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Account down to FRRP

In the past, the Financial Reporting Review Panel (FRRP) was not viewed as a great threat to financial directors. Sure, it had teeth, but only if someone lodged a complaint. All that is about to change. Instead of waiting for problems to turn up in its in-tray, the FRRP is now actively digging out serious problems within company accounts, and senior FDs will have to face up to what this means for them.

Set up 15 years ago to handle complaints about company accounts – and to wield a large legal stick if transgressions were found – the FRRP has tended to deal with small companies. Ron Paterson, one-time technical chief at Ernst & Young, who has served on the panel for almost eight years, says: “An awful lot of the FRRP’s judgements have not really been concerned with matters of great moment. It has been more a matter of ‘parking tickets’ for errors of disclosure.”

Carol Page, secretary and director of operations at the FRRP, agrees. “The type of company that people normally complained about was not at the top end of the market,” she explains. “Now we are dealing proactively with larger, listed companies.”

Part of this is a focus on specific areas. Interim reports, for example, will receive a going-over this year. But part of it is simply being able to take a more robust attitude as the FRRP goes out looking for what is going wrong. “If companies follow the rules of the game, they won’t have a problem,” says Ian Brindle, former chairman of PricewaterhouseCoopers and current FRRP deputy chairman. “That sounds obvious, but you’d be surprised how many people forget.”

This new attitude, according to Brindle, is what’s driving the change. “Financial reporting is pretty good in the UK,” he says. “We will be looking at people who are bending the rules and struggling to meet profit forecasts, and who may be tempted to twist it a bit.”

For the first time this year, the FRRP will be able to examine interim announcements. Its power to do so comes from legislation enacted last year and a ‘memorandum of understanding’ announced in April 2005 with the Financial Services Authority. Organisations with listing responsibilities but which fell outside the Companies Act (such as building societies) and areas of financial reporting (such as interim reporting), which in Page’s words “fell between two stools”, will now come under the scrutiny of the FRRP. “The government suggested that we do the work but then report it to the FSA as a listing authority so it can decide on the appropriate enforcement action,” explains Page.

Interims are seen as a fruitful place to look for reporting aberrations. “It may be that important issues are poorly or briefly described when companies ought to have taken a bit more care,” says Brindle.

The second, and rather more ominous, agreement is expected to be with the Inland Revenue. This one is still out for consultation before being put into practice, but the Inland Revenue is itself showing a much greater interest in the value of the FRRP’s work.

In particular, as old audit hands will tell you, the Inland Revenue is taking an interest in the accounts of subsidiaries, which seems logical given that, for tax purposes, it spends much of its time digging about subsidiaries’ accounts. The word is that the Inland Revenue has been in touch with the FRRP, pointing out that there are a lot of issues worth exploring in the accounts of subsidiaries.

And discreet messages have been sent from the Inland Revenue to the auditor community, via the FRRP, saying it ought to be sorted out. There is a clear suggestion that if it is not sorted out, then the Inland Revenue would work, via the proposed memorandum of understanding, with the FRRP to achieve that goal. FDs would be well advised to spend at least part of the current year scurrying around this area and making sure all is crystal clear ahead of any future scrutiny.

Last year the FRRP targeted revenue recognition as an issue of concern, and it was surprised at what it found. It was a clear vindication of its belief that if you look at the simple things you often find more complex issues underneath. “In some accounts we only looked at the notes on revenue recognition,” says Page. And those alone gave cause for concern. “We were surprised at the paucity of some of the accounting policy notes, which gave little indication of how things had been calculated,” explains Brindle.

After talking to the companies the FRRP found that often the notes had remained the same while serious changes had in fact taken place. “They would have used the same accounting policy notes, but had actually changed the policy,” says Brindle. “These things tend to get rather boilerplate. Companies copy them out from the previous year without thinking. Some large household names were a bit sloppy on that. As as result, you will see changes this year.”

This sort of thing, which large companies would like to give the impression simply never happens, has changed the view of the FRRP in dealing with their responsibilities. Further down the corporate standings, the FRRP already knew that things were not so good. “A frequent criticism of the FRRP is that it has tended to deal with non FTSE-100 companies,” says Paterson. But this experience has alerted it to the failings which it has discovered. “Finance directors at that level are not at the cutting edge. We were surprised at the lack of understanding of the rules when you get to companies that are not near top-level. They rely too much on their auditors and, again, when you get below the top-level of auditors they themselves may not understand the issues fully. I was surprised there wasn’t a great understanding in companies that were listed, but not leading edge.”

Part of this is the increasing complexity of accounting standards, which become ever more an area of specialised knowledge. Certainly, this year’s switch to international financial reporting standards will provoke more than a few FRRP enquiries. But part of it, as FRRP members suggest, is down to attitude. Increasingly, this attitude is going to be tested. Companies and FDs are going to receive many more enquiries from the FRRP for information. “We are seeing a lot more letters,” says Michael Hughes, chairman of audit at KPMG UK, “but they are more of an enquiry nature to see if there is a problem.”

What companies and FDs need to take on board is how to deal with such enquiries. They need to handle them in such a way that they stay routine. The last thing anyone should do is ruffle a few feathers at the FRRP.

“If we write a letter to a company,” says Brindle, “it could just be because things are not clear, like very brief notes over revenue recognition, for example. It may not be clear what the company’s accounting policies are.”

How the FRRP follows through on its enquiries depends on the response it receives. “We ask companies to reply in a few weeks, appreciating that they may want to consult their audit committee. It saves a lot of time if companies reply with a fulsome answer.”

But that is often not the way it works, and there is a definite downside to not respecting to the enquiry. Brindle says that people can sometimes be cavalier and insist that their accounts follow the standard. “We get pissed off and have to ask again for them to explain,” says Brindle. “Some large companies have given us a ‘piss off’ answer, but then have contradicted what they said in their accounts and have given us a new avenue for enquiry.”

He cited a recent informal meeting between FDs and the FRRP. “We said that we hoped large companies had taken our letters through the audit committees. All the finance directors at the meeting said ‘yes, absolutely’. We told them that that was not our experience and were surprised that our letters had not been seen by audit committees. We would have expected the audit committee chairman to have seen our letter and commented on it.”

This failure is another one which opens up other avenues for the FRRP. “We have had examples of the audit committee telling the FD that his response to the FRRP letter was not good enough,” says Brindle. “We know that because one FD rang up saying he couldn’t meet our deadline because the audit committee had asked for a better response.”

Another obvious failing is when companies drag out the process. “Companies can be slow at replying,” says Brindle, “particularly with their second response. You can wait for weeks on end. We don’t worry too much, but we don’t want to be in that position. We want things to be done quickly and efficiently. There is a need to speed things along, underlined by the need for quality of response.”

It is also worth keeping lawyers out of it as much as possible, and Paterson’s experience on the FRRP emphasises this: “Some companies have been co-operative but didn’t know what they were intended to do. Some are a bit helpless. Some resent being asked. And some people’s first instinct is to send for their lawyers.” Paterson warns about this. “It’s becoming more the domain of lawyers,” he says. “Lawyers see it as a legal debate rather than what the accounts should say.”

The impact of the FRRPs’ seachange in its processes has yet to be felt. “For a FTSE-350 company,” says Hughes, “there is a fairly good prospect that their accounts will go through serious scrutiny.” FDs, as ever, will need to be on their toes.

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