FRC study pushes for better Covid-19 disclosures
The impact of the coronavirus has put preparers of financial statements under pressure to provide clear information on how companies have been affected. The FRC recently responded with a how-to review drawing on 17 interim and annual statements from the period ending 31 March 2020.
Introducing the FRC Lab review of the financial reporting effects of Covid 19 for a sample of interim and annual reports and accounts with a March period end, the authors highlighted a number of areas where disclosures affected by Covid-19 could be improved.
“Companies should aim to ensure that not only mandatory disclosure requirements have been met but that sufficient explanations have been included within the financial statements to enable a user to understand how Covid-19 has affected both the amounts presented and the company's future prospects,” they wrote.
The meat of the report works through all the main sections of the annual report, discussing oversights and shortcomings, but more importantly including examples of good practice. Among the key points it emphasised, were the need to:
- Apply existing accounting policies for exceptional and other similar items to Covid-19 related income and expenditure consistently – preparers “should not split income and expenses between Covid-19 and non-Covid-19 financial statement captions arbitrarily”.
- Prepare interim reports that provide sufficient information to explain the impact that Covid-19 has had on their performance, position and future prospects.
Other topics of particular interest in the report are covered below.
Going concern and viability statements
Going concern assessments have been a particular focus for companies and auditors in recent months. Good examples cited by the FRC report explained the period over which viability was considered and why that period was appropriate. Good going concern disclosures also highlighted areas which were particularly subject to uncertainty and how the uncertainty was being mitigated.
Cash, liquidity and covenant compliance
Another, crucial area for any business at this time, including listed and public interest entities. Yet the quality of disclosures encountered in this area of annual reports was mixed. In one less impressive example, a company with significant debt and hedging activities received a credit rating downgrade prior to the year end. The downgrade and additional annual interest payable, as a result, were disclosed in the annual report, but commentary did not cover remeasurement of the company’s debt, its hedging relationships, or impact on profit and loss.
“In case of a significant credit rating downgrade, we expect companies to explain the impact both on their existing financial instruments and on future liquidity,” the FRC Lab noted.
In contrast, Reuters explained its position at the end of its six month interim reporting period and the measures it took to enhance liquidity around the period end. The company clarified elsewhere in the report that without putting the mitigating measures in place, it could have potentially breached the leverage covenant on its debt over the next two testing dates.
Nearly 20% of the FRC report – 10 pages – rake over the strategic reports issued by directors alongside their annual accounts. The authors rightly expected strategic reports to comment on the impact of Covid-19.
“Whilst all companies in the sample identified Covid-19 as a principal risk, the quality of the disclosures presented was varied,” the report noted. “Some companies clearly explained the specific risks they faced as a result of Covid-19, outlined the specific mitigations for each of these risks and linked risks identified to their strategy. Weaker disclosures identified Covid-19 as a risk but did not clearly articulate the specific risk faced by the company, the way in which the specific risk was mitigated and failed to link the risk to strategy.”
The Land Securities strategic risk chart was presented as a good way of presenting these risks and their link to company strategy
Given the cash repercussions, the FRC team expected to see discussions of the impact of Covid-19 on companies’ cashflow statements as well as the profit and loss accounts and the statement of financial position, but none of the sampled reports did this.
Alternative performance measures (APMs)
The FRC has been interested in alternative APMs for some years, and has no problem as long as their relevance and use are explained adequately, they are reconciled to the closest IFRS measure and are not given more prominence than GAAP measures.
In the current circumstances, however, the authors warned against attempts to provide normalised or pro forma results that exclude the estimated effect of the Covid 19 crisis as these are “likely to be highly subjective and, therefore, unreliable”.
Fair value measurements and impairments
As we heard during the recent funding advisory webinar with Swoop, coronavirus may lead to situations where auditors need to consider including emphasis of matter paragraphs in their reports. An emphasis of matter paragraph does not modify the audit opinion, but brings forward a matter presented or disclosed in the financial statements that the auditor judges to be fundamental to users’ understanding of those statements. The ICAEW Audit and Assurance Faculty recently published a guide explaining how emphasis of matter paragraphs should be used.
And earning more brownie points for its presentation, the discussion of property values by Land Securities was offered up as an example worth following. “The valuer’s report for the year ended 31 March 2020 contained a ‘material uncertainty’ clause due to the disruption to the market at that date caused by Covid-19. The inclusion of this clause indicates that there is substantially more uncertainty than normal and therefore a higher likelihood that the assumptions upon which the external valuer has based its valuations prove to be inaccurate.” The sensitivities for extensive changes in assumptions were disclosed in separate tables.
- Dividends and capital management
- Presentation of primary statements
- Expected credit loss provisioning
- Significant judgements and estimates
- Defined benefit pension schemes
- Provisions and onerous contracts
- Adjusting and non-adjusting post balance sheet events
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