The Financial Reporting Council (FRC) has issued useful guidance for companies preparing annual reports stressing the importance of materiality and clarity
The annual report and accounts (ARA) is the cornerstone of corporate reporting and should provide investors and other stakeholders with clear and relevant information on the company’s performance and prospects to help them make informed investment decisions and to promote effective stewardship.
To Illustrate these, the publication provides a range of good practice examples which have been identified by the FRC as part of its ongoing supervision work.
The focus should be on company specific information, which is clear, concise and understandable. It also needs to be clutter free and relevant, while comparability is critical.
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The FRC stressed that ‘materiality is the bedrock of corporate reporting. It is a fundamental concept embedded in accounting frameworks and the primary tool that helps companies to focus on key matters for them and their stakeholders. Materiality informs the breadth and depth of what needs to be included in the full ARA’.
Determining whether something is quantitatively material is a matter of judgment, not a mechanical exercise. Common benchmark examples include revenue, profitability, balance sheet ratios and cashflow measures, but the benchmark used should be that which is most appropriate in the context of the business and of greatest value and interest to the users.
For example, a property investment company is likely to use a balance sheet ratio as a benchmark because investors assess its performance on a net asset basis; whereas a manufacturer is likely to use a profitability benchmark as investors are more likely to assess performance on an earnings basis.
The FRC also encourages companies to disclose the basis on which they have assessed the materiality of climate-related disclosures. This helps readers to understand whether materiality considerations have driven omissions of recommended disclosures, or whether disclosures have been omitted for other reasons such as the non-availability of information.
The accuracy of the ARA depends, to a large extent, upon the quality of the company’s underlying data supporting both financial and nonfinancial information.
Companies need to:
- develop effective information systems to collect relevant and complete data;
- introduce robust internal controls to maintain data and protect its integrity; and
- apply an accounting system that enables data to be retrieved and reported fully.
Inadequate descriptions of the nature of certain events and transactions or poor explanation of the accounting applied are likely to prompt regulatory challenge by FRC inspectors.
‘The ARA should be a standalone document. We acknowledge that it may be helpful to refer to reports or websites which include additional information that exceeds relevant reporting requirements (for example, sustainability disclosures). In these circumstances we encourage companies to use specific cross references to make additional information easy to locate,’ the FRC said.
‘We encourage preparers to remove irrelevant information. This is particularly important given the drift of increasing reporting requirements.’
Preparers should replace boilerplate disclosure with information that is tailored to the company’s specific circumstances. This provides better quality, more decision useful information.
A high quality ARA will:
- comply with relevant accounting standards, laws and regulations, and codes;
- be responsive to the needs of stakeholders in an accessible way; and
- demonstrate the corporate reporting principles and effective communication characteristics outlined in this publication.
FRC’s executive director of supervision, Sarah Rapson said: ‘It is clear that many companies rise to the challenge of producing high quality ARAs to anticipate and meet the needs of their stakeholders. However, some companies need to improve.
‘This publication is the latest in the FRC’s ‘What Makes a Good…’ series and clearly sets out the FRC’s view of the characteristics associated with a high quality ARA in a clear and accessible way, which we believe preparers, including audit committee chairs and company secretaries will find helpful in producing decision useful reports and accounts for stakeholders.’
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