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Accounting: Embrace change

UK plc appears to be suffering from the corporate equivalent of the Stockholm
Syndrome. Chancellor Gordon Brown tears up the statute book on Operating and
Financial Reviews and instead of being grateful, or at least relieved, British
business collectively throws its toys out of the cot.

There are genuine reasons why British business could feel miffed about the
timing of Brown’s announcement. Pulling the plug just a few months before the
first statutory OFRs were due to appear ­ when a lot of the work has been done
and millions spent by finance directors and others ­ is insensitivity. But
politicians like making headline-grabbing announcements knowing they won’t have
to deal with the consequences. While Brown may have run true to form for a
politician, business leaders ­ who spend much of the time calling for cuts in
red tape ­ were acting out of character, busy making announcements, in effect
saying that abolishing the statutory OFR was the wrong sort of legislative
burden reduction. Since when did business fall in love with red tape?

The CBI welcomed the move, but maybe it only did so out of politeness,
because Brown was speaking at its conference. Most representative bodies seemed
perturbed by the move. For instance, the Institute of Directors said that to
abolish the OFR at this late stage, after many companies had incurred costs to
meet the requirements, showed a slap-dash approach to regulation policy. And,
indeed, Brown certainly has created regulatory confusion. The Reporting Standard
1 (RS1) ‘Operating and Financial Review’, issued by the Accounting Standards
Board flows from statutory instrument 1011/2005, which needs to be repealed to
fulfill Brown’s announcement. But these are technical niceties that regulators
and civil servants are well remunerated to untangle.

All those who criticise the non-appearance of the statutory OFR need to
remind themselves of the bigger picture. Brown has done the right thing, even if
he has done it for wrong, or muddled reasons. As the Financial Reporting Council
noted in its response to Brown: “The FRC has long believed that the publication
of a narrative explanation of a company’s development, performance, position and
prospects should be encouraged as an important element of best practice in
corporate reporting. A significant number of FTSE-100 companies already publish
an OFR. Regardless of whether or not an OFR is a statutory requirement, the
FRC’s view of best practice remains unchanged. RS1 is the most up to date and
authoritative good source of good practice guidance for companies to follow.”

There is a danger that because Brown has pulled the rug from under the OFR,
companies will be tempted to take it less seriously than if the idea of
statutory backing had never been mooted. But this need not happen, the FRC
carries clout these days and if it joins forces with regulators, such as the
FSA, the message will soon hit home that the OFR remains a document that
directors must take seriously.

A Deloitte survey found that 82% of companies were preparing an OFR, or
something like it, and regulators should be looking for that figure to continue
to edge upwards. Allowing the OFR to revert back to its persuasive, rather than
mandatory, status should encourage companies to meet the expectations of the
City and to produce reports and accounts that offer a summary of the
opportunities, risks and challenges that the directors understand the business
to be facing. If shareholders want the company to produce sensible OFR-style
information then they should make sure the directors understand that. Equity
analysts in particular should have the courage to mark down the shares of those
companies that fail to produce the goods.

This is an opportunity for companies to pick out the relevant elements for
their organisation from RS1 ­ in whatever form it emerges and whatever status it
has ­ and ditch the auditor-type process, which had built up around the OFR. The
OFR started to diminish rapidly in value in 2003 when the ICAEW released
guidance aimed at directors on how to prepare one. This was the OFR from the
point of view of auditors, where naturally the emphasis was on due process
rather than the output. A DTI-sponsored working group chaired by Rosemary
Radcliffe also wrote guidance for directors on producing an OFR. Plus, of
course, the ASB had updated its guidance and explanation. The OFR was being
turned into a regulation-fuelled industry where vested interests were seeing the
OFR as a way of forcing directors to take account of their particular hobby
horse ­marketing, sustainability and environment, human capital management and
diversity, to name but a few. Now it has a chance to return to its proper and
original role.

In May 2004, the then Trade and Industry Secretary, Patricia Hewitt, said the
OFR was the “directors’ overview of the company providing shareholders with key
information on the organisation’s objectives, strategies, past performance and
future prospects”. She was right then and her words hold true now. Directors
should be capable of delivering a decent OFR, even if they are not obliged to do
so by law and reams of regulation.

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