The Financial Reporting Council (FRC) has issued a document highlighting issues for company directors to consider around the impact of Brexit on their financial reporting.
The corporate governance watchdog highlighted the “consequential uncertainties in the political and economic environment” following the UK’s vote to leave the EU, and urged all companies to instigate early dialogue with their auditors.
Considerations included the impact the vote may have on future business performance, increased market volatility and whether the going concern basis of accounting is appropriate.
The points raised by the FRC were “designed to stimulate thinking”, and the regulator drew attention to “the importance of high quality narrative information” that supplements financial statements.
Principal risks and uncertainties
While the FRC acknowledged the outcome of the referendum may give rise to general macro-economic risks or uncertainties, the watchdog encouraged directors to consider the impact it may have on their specific sector and business.
Any risks judged to be ‘principal’ must be disclosed, according to the FRC, and explained in the company’s interim management or strategic report. Care should be taken to avoid ‘boilerplate’ disclosures. “Company-specific disclosures are more informative and useful to investors”, said the statement, “for example, the impact of trade agreements for companies with a high level of exports to Europe.”
As part of the assessment of principal risks and uncertainties, the FRC encouraged boards to consider whether the vote gives rise to solvency, liquidity or other risks that may threaten the long-term viability of the business. The statement also outlined that it expected boards to provide an explanation of any steps that they are taking to manage or mitigate potential risks.
Market volatility
The statement suggested that the volatility in the markets following the result “may have an impact on balance sheet values at 30 June 2016 or at subsequent reporting dates”. Cash flows included in future forecasts may also need to be re-evaluated.
An example given of the balance sheet impact by the FRC involved financial instruments measured at fair value and discount rates used in measuring pension and other liabilities, which may be affected by changes in foreign exchange rates, interest rates or market prices.
In respect of foreign exchange risk, the FRC encouraged boards to consider the potential gains or losses arising from transactions in foreign currencies, for example, the impact on future earnings as a consequence of the decline in the value of sterling for non-UK sales.
Boards should also consider the disclosure of events after the reporting period that have not been adjusted in the financial statements, according to the FRC’s guidance. Examples mentioned included abnormally large changes in asset prices or foreign exchange rates.
Half-yearly financial reports
The FRC also reminded directors that there is a general requirement for the interim management report of listed companies to include disclosure of important events that have occurred during the first six months of the financial year, and an indication of their impact on the interim financial statements.
Going concern basis of accounting
As part of the preparation of financial statements, the FRC urged directors to consider whether the going concern basis of accounting is appropriate, and examine whether disclosures of material uncertainties are needed, “particularly where there is a material risk of breach of covenants”.
Think ‘as specifically as possible’
Responding to the statement Danielle Stewart, head of financial reporting at RSM said that it was “helpful”, but went on to say that her firm are encouraging their clients to think “as specifically as possible” about how does Brexit affect their own activities in particular.
“For example”, continued Stewart”, the FRC doesn’t mention contingent liabilities that may arise from Brexit, depending on the deal that is done with the EU, the potential impact on profitability of non-recoverable VAT for companies which currently incur and recover a lot of input tax in other EU states, the effect of no longer receiving a grant or subsidy from the EU, nor even the somewhat unlikely impact on operations of a mass exodus of European employees.
‘Directors need to think entity specific, outside the box, and disclose as much as they can, because one thing is for sure - Brexit will impact on all companies. What the user of a set of accounts needs to know is, how does it impact on your company?”
What should companies be thinking about in the post-leave environment? Have the FRC missed anything?
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