UK: UK GAAP – Narrative Reporting: How Are Companies Doing?

Last Updated: 19 July 2007

The introduction of several new narrative reporting standards over the past two years has made it a confusing time for companies.

During 2005 and 2006 we saw the introduction and then subsequent removal of the statutory Operating and Financial Review (OFR) and the issue of the Accounting Standards Board’s (ASB) reporting standard on the OFR, which was quickly changed to a best practice reporting statement. Finally, there was the establishment of the requirement for all but the smallest of companies to prepare a ‘business review’ for inclusion in the directors’ report, as well as disclosure of risks arising from the company’s use of financial instruments.

At present, quoted companies (i.e. those whose shares are quoted on the official list of the London Stock Exchange) are subject to the same narrative reporting requirements as any other large company in the UK (although, as discussed below, this will change under the Companies Act 2006). However, the majority of quoted companies voluntarily provide a significant amount of additional narrative reporting and many provide a full OFR.

The ASB conducted research during 2006 into the narrative disclosures made by listed companies, with the dual objectives of assessing:

  • best practice – the degree to which companies have adopted the recommendations in the ASB’s Reporting Statement on the OFR
  • compliance – how UK companies are performing in light of the legal requirement under the Companies Act 1985 for them to prepare a business review.

In January this year the ASB published the results of its review and the conclusions were, overall, positive.

With respect to the requirements to prepare a business review, it was noted that companies are generally complying. However, this overall conclusion was not without some caveats.

The review highlighted that the disclosure of key performance indicators (KPIs) appears to be one of the most challenging areas for companies, with a warning issued that a lack of inclusion of any KPIs in a business review would suggest to the Financial Reporting Review Panel (FRRP) that the review may not be compliant with the law. Listed companies should therefore be very careful if they fail to include any KPIs or any non-financial KPIs in their business review, as this could lead to their annual report being investigated by the FRRP.

The review also noted that companies could be better at providing a "balanced" analysis of development and performance of the business, as required by the Companies Act. It seems that, quite understandably, companies are keener to tell readers of the accounts about good news rather than bad.

In order to review the examples of narrative reporting against best practice, the ASB looked to their reporting statement on the OFR.

The review noted that the greatest area of difficulty is the disclosure of forward looking information, although it is to some extent understandable that companies are hesitant to include this information for fear of increasing or decreasing the expectations of shareholders, potential future investors and lenders.

There also appears to be a need for improvement in the description of resources available to a company not reflected in the balance sheet; in particular, intangible items such as brand strength and corporate reputation. The report gave as an example of best practice a company which had provided details of contractual agreements, reputation, employees and trademarks.

The review highlighted a wide divergence in practice with regard to the number and level of disclosure of principal risks and uncertainties. It was particularly scathing about one company which had disclosed 33 principal risks and uncertainties. It noted that companies need to describe more carefully their principal risks and uncertainties, and set out their approach to managing and mitigating those risks, rather than simply providing a list of all risks.

Smith & Williamson Commentary

Although the ASB’s review focused on narrative reporting by fully listed companies, the findings are equally important for AIM and PLUS market companies, as well as unlisted companies. It is already becoming clear that areas of non-compliance with the requirements set out in the Companies Act are being challenged by shareholder groups and lenders. All companies should therefore take the opportunity to review their most recent directors’ report disclosures in light of the findings and ensure that they are meeting the business review requirements going forward.

And there’s more to come...

For quoted companies, the Companies Act 2006 (the Act), which received Royal Assent last November, will bring back some of the provisions contained in the original OFR legislation.

To the extent that it is necessary for an understanding of the company, quoted companies will be required to provide information about environmental matters, the company’s employees, social and community issues, and individuals with whom the company has contractual or other arrangements which are essential to the business.

The transitional provisions in relation to this part of the Act have yet to be published. However, we know that it is the Government’s intention that all parts of the Act will be effective by October 2008. It therefore looks as though 2008 will be yet another year of change for narrative reporting by quoted companies.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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