Business review requirements on risks and uncertainties not being met
The FRRP is part of the Financial Reporting Council (the FRC); its role is to examine the annual accounts of public and large private companies to see whether they comply with the requirements of the Companies Act 2006 (the Act) including applicable accounting standards.
The business review that a company must include in the directors’ report in its annual report and accounts
The Act requires, at section 417, that all companies other than small companies must produce a business review in their annual directors’ report. The purpose of this business review is to inform members of the company and help them assess how the directors have performed their statutory duty (contained in section 172 of the Act) to promote the success of the company”. The business review must contain a “description of the principal risks and uncertainties facing the company”, and it is this description that the FRRP has found wanting in its review of company accounts.
The FRRP’s criticism of some business review descriptions of risks and uncertainties
The FRRP states that it “has challenged a number of companies” where:
- “The directors’ report does not clearly identify which risks and uncertainties the directors believe to be the principal ones facing the business.
- A long list of principal risks and uncertainties is given and the list raises a question as to whether all the risks and uncertainties on the list are actually principal ones.
- The description given of a risk or uncertainty is in generic terms and it is not clear how that risk or uncertainty applies to the company’s circumstances.
- The disclosure is of a risk framework rather than of the risks or uncertainties themselves.
- The principal risks and uncertainties disclosed are not consistent with other information given in the report and accounts.
- The directors’ report does not state how the company manages its principal risks and uncertainties. As the purpose of the business review is to inform members of the company and to help them assess how the directors have performed their duty to promote the success of the company, the Panel believes that a Board should state how the company manages its principal risks and uncertainties”.
The FRRP’s recommendations to achieve better reporting of risk
The FRRP “encourages boards of directors to consider their disclosure of the principal risks and uncertainties facing their businesses by considering the following questions:
- Do the disclosures state clearly which are the principal risks and uncertainties facing the business?
- Are those risks and uncertainties described as principal the main risks and uncertainties that currently face the business? For example, have the risks and uncertainties listed as principal been the subject of recent discussions at board or audit committee meetings? Are there risks which have been the subject of such discussions which should be considered as principal?
- Is the description of each principal risk and uncertainty sufficient for shareholders to understand the nature of that risk or uncertainty and how it might affect the company?
- Are the principal risks and uncertainties described in a manner consistent with the way in which they are discussed within the company?
- Are the principal risks and uncertainties shown consistent with the rest of the report and accounts? Are there risks and uncertainties on the list which are not referred to elsewhere or are there significant risks and uncertainties discussed elsewhere which do not appear on the list?
- Is there a description, in the directors’ report, or elsewhere in the report and accounts and explicitly cross-referenced from the directors’ report, of how the company manages each of the principal risks and uncertainties?”.
The FRRP’s recommendations reflect the increased focus by regulators on the quality of company reporting, both financial and narrative. The financial crisis showed that company disclosures about the risks facing their business were inadequate and in some cases useless.
As a consequence of these perceived failures of reporting, there are a number of broad-based consultations on how to improve reporting currently in train:
- The Government consultation on ”The Future of Narrative Reporting” closed in January 2011 (and see our update on this)
- The FRC published a discussion paper in January 2011 on “Effective Company Stewarship: Enhancing Corporate Reporting and Audit“.
- The Accounting Standards Board published in October 2010 for comment an exposure draft on “The Future of Financial Reporting in the UK and Republic of Ireland“.
- The European Commission consultation on narrative reporting by companies has closed and the Commission is analysing the responses (consultation document appears to be no longer available online).
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