be interested in the amount of reserves elsewhere in the group that are available to pay up to the parent. However, the ability to make use of these reserves may be subject to a variety of risks and uncertainties. These could include local regulatory requirements in the jurisdictions concerned and adverse taxation consequences.
3. Dividend resources
In reality the availability of cash will often be a greater restraint than the level of distributable reserves, so disclosing dividend resources as a whole i.e. cash and distributable reserves, is helpful.
4. Location of disclosure
The FRC Lab report points out that some disclosure is made by companies, but it is not always easy to assess as it can be scattered throughout an annual report – in the strategic report, financial statements and shareholder information sections. “Clear and concise” reporting is the order of the day from the FRC and it applies here too, so consolidating and linking dividend disclosure to other relevant information in an annual report is helpful.
The demand of investors for more relevant information, presented in a clear and concise way, does not show any sign of abating. This FRC Lab report helps companies consider whether rethinking their disclosure could pay dividends.
Amanda Swaffield is audit director at Deloitte