UK: Corporate Governance Update Part 3 of 3
A new chapter – updating directors’ reports and OFRs

1.

Principles

RS:OFR reference

Yes/No

The appropriate elements of information used in managing the entity, including its subsidiary undertakings are disclosed.

5

Where appropriate, give greater emphasis to those matters which are significant to the entity and its subsidiary undertakings taken as a whole. Such matters may include issues specific to business segments where relevant to the understanding of the business as a whole.

5

The directors have considered the extent to which they report on matters primarily of significance to other users (e.g. other investors, potential investors, creditors, customers, suppliers, employees and society more widely) where because of those issues influence on the performance of the business and its value, they are also of significance to members.

7

The factors discussed are those that have affected development, performance, and position during the financial year and those which are likely to affect the entity’s future development, performance and position.

9

Given the nature of some forward-looking information, in particular elements that cannot be objectively verified but have been made in good faith, directors may want to include a statement in the OFR to treat such elements with caution, explaining the uncertainties underpinning such information.

10

No statutory safe harbour provisions have been introduced. US registrants will be familiar with the disclaimer wording used in Management’s Discussion and Analysis (MDA) to highlight forward looking information. Similar wording may be appropriate in the OFR. This is an area in which it may be appropriate to consider taking legal advice.

No disclosure of information about impending developments or about matters in the course of negotiation should be made if the disclosure would, in the opinion of the directors, be seriously prejudicial to the interests of the entity.

79

The OFR comments on the impact on future performance of significant events after the balance sheet date.

11

The OFR discusses predictive comments, both positive and negative, made in previous reviews and whether or not these have been borne out by events.

12

The OFR provides useful financial and non-financial information about the business and its performance that is not reported in the financial statements but which, the directors judge, might be relevant to the members’ evaluation of past results and assessment of future prospects.

14

Where relevant the OFR provides additional explanations of amounts recorded in the financial statements.

15

Where relevant the OFR explains the conditions and events that shaped the information contained in the financial statements.

15

Where amounts from the financial statements have been adjusted for inclusion in the OFR, that fact is highlighted and a reconciliation has been provided.

15

The directors have considered whether the omission of information might reasonably be expected to influence significantly the assessment made by members.

17

When preparing the OFR, the directors have focussed on the objective of quality, not quantity.

18

Where relevant, an explanation has been provided of the source of the information and the degree to which the information is objectively supportable to allow members to assess the reliability of the information presented.

19

Where additional information is discussed elsewhere in the annual report, or in other reports, this information has been cross-referenced to those sources to assist members. The directors have considered the key issues to include in the OFR that will provide members with focused and relevant information.

20

The OFR should be written in a clear and readily understandable style.

21

The directors should ensure that the OFR retains balance and that members are not misled as a result of the omission of any information on unfavourable aspects.

23

Disclosure is sufficient for the members to be able to compare the information presented with similar information about the entity for previous financial years.

25

Directors have considered the extent to which the OFR is comparable with reviews prepared by other entities in the same industry or sector.

25

2.

Disclosure Framework

RS:OFR reference

Yes/No

The directors have considered how best to use the framework and key content elements in the Reporting Statement to structure the OFR as a whole and its precise content, including the level of detail to be disclosed, given the particular circumstances of the entity. These circumstances may include:

26

(a) the industry or industries in which it operates;

(b) the range of products, services or processes it offers;

(c) the number of markets it serves.

3.

The nature, objectives and strategies of the business

RS:OFR reference

Yes/No

The description of the business provides members with an understanding of the industry or industries in which the entity operates, its main products, customers, business processes and distribution methods, the structure of the business, and its economic model, including an overview of the main operating facilities and their location(s).

31

Where relevant, the OFR includes discussion of matters such as the entity’s major markets and competitive position within those markets and the significant features of the legal, regulatory, macro-economic and social environment that influence the business.

32

Where appropriate, objectives in non-financial areas are discussed in addition to financial objectives.

34

The directors have determined an appropriate time perspective for reporting in the OFR based on the nature of the industry within which they work.

35

Directors’ strategies have been disclosed so that members can assess the current and past action undertaken by directors in respect of the stated objectives.

37

The KPIs disclosed are those that the directors judge are effective in measuring the delivery of their strategies and managing their business.

39

Where available, the directors have used KPIs accepted and widely used either within the industry sector or more generally.

40

Where appropriate, the directors have included narrative evidence describing how they manage the business or quantified measures used to monitor the entity’s external environment and/or progress towards the achievement of its objectives.

42

4.

Current and future development and performance

RS:OFR reference

Yes/No

The trends and factors in development and performance as suggested by an analysis of the current and previous financial years have been highlighted. Development and performance are described in the context of the strategic objectives of the business.

44

The OFR covers significant aspects of the statements of financial performance and where appropriate is linked to other aspects of performance.

45

The OFR sets out the directors’ analysis of the effect on current development and performance of changes during the financial year in the industry or the external environment in which the business operates and of developments within the business itself.

46

The OFR discusses the current level of investment expenditure together with the planned future expenditure and explains how that investment is directed to assist the achievement of business objectives.

48

Any assumptions underlying the main trends and factors above have been disclosed.

48

Directors have considered the potential future significance of issues in deciding whether or not to include an analysis of them in the OFR.

49

5.

Resources

The OFR sets out the key strengths and resources, tangible and intangible, available to the business, which will assist it in the pursuit of its objectives and, in particular, includes those items that are not reflected in the balance sheet.

51

Depending on the nature of the business, these may include: corporate reputation and brand strength; natural resources; research and development; intellectual capital; licences, patents, copyright and trademarks; employees; and market position.

6.

Principal risks and uncertainties

The strategic, commercial, operational and financial risks are disclosed where these may significantly affect the entity’s strategies and development of the entity’s value.

53

The description of the principal risks and uncertainties covers both the exposure to negative consequences as well as potential opportunities. The directors’ policy for managing principal risks is disclosed.

55

The OFR covers the principal risks and uncertainties necessary for an understanding of the objectives and strategies of the business, both where they constitute a significant external risk to the entity, and where the entity’s impact on other parties through its activities, products or services, affects its performance.

56

Directors have considered the full range of business risks.

56

7.

Relationships

RS:OFR reference

Yes/No

The directors in deciding what to include, have considered the extent to which the actions of stakeholders other than members, can affect an entity’s performance and thus its value.

58

Where necessary for an understanding of the business, the OFR should describe receipts from, and returns to, shareholders in relation to shares held by them. This should include a description of any distributions, capital raising and share repurchases.

59

8.

Financial position

The analysis, whilst based upon the financial statements, comments on the events that have impacted the financial position of the entity during the financial year, and future factors that are likely to affect the financial position going forward. The analysis should supplement FRS25/IAS32 disclosures.

61

The OFR highlights accounting policies set out in the notes to the financial statements and discusses those accounting policies that are critical to an understanding of the performance and financial position of an entity, focusing on those which have required the particular exercise of judgement in their application and to which the results are most sensitive.

62

The OFR draws attention to accounting policies changed during the financial year under review.

62

The discussion includes comments on short and longer-term funding plans to support the directors’ strategies to achieve the entity’s objectives.

64

The discussion includes comment on why the entity has adopted its particular capital structure.

The OFR discusses the implementation of these treasury policies in the financial year under review.

66

The purpose and effect of major financing transactions undertaken up to the date of approval of the financial statements is explained.

67

The effect of interest costs on profits and the potential impact of interest rate changes is also discussed.

67

9.

Cash flows

RS:OFR reference

Yes/No

The discussion of cash flows supplements the information in the financial statements. Comments might include:

69

(a) special factors influencing cash flows in the current financial year and those that may have significant effect on future cash flows; and

(b) the existence and timing of commitments for capital expenditures and other known or probable cash requirements.

Where entities have cash that is surplus to future operating requirements and current levels of distribution, the discussion includes future plans for making use of the excess cash.

69

Where segmental cash flows are significantly out of line with segmental revenues or profits, it is indicated and explained.

70

10.

Liquidity

The ability of the entity to fund its current and future operations and stated strategies is discussed.

71

Internal sources of liquidity are discussed and reference is made to any restrictions on the ability to transfer funds from one part of the group to meet the obligations of another part of the group, where these represent, or might foreseeably come to represent, a significant restraint on the group. Such constraints include exchange controls and taxation consequences of transfers.

73

Where the entity has entered into financing contracts with covenants with lenders which could have the effect of restricting the use of credit facilities, this is disclosed. Negotiation with the lenders on the operation of these covenants that are taking place or expected to take place is also discussed.

74

Where a breach of a covenant has occurred or is expected to occur, details are given of the measures taken or proposed to remedy the situation.

74

11.

Key Performance Indicators (KPIs)

RS:OFR reference

Yes/No

The following information is provided for each KPI disclosed in the OFR:

76

(a) the definition and its calculation method is explained;

(b) its purpose is explained;

(c) the source of underlying data is disclosed and, where relevant, assumptions explained;

(d) quantification or commentary on future targets is provided;

(e) where information from the financial statements has been adjusted for inclusion in the OFR, that fact is highlighted and a reconciliation provided;

(f) where available, the corresponding amount for the financial year immediately preceding the current year is disclosed; and

(g) any changes to KPIs are disclosed and the calculation method used compared to previous financial years, including significant changes in the underlying accounting policies adopted in the financial statements, is identified and explained.

12.

Other performance indicators

13.

Statement of compliance

14.

Definitions

Directors

3

Reference to either "directors" or "board of directors" within the Reporting Statement is taken to be the entity’s governing body where the entity is not a company.

Key Performance Indicators (KPIs)

3

KPIs are factors by reference to which the development, performance or position of the business of the entity can be measured effectively. They are quantified measurements that reflect the critical success factors of an entity and disclose progress towards achieving a particular objective or objectives.

Operating and Financial Review (OFR)

3

An OFR is a narrative explanation, provided in the annual report, of the main trends and factors underlying the development, performance and position of an entity during the financial year covered by the financial statements, and those which are likely to affect the entity’s future development, performance and position.