12 November 2012

FRC/Fleck: The importance of confidence in financial reporting

The Financial Reporting Review Panel FRRP is authorised to review the financial statements prepared by public limited companies – including all listed and UK AIM quoted companies – and large private companies. The Panel is very aware that many companies and users of company financial statements are concerned at the length, complexity and impenetrability of modern day financial statements. This was, and remains, a concern of the Financial Reporting Council which, in 2011, published 'Cluttering Clutter'.

The FRRP is only too aware that this policy objective – to ensure that important messages, policies and transactions are appropriately highlighted and not obscured by irrelevant detail – might be seen to conflict with its duty to enforce the disclosure requirements of both legislation and accounting standards.

One of the recurring criticisms following the financial crisis has been that banks and other financial sector companies did not make any reference, for example, to the stability of the credit markets in their 2007/8 annual reports. The Panel attaches considerable importance to the requirement that a company’s business review includes a clear description of the principal risks and uncertainties it faces. Boilerplate disclosures referring to every obvious risk are neither appropriate nor helpful to the reader.

• The disclosure of principal risks should be sufficiently specific to the company so that the reader can understand why they are important to that company.
• The disclosure should focus on the principal risks – which are those risks that the company pays most attention to when assessing and implementing its strategy.
• It should explain the mitigating actions taken by the Board to manage the impact of those principal risks and uncertainties.

The FRC does not set time limits for responses (as occurs in the US). The FRC is therefore dependent on timely – and comprehensive - responses by companies.

The FRC launched the Financial Reporting Laboratory (FRRP) with the aim of improving the effectiveness of corporate reporting and audit committee reports. It provides an environment where corporates and investors can come together to develop pragmatic solutions to today’s reporting needs. This is not another talking shop. Instead the Lab encourages management and investors to experiment with new reporting formats that offer a tangible step forward in effective communication.

In just a year, it has produced reports on the following four projects:

• debt terms and maturity tables;
• operating and investing cash flows;
• net debt reconciliation; and
• a single figure for remuneration.

Regarding confidence in the integrity of financial reporting, Mr Fleck said that anyone who watches Question Time on the BBC, which is itself facing a crisis of public confidence, cannot fail to note the unhesitating criticism of business:

• the bankers who have become the whipping boys of the media and politicians,
• utility companies who make too much profit,
• petrol companies that don't pass on reductions in oil prices,
• transport companies that put up prices to fund infrastructure investment,
• pharmaceutical companies that fail to identify damaging side effects of new products.

And sadly, financial reporting has become another area where trust has been eroded. That occurred, particularly, after the financial crisis in 2007/2008. Commentators queued up to complain that banks and other companies in the financial sector produced accounts that failed to correctly reflect their financial position, were prepared on a going concern basis when the companies concerned faced real difficulties and uncertainties and, perhaps most serious of all, raised funds through rights issues that were shown to be based on unsound data only a few months later.

Most major companies comply with the legal requirements and accounting standards relating to financial reporting. But that is not enough. The financial statements must inspire confidence – and that won't be achieved if users and commentators believe that financial statements are capable of manipulation to suit the preparer.

This is important because if society does not have confidence in the integrity of financial statements, capital markets will not thrive - and they make a vital contribution to the economy, to the UK's ability to compete internationally and globally, to growth, to employment, to pensions – indeed throughout society.

Full speech

© FRC