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Tuesday, 23rd April 2024
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Increasing demands for disclosure Back  
There is increasing complexity in the activities of many companies, particularly at the larger end of the scale, the demand for increased disclosure is a major contributor. It is considered essential by many investors and analysts that the financial statements are accompanied by management commentary to give readers a valuable insight into management views of the main trends and factors underlying the current position, performance and future development of the entity’s business, writes Marguerite Larkin.
With the growing plethora of financial reporting standards and, in many cases their increasing complexity, investors and other users of financial statements find themselves constantly grappling with understanding what is being reported in annual reports. A recent survey carried out by Deloitte showed a massive increase of 59 per cent in the average length of listed company annual reports in the UK since 1996, and each year they seem to get larger and more complicated.

While there is increasing complexity in the activities of many companies, particularly at the larger end of the scale, the demand for increased disclosure is a major contributor.

It is therefore considered essential by many investors and analysts that the financial statements are accompanied by management commentary to give readers a valuable insight into management views of the main trends and factors underlying the current position, performance and future development of the entity’s business.

Management commentary – international perspective

The International Accounting Standards Board (IASB) published on 27 October a Discussion Paper – ‘Management Commentary’ - that assesses the role the IASB could play in improving the quality of management commentary and promotes the international convergence of the varying practices around the world.

The IASB describes the objective of management commentary as providing information to help investors:
• To interpret and assess the related financial statements in the context of the environment in which the entity operates
• To assess what management views as the most important issues facing the entity and how it intends to manage these issues
• To assess the strategies adopted by the entity

The IASB is proposing that the standard should set out the principles and qualitative characteristics, as well as the essential areas of the management commentary, necessary to make the information useful to investors. It does not deem it appropriate to specify the precise information that must be disclosed, or how it is presented.

The IASB Discussion Paper is a welcome development with regard to international harmonisation in the area, albeit that it may yet be some time before we reach the point of having a standard in place.

Operating and financial review

Regulatory requirements in the UK require UK quoted companies to prepare an Operating and Financial Review (OFR) for financial years beginning on or after 1 April 2005. The Accounting Standards Board (ASB) was directed by the UK government to draw up the reporting standards for the OFR and earlier this year issued Reporting Standard 1: ‘Operating and Financial Review’ (RS1). For a number of years, the ASB has had in place a Statement of Practice regarding the OFR to provide guidance to companies and this has been replaced by RS1 and the accompanying regulations.

While not a regulatory requirement in Ireland, many believe that as a matter of best practice our listed companies will choose to report in line with RS1, particularly as many of them are also listed on the London Stock Exchange. It is worthwhile therefore to focus on what RS1 outlines as being the key principles of the OFR.

These are to:
• Reflect the directors’ view of the business
• Be addressed to the members and focus on matters that are relevant to the members
• Have a forward-looking orientation
• Complement as well as supplement the financial statements
• Be comprehensive and understandable
• Be balanced and neutral with both good and bad aspects
• Be comparable over time

RS1 also provides a framework of disclosures to be provided by directors in the OFR.

Its key elements cover:
• The nature, objectives and strategy of the business;
• The development and performance of the business, both for the current period and the future;
• The resources, risks and uncertainties and relationships that may affect the entity’s long-term value;
• The position of the business, including a description of the capital structure, treasury policies and liquidity of the entity, both in the period under review and in the future;
• Environmental matters, employees and social and community issues; and
• Key performance indicators.

Survey of UK listed companies

A survey carried out by Deloitte of OFR and narrative reporting in UK listed company annual reports, titled ‘Hold the Front Pages’, comments that the imposition of a statutory OFR will represent a significant task for listed companies and a considerable challenge and burden for many.

Key findings of the 2005 survey are that while 82p.c. of companies surveyed prepare an OFR, many of them have significant shortcomings when measured against the new rules for 2006, for example:-
• 59p.c. disclose no key performance indicators (KPI’s)
• 55p.c. do not disclose the principal risks facing the business
• 67p.c. do not have a forward looking orientation, they merely discuss the past
• 47p.c. do not clearly discuss the business objectives and strategies

An equivalent survey carried out of Irish listed companies would most likely show similar findings.

Private companies – more reporting?

Regulations introduced in Ireland earlier this year which primarily relate to the implementation of IFRS also included a number of miscellaneous amendments to Companies Acts based on the EU Modernisation Directive. One of these was the requirement for non-listed companies to produce enhanced directors’ reports to include:
• A fair review of the business
• A description of the principal risks and uncertainties facing the company
• The regulations state that the commentary shall be a balanced and comprehensive analysis of the development and performance of the company’s business and of it’s financial position, consistent with the size and complexity of the business. To the extent considered necessary, it shall include analysis of financial, and, where appropriate, non-financial key performance indicators relevant to the particular business, including information relevant to environmental and employee matters.

This information is to be disclosed in directors’ reports of all companies for periods beginning on or after 1 January 2005. Implementation of this will provide an interesting challenge for the large numbers of private companies who heretofore have not been used to disclosing information of this nature.

It is clear that the momentum is growing for companies to include high-quality narrative in their Annual Reports, to explain and complement their financial reports. This must be welcomed if it leads to users of financial statements being in a stronger position to make important investment and economic decisions.

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