1. EXECUTIVE SUMMARY
Welcome to the latest edition of our annual report insights report, 'Providing a clear steer'.
It has been an eventful year with the introduction of the new strategic report, debate around going concern and risk reporting and the need for directors to state that their annual report and accounts as a whole were 'fair, balanced and understandable'.
Our report looks at how companies have gone about dealing with these challenges, the extent to which they have met the requirements and innovated, plus how well they have linked the narrative reporting to the financial reporting. And from this mass of information we have identified areas for improvement as well as providing best practice examples, enabling companies to tell their stories effectively and provide a clear steer to their readers.
Here Veronica Poole, head of UK corporate reporting within Deloitte, and William Touche, UK head of corporate governance within Deloitte, draw from their experience of the year, share their insight and thoughts on the highlights from the survey and look at the challenges ahead.
Q: Companies were really up against it last year. How well did they cope with all the changes they had to face?
A: Overall I think they have done well. All hundred companies surveyed included a strategic report although they really struggled to cut clutter. While we had hoped that the size of reports would start to fall, instead they have risen again. The average length of an annual report is up from 122 to 132 pages, much of it driven by an increase in the length of narrative reporting, in particular the new style remuneration reports. But on the plus side some companies have used the opportunity presented by all the changes to restructure their narrative reporting. This is important and it will hopefully give them a good foundation to embrace the Financial Reporting Council's latest messages on clear and concise reporting.
Q: With reports getting longer how cohesive did they tend to be in telling their story? Were preparers managing to link together all the different components?
A: Somewhat disappointingly there was a continued lack of cohesiveness, or in the FRC's words linkage, between the story told in the narrative and the numbers in the back. Whilst the majority of companies made efforts to link some parts of their annual report, in particular the discussion around strategy to their KPIs, only 29% showed up-front, in their summary pages, how their report as a whole linked together. But all in all, companies are making steps in the right direction.
Q: What does the survey tell us about non-GAAP measures? They have been exercising regulators recently and there is a raft of proposals from various regulators and other bodies.
A: Non-GAAP measures continue to be an important feature of annual reports: 86% of companies presented them in their summary pages and of those over 60% gave them greater prominence than associated GAAP measures. Furthermore, most companies use them on the face of the income statement. These findings will not please regulators. IOSCO is currently consulting on the use of non-GAAP measures and ESMA is expected to publish its guidelines on the subject before the year is out, so this is certainly an area that companies need to think about carefully when they prepare this year's accounts.
Q: As we move into the new reporting season what other corporate reporting issues should companies be focusing on at this time?
A: The new proposals around the reporting of going concern and risk reporting will come into effect for periods commencing on or after 1 October this year and merit close attention. Country-by-country reporting also comes into force from 1 January 2015 and will have a big impact for those in the extractive industries.
Q: When it comes to corporate governance what are the messages we can learn from the survey?
A: In terms of corporate governance messages from our survey, we have to remember that we have a comply or explain model in the UK, but nevertheless it is still quite surprising that only 57% of companies reported they were fully compliant with the UK Corporate Governance Code, which was the same level as the prior year. The most common areas of non-compliance are around the independence of directors and the composition of audit committees. And as we know the FRC is encouraging much more meaningful explanations for non-compliance to be included. But boards are making some, albeit slow progress, on getting women into the boardroom. 73% of companies have a woman on the board but the overall number of female directors remains quite disappointing – from 13% to 15%. There is still a need to boost the number of female directors on UK boards.
Q: This last year saw the introduction of the requirement for the directors to state that the report and accounts were "fair, balanced and understandable". How well did companies cope with that?
A: All but four of the companies in our sample included the new fair balanced and understandable statement, typically in the directors' responsibility statement. And those four which did not were at the smaller end of the listed company spectrum. What was encouraging was that 23% chose to provide some description of the process they had undertaken to support the statement by the board. We hope that this enhances shareholder confidence that the new requirement was taken seriously and that the governance of the annual reporting process was robust.
Q: Audit committees were also given greater responsibilities this last year. How did that work out?
A: Audit committee reporting has made a giant leap forward. Now two thirds of companies made the audit committee report a distinct section within the annual report, compared to only 45% – less than half – last year. This reflects the greater profile being given to the audit committee's stewardship and reporting responsibilities. And audit committee chairmen are now taking much more ownership of the report as the very personal introductions imply. Nearly three quarters of companies report in this manner compared to less than half in the prior year. And of course the reporting of the significant issues considered by the audit committee coupled with the extended reporting by auditors provides investors with a much greater basis for engagement.
Q: And what challenges lie ahead?
A: On the governance side, as with the world of narrative reporting, preparers will have few disclosure changes to contend with this year – for December 2014 year ends. However, the FRC's finalised guidance on risk management and internal control is now out and companies are going to need to look closely at this, the governance implications of the new viability statement and the other revisions to the Code particularly on internal control and the reporting of weaknesses from the directors' internal control review. And these apply for accounting periods beginning 1 October 2014.
Q: Moving back through the book to the financial statements what were the highlights amongst the back half of the report?
A: A few companies are innovating in areas like presentation of accounting policies and are including narrative reporting in their financial statements. And non-GAAP measures are proving as popular as ever. As mentioned, some 68% included such metrics in their income statements. Encouragingly, many were adhering to the FRC's reminders at the end of last year about the use of exceptional items, in that they were not describing recurring items as exceptional. And, even though there was pressure to cut clutter, some companies still included voluntary disclosures. Some 44% included net debt reconciliations or similar information and 10% included insight on tax governance and strategy.
Q: And what are the challenges ahead?
A: 2014 will be the first year that many companies have had the IASB's package on consolidations to deal with, including all the new disclosures required by IFRS 12. Looking further ahead there is the newly published standard on revenue recognition to prepare for.
Q: Integrated reporting was a much discussed topic through the year. How far did the discussions make it through into the reporting?
A: With the focus on growth, long term investment and the broader role of business in the society, integrated reporting offers an excellent opportunity for companies to tell their value creation story. Although only five companies surveyed mentioned integrated reporting, the vast majority, 80%, already discuss value creation in their reports. Of course, integrated reporting is not really just about reporting, it is about integrated thinking and behaviours, integrated from strategy and business model to business performance, from internal performance management measures to external reporting.
The strategic report framework in the UK creates an excellent enabling environment and allows companies to experiment and innovate. Our survey and its findings will also help companies to innovate and enhance their reporting by drawing on the many best practice examples we have provided. Hopefully, with the developments around integrated reporting and the FRC's encouragement for clear and concise reporting companies will feel empowered in their efforts to provide a clear steer to the readers of their reports.
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