The new OFR is just around the corner

Richard Martin reports on the UK Government's draft law requiring listed companies to produce an Operating and Financial Review (OFR) to go with the rest of their report and accounts for shareholders.

The UK Government has published a draft law requiring listed companies to produce an Operating and Financial Review (OFR) to go with the rest of their report and accounts for shareholders. The legislation is now out for any final comments by 6 August. Listed companies need to start thinking as the deadline for compliance is the 2005 accounts. Large unlisted companies will also be affected by some similar but less extensive requirements as part of a re-vamped directors' report.

Currently, about 60% of UK listed companies produce an OFR based on the ASB's best practice guidance. This leaves about 500 companies who may have to start from scratch. Probably no existing OFR meets the new requirements.

The general objectives of the OFR will be for the directors to provide shareholders with information to help them assess the company's strategies and their potential for success. Strategy and risk factors are to be disclosed and it is to be forward looking.

As far as content is concerned, there are compulsory and other elements. The 'compulsory' ones are:

• analysis of performance and development
• analysis of the position of the business
• factors and trends underlying these
• factors and trends affecting the future
• description of business, objectives and strategies
• resources available
• risks and uncertainties faced, and
• capital structure, treasury policies and liquidity.

Much of this will seem familiar from the existing OFR and is material commonly provided there or in chairman's statements. Resources will need to be considered including intangible items such as advertising, workforce and research. Studies have, however, shown that the future elements, the risks and the strategies are often not currently included or done badly. This is material some companies find uncomfortable putting out into the public arena.

The 'other' content would include information regarding:

• employees
• environmental matters
• social and community issues
• key relationships
• returns to shareholders, and
• appropriate key performance indicators (KPI).

These are not voluntary items, but should always be included 'to the extent necessary' to achieve the general objectives of the OFR. Much more of this content will be unfamiliar and is currently only dealt with superficially. Does this mean that many companies will avoid these disclosures with some boilerplate statements? The narrower focus chosen by the law on shareholders rather than stakeholders is important here. Will environmental disclosures, for instance, be excluded based on claims of lack of shareholder interest in such subjects?

Guidance for directors from the UK DTI stresses the longer term perspective and steers companies towards considering that most of these 'other' items are likely to be needed. There will be OFR standards produced by the ASB fleshing out the legal requirements. The existing ASB approach has been to give likely common examples of items which should be included. They have fallen short of specifying the compulsory disclosures and metrics that are the stuff of accounting standards. To what extent the OFR standards will move at all in that direction remains to be seen.

The auditors will report whether the statutory OFR has 'been prepared after due and careful enquiry'. The focus will therefore be on the process used to prepare the OFR. The DTI guidance helps here and gives 10 key questions for companies on process, from planning to review, including how the subjects were decided on, how shareholders' concerns were identified, how KPIs and external benchmarks were selected. The OFR must be neutral, including bad news as well as good.

The Financial Reporting Review Panel will also be able to consider the OFR in future. Similar fines and directors' responsibilities apply as to the rest of the report and accounts over failure to comply and defective reporting.

This is the prospect for listed companies. Some of these changes are proposed for large unlisted companies as well. There will be a new expanded requirement for the directors' report to review the activities and developments during the period. This mentions the use of KPIs and covering environmental and employee matters. It does not elaborate the content to the same degree as the OFR and no specific forward looking focus is included.

The overall picture seems clear, though some aspects of the proposals might still change as a result of the DTI's consultation. The new OFR standards will appear as drafts before the end of 2004. Accountants will be taken further away from the comfort zone of financial historical reporting and deeper into the less familiar forward looking non-financial 'other' subject areas.

Richard Martin is ACCA's head of financial reporting.