FRC sets out improvements for cashflow statements
On 17 November, the FRC issued a press release stating that the preparation of cashflow statements needs to significantly improve. This release followed the FRC’s review of corporate reporting for 2019/20.
While the review focuses on those entities which report under IFRS, the content of the FRC’s corporate reporting review can be applied to financial statements prepared under UK GAAP for private entities.
The FRC has challenged companies where they have found deficiencies in their cashflow statements. Notably, the FRC challenged:
- material inconsistencies between items in the cashflow statement and the notes;
- missing or incorrectly classified cashflows; and
- inconsistencies between financing cashflows and the reconciliation of changes in liabilities arising from financing activities in the notes.
The FRC has also identified several areas for improvement in the disclosure of accounting policies for the treatment of significant and large, one-off transactions in the cashflow statement. The FRC is also concerned about ‘boilerplate’ disclosures in respect of liquidity risk and related issues. Conversely, the FRC has noted improvements in going concern, viability and liquidity disclosures.
The FRC’s Corporate Reporting Review 2019/20 confirms that a number of companies agreed to restate their cashflow statements following queries raised by the FRC and according to the FRC’s Thematic review: Cashflow and liquidity disclosures (Nov 2020), the cashflow statement has featured in the top ten most frequently raised topics by the FRC.
The FRC strongly recommends that companies consider the guidance and case study which was provided in the 2019 Corporate Reporting Review on pages 12 to 14.
Concerns raised by the FRC in respect of the cashflow statement are as follows:
- Companies with reverse factoring arrangements failed to explain how the related cashflows were presented and the overall impact of those arrangements on the cashflow statement.
- Non-cash amounts were presented as cashflows, such as assets acquired under finance leases and non-cash finance changes.
- Proceeds from borrowings and repayment of borrowings were offset as opposed to being shown gross.
- Errors were noted where the cashflow statement was prepared on an indirect basis. The report cites share-based payment charges being deducted from pre-tax profit instead of being added back.
- The FRC identified material unexplained inconsistencies in reported cashflows and disclosures provided in other sections of the financial statements, such as in the strategic report.
- Queries were raised by the FRC where accounting policies stated that cash equivalents included amounts with an original maturity of more than three months. IAS 7 cashflow Statements explains that an investment normally qualifies as a cash equivalent when it has a short maturity of, say, three months or less from the date of acquisition (this is also the same under FRS 102, para 7.2).
Classification of cashflows
- Certain costs such as acquisition-related costs and consideration for post-acquisition services were charged to profit and loss. However, the related cashflows were classified as investing cashflows rather than operating cashflows.
- cashflows in respect of acquisition from non-controlling interests were classified as investing activities rather than as financing activities.
- Derivative-related cashflows were classified as financing activities even though the derivatives related to operational hedges and hedges of net investments in foreign operations.
- The FRC noted that some entities’ financial review did not discuss significant cashflow matters, such as significant changes in operating cashflow and movements in restricted cash.
- Some reconciliations of liabilities arising from financing activities failed to meet the IAS 7 requirements. For example, because they were presented on an aggregate basis for an entity’s net debt, including cash and cash equivalents and derivative assets, which are not liabilities from financing activities.
- Some companies failed to make the required disclosures in accordance with IAS 7. For example, they failed to disclose dividends received from associates and joint ventures or net cash paid on acquisitions.
The FRC’s thematic review states that they will write to three companies which were included in their sample where there is a substantive question concerning their cashflow statement. In addition, the FRC will write to a further five companies to draw their attention to aspects of their disclosures where improvements are required.
The FRC has also said that they will challenge companies where they do not see:
- Clear explanation of going concern, viability and liquidity information, such as availability of cash, undrawn borrowing facilities and compliance with covenants.
- Disclosure of assumptions and judgements made in assessing going concern and viability.
- Disclosure of supplier financing arrangements, including the impact on liquidity risk management.
- Evidence of robust pre-issuance reviews to ensure cashflow statements and related notes are compliant with the requirements of IAS 7 and free from basic errors.
- Consistency between the amounts and descriptions of items in the cashflow statement, and other areas of the annual report including: the strategic report, other primary statements, disclosures of changes in financing liabilities and other notes.
- Disclosure of any judgements in relation to the cashflow statement, particularly for large, one-off transactions, and disclosure of related accounting policies, such as for the composition of cash and cash equivalents, the presentation of interest and contingent consideration.
The FRC’s thematic review contains a useful summary of historical cashflow statement errors where corrective action was required as follows: