Corporate reporting needs to improve to help build public trust in businesses, the Financial Reporting Council (FRC) has said.
In its latest annual review of corporate reporting, the FRC said companies have taken steps to improve the quality of their disclosures, but that there remains "scope for improvement".
"This is particularly true in respect of forward looking information, the potential impact of known and emerging risks and opportunities on future business strategy and the carrying value of assets and the recognition of liabilities," the FRC said. "Failure to discuss such risks and opportunities, including those with a longer time horizon, can lead to the conclusion that management is not aware of their potential impact, is not managing them effectively or is being opaque. High quality reporting improves trust in businesses and how they are being run."
The FRC, which is the body behind the UK's Corporate Governance Code, said it had undertaken 207 reviews into companies' compliance with corporate reporting standards in the year up to 31 March 2019 and that the reviews led to it raising 80 "substantive queries" with businesses about their reporting. Often the reviews lead to companies providing undertakings to the FRC to improve their disclosures in future, it said. In 12 cases last year, the FRC said it asked companies to "specifically reference" the FRC's intervention in their subsequent annual reports.
Corporate law expert Tom Proverbs-Garbett of Pinsent Masons, the law firm behind Out-Law, said the FRC had focused its queries on the same areas it had done so in the previous two years, particularly around financial judgements and estimates. He said it suggests the FRC's message is "getting through in only a limited way".
Proverbs-Garbett also highlighted that the FRC had found errors within cash flow statements and related disclosures, and that it had expressed concern that the mistakes had not been picked up by companies’ own quality control procedures or those of their auditors.
"Reviews of cash flow statements – a principle concern of the FRC – continued to reveal errors, something that the FRC hopes will be ameliorated by the recent publication of the Financial Reporting Lab's paper on 'disclosures on the sources and uses of cash'," Proverbs-Garbett said. "With these resources to hand, and the willingness of the FRC to revisit recent ground, it is likely that companies will continue to see this area tested."
The FRC also confirmed that it had written to companies whose business models it believes appear to give rise to significant climate risk but who had failed to disclose that risk in their reports. It said it expects "disclosure of significant physical or transitional risks" in this area.
Proverbs-Garbett said the comments on climate risk show that environmental, social and governance considerations "remain a headline issue for the FRC".
"Again, the FRC points companies towards resources available to them: in this case the government's green finance strategy," he said. "Given its topical nature, this is an area that seems set to continue to be of interest to the FRC and, if for no other reason, to reporting companies."
The green finance strategy contains an expectation that publicly-listed companies and large asset owners will disclose how climate change risk impacts their activities by 2022.
The FRC also flagged in its report that it is working with the UK government to generate new powers to enhance its monitoring of corporate reporting. Proverbs-Garbett said this follows a recommendation contained in the Kingman review.
He said: "As there is a need for primary legislation, this is not imminent, although where recommendations can be implemented without recourse to legislation the FRC and Department for Business, Energy, Innovation and Skills (BEIS) will investigate how best to bring this into effect. This has the tone of a holding statement but may result in, for example, more frequent reviews."
Alongside its annual report the FRC also published a letter it has sent to audit committee chairs and finance directors.
Proverbs-Garbett said: "Singled out in the letter is the so-called section 172 statement – the new statutory requirement for boards to include a statement within their strategic report describing how they have had regard factors set out in section 172 of the Companies Act 2006 when working to promote the success of their business – and the obligation to provide more detailed environmental disclosures for large and listed companies."
The new section 172 reporting requirement applies to reporting periods commencing after 1 January 2019. The FRC explained in its letter that the requirements broadly include "the likely consequences of any decision in the longer term, the interests of employees and the need to foster business relationships, the impact of the company’s activities on the environment, the desirability of high standards of business conduct and the need to act fairly as between members of the company".
