BIS: the future of narrative reporting

Comments from ACCA to the Department for Business, Innovation and Skills (BIS), 25 November 2011.


The Association of Chartered Certified Accountants (ACCA) is pleased to comment on the proposals in the above consultation document to restructure the UK statutory directors report. We address later on specific consultation questions but would like to make some general comments at the outset.

General comments

ACCA supports the current initiative, as well as the related work being carried out by the FRC on effective stewardship, because we believe that the potential of narrative reporting for adding value to the information contained in companies' financial statements is not being fully achieved within the current structures of the directors report and the annual report more generally. We believe also that this project offers an important opportunity to ensure that companies prepare and publish information which helps to facilitate investor engagement and to encourage both sides to address the wider issue of long-term focus.

High quality narrative reporting can help to enhance the process of communication between companies and their investors - and other stakeholders - for their mutual benefit. When companies explain what they are doing in a way which satisfies the specific information needs that investors have, it serves the public interest goal of transparency and at the same time enhances the efficiency of decision-making in the marketplace. Where companies are able to explain their actions and future plans in a way which has the effect of increasing trust and confidence in what they are doing, that stands to benefit companies themselves by enhancing their attractiveness to investors and potential investors. It is therefore in the interests of both sides that narrative reports be prepared in a way which focuses on what the markets want to hear, not on what companies want to talk about.

Within the boundaries imposed by EU legislation, the UK is entitled to re-assess what it is that its statutory narrative report is meant to achieve, and what investors would most value about the report. We welcome the fact that BIS has engaged in a new dialogue with investors to gauge what sort of information they would like to see in narrative reports and that this exercise has informed its new proposals. ACCA has itself carried out a number of studies in recent years which have looked at the issue of narrative reporting from the perspectives of both preparers and users: the results of these exercises have underlined the need for policy makers to i) restrict mandatory disclosures to those which are likely to add value for users and ii) allow companies the freedom to tell their own 'story' in a way which communicates their boards' genuine desire to engage with their stakeholders.    

A long-standing flaw in the design of the UK's statutory directors report is that it has tended to act as a convenient repository for information mandated to be disclosed by various items of law and regulation. As time has gone on the number of disclosures required to be made in the directors' report has increased, and the cumulative effect of this process has been to make the report progressively less capable of communicating a coherent message. Given this experience it makes much sense, going forward, to separate compliance-related disclosures from the strategic narrative. The proposed Annual Directors Statement should however have its own coherent rationale and should not simply become a repository of ad hoc disclosures.

In planning for the future, the UK needs to remain aware of, and avoid creating inconsistencies with, parallel developments in this area which are happening in the wider international community. The IASB has recently issued a Management Commentary standard which provides substantial advice for companies on how to provide further explanation of the results in the financial statements: listed companies will be obliged to adopt that standard. The IIRC is also working on a more ambitious project to develop a new framework for 'integrated reporting', which may in due course either become the acknowledged benchmark for narrative reporting or even become the sole reporting statement. Whatever new requirements are introduced in the UK should aim to be broadly consistent with these international developments so as to minimise the risk of future disruption.

Specific questions

Our comments on specific questions posed in the document are set out below. We have not addressed the majority of the specific questions dealing with remuneration but will be responding on the separate consultation exercise on that matter. 

Q1: Do you agree with the restructuring of the current reporting framework into a Strategic Report and an Annual Directors Statement?

In principle, yes. The proposal addresses the issue of the current directors' report lacking focus because of the confusion of information required to be disclosed in it. The proposed reform will provide the opportunity for the development of a report which concentrates on providing investors with the information which is relevant to a high level assessment of the performance and prospects of the reporting company. We recommend that the strategic report be given an overriding theme, as is currently the case with the Business Review, in the interests of encouraging coherence and comparability, but that the level of prescription in the requirements be limited so as to give freedom to each reporting company to communicate their 'story' in the context of their own particular circumstances.

If the potential of the two new reports is to be realised, they need to remain distinct, and the character of the information to be disclosed in them should be determined with that in mind. In that connection, BIS should be careful not to see the Annual Directors Statement as being a convenient repository for ad hoc disclosures or for information which is supplementary to disclosures in the Strategic Report.

Q2:  Do you agree that the Strategic Report should include [the listed types of information]?

While the outline provided does not suggest that the Strategic Report will look very different from the Business Review, we support the general idea of the creation of a report which is focused on communicating a company's strategy, business model and material risks. With this in mind, it would be curious if the strategic report for companies below the listed company level were not expected to discuss their strategy and business model in their reports. It should be possible to devise a template whereby these matters were required to be discussed by non-listed companies in a proportionate way.  

Q3: Do you agree that the proposed Strategic Report should replace the Summary Financial Statement?

Yes, provided that key financial information is to be included in the new report. BIS will need to resolve the issue of all companies, including private companies, now being entitled to produce a Summary Financial Statement.

Q4: Do you agree that the Strategic Report should be signed off by each director individually?

This proposal would not add anything in substance to the current situation, whereby the accounts and directors report are required to be agreed by the board as a whole. The fact that only one director currently signs those reports does not affect the documents are approved on a collective basis. With respect to the suggestion in para 3.21, that the proposal would encourage all directors to take ownership of the report, there is no evidence that directors do not currently appreciate their collective responsibility, and for obvious reasons there is no evidence that multiple signings would make any difference in this respect.

Q5: Do you agree that the Annual Directors Statement should include [the matters set out]?

There is a risk that the Annual Directors Statement could suffer the same fate as the Directors Report and become a mere repository for compliance related information of all kinds, and hence lose coherence. If this fate is to be avoided, attention will need to be given to what is to be the rationale for the new statement, and this rationale should govern the range of information that companies are to be required to disclose within it. Of the disclosures suggested, we would say that the corporate governance statement and the directors remuneration report should have a separate existence, with appropriate cross-references to their more material content made in the Strategic Report. Ideally, the rationale for the Statement should be consistent for quoted companies and non-quoted companies alike.

Q6: Do you agree that companies should be able to include material in the Annual Directors Statement by cross reference to information published elsewhere?

This would help to keep the length of the statement down, to avoid duplication and to cut preparation costs. While there may be implications for the amount of work the auditor would have to do in checking the information cross-referred to, this would not be incompatible with the role of the auditor.

Q7: If companies are to include material in the Annual Directors Statement by cross reference, do you agree that they should make an annual statement confirming they have reviewed information and noting any changes?

There should be no need for a separate statement to this effect. If directors are prepared to sign the full statement off as complying with the relevant preparation and disclosure requirements, it will be incumbent upon them to satisfy themselves that all information provided in the statement, including any material cross-referred to, is accurate and up-to-date.

Q8: Do you agree that the Annual Directors Statement should be presented online with a hard copy available to shareholders on request?

There is already sufficient flexibility in company law to allow companies to use electronic communication as the default means of transmitting corporate documents to shareholders. This existing basis should continue.

Q9: Do you support removal of the disclosure requirements [in Table 1]?

Of the proposed list of disclosure items suggested for removal, we believe two should be retained. Firstly, the requirement to disclose charitable donations remains appropriate since shareholders are, in our view, entitled to know how much of their money has been spent by the company on matters unrelated to the pursuit of the company's objectives. This is in itself a justification for retention of the current requirement. Secondly, companies should continue to be subject to a requirement to disclose their policies and practices on payment of creditors. Late payment is a long-standing problem in the business environment, in the UK and other countries, and tends to get worse during periods of economic slowdown when creditors are seen as a source of cheap working capital. We would agree that the existing disclosure requirement does not appear to have impacted on the prevalence of the problem. But the ineffectiveness of the disclosure requirement can, we suggest, be attributed at least in part to the ease with which figures can be smoothed and to the absence of any sanction for non-disclosure. If the current requirement were to be removed, this would we fear send an unwelcome signal to companies that late payment is no longer seen as an important issue of public policy. This would be a potentially dangerous consequence given the current economic conditions, which are likely to increase the temptation for companies to pay their debts late. Rather than abolish the disclosure requirement, therefore, it would be better to revisit the current requirement and refocus it so as to require the disclosure of more meaningful information.

Q11: Should companies be explicitly required to include information about human rights in the Strategic Report?

If such a requirement were to be introduced, it would be necessary to define exactly what was meant by the term human rights: the term tends to be given a very wide interpretation by the courts. Our preference would be for companies to be prepared to address such issues in the context of the overriding rationale for the Strategic Report without the need for an express statutory disclosure requirement. If the function of the Strategic Report is to communicate to users the information necessary for a proper understanding of the company's strategy, business model and material risks, then we would expect a company to report on any material human rights issues, including its use of child labour, that were material to such an understanding. An expectation of this kind could be set out in non-statutory guidance.

Q12: Do you support the government's proposals for quoted companies to disclose the proportion of women on boards and in companies as a whole?

While we support fully the principle of equal opportunities and believe that gender balance can have a positive impact on corporate behaviour in many ways, we do not believe the case has been made out for this proposal. We are aware that the Code on Corporate Governance is already in the process of being revised so as to reinforce the importance of diversity in the creation of an effective and balanced board, and specifically for boards to report, in their annual report, on their policy on diversity, including gender diversity, setting out their objectives on that matter and the progress they have made on achieving those objectives. Given that the proposed statutory disclosure would be aimed only at listed companies, which are already to be covered by the new governance disclosure, there would be a danger of unhelpful duplication. In our view, the planned new disclosures in the Code address the issue adequately, and do so in a way which implicitly accepts that the primary significance of gender balance as far as companies are concerned lies in its potential for enhancing board and corporate effectiveness: the proposed statutory disclosure would, in contrast, be compliance-orientated. As such, we would argue that a disclosure of this kind would not belong in the Strategic Report anyway.  

Q15: Do you agree that the key information on remuneration should be included in the new Strategic Report? If so, would a standard format for this information be helpful?

We agree that, in respect of listed companies at least, the inclusion in the new report of selected information about board and executive remuneration would be justified in the light of the proposed overall theme for the report of linking the company's performance to its plans and risks. Investors appreciate the relationship between pay and competitive position: they understand that companies need to have in place remuneration packages which enable them to appoint and retain the quality of individual most likely to help them achieve their objectives and which incentivise those persons appropriately to contribute to high corporate performance. Selected information which enables investors to assess whether the company's policies and practices on remuneration are appropriate (i.e sufficient to attract and retain but not over-generous in the light of the company's financial position and performance) would therefore be entirely suitable for inclusion in the report. The disclosures suggested in the second, third and sixth bullet points in para 5.7 appear to us to be very relevant in this light. It is less evident to us that information relating to the packages and contracts of individual directors would be relevant to investors' assessment of the company's overall policies and practices. As for the suggestion that a standard format be used for the disclosure of this information, we would argue that prescription in presentation should be avoided as far as possible in the interests of allowing companies optimum freedom to frame their reports in the way they see best. If the concern is to ensure that disclosures on this matter are clear and concise, we would argue that those qualities should characterize all disclosures in the new report: it would be helpful if any new guidance of the kind discussed under question 33 could stress the importance of both qualities for the preparation of an effective report.

Q29: Do you agree that the current legislative regime for audit and assurance for narrative reporting is adequate for your needs?

While the proposed new shape of the statutory narrative report differs from the existing model, we believe that the basic remit for the auditor to report on consistency between the Strategic Report and Annual Directors Statement and the financial statements will remain workable and will add value to users' understanding.  

We would suggest however that in one respect the proposed new content would benefit from a higher level of assurance. The new Strategic Report would require listed companies at least to discuss their business model, and how this relates to their strategic plans and financial performance. As already stated, we agree that this will provide useful information to users of those companies' reports. That information would become more useful if additional assurance were to be provided on it. It would not be reasonable or practical for auditors to give assurance on the feasibility or correctness of the business model itself, since decisions on those matters are the preserve of management alone and should remain so. But we see merit in the auditor giving an opinion on the financial assumptions which lie behind the company's chosen business model.

Q30: Are there any actions that the Government could take to make the process of obtaining additional assurance on specific information in company narrative reports easier or less costly?

It is a matter for individual companies to decide whether and to what extent additional assurance is commissioned. We see no role for the Government in influencing the cost of assurance.  To make obtaining additional assurance easier, however, the Government could introduce measures to enhance the number of potential suppliers of assurance. This could be in two ways.  Firstly, it should be made clear that independent assurance need not mean that the auditor of the financial statements necessarily has to undertake such work.  Second, a safe harbour provision should allow assurers to limit their liability for such work as inevitably, their exposure could be equivalent to that of the financial statements auditor. The Government could also encourage the FRC to issue guidance for directors on such assurance and for assurers on appropriate application of ISAE 3000 once that international standard is implemented in the UK.

Q31: Do you agree that the audit committee report should contain, in addition to existing requirements, [the listed matters]?


Q33: What guidance should be provided for preparers of the Strategic Report and the Annual Directors Statement?

We welcome the decision not to issue statutory guidance on the content of the new narrative reports. Research carried out by ACCA and Deloitte in 2010 (1) sought the views of CFOs globally on what for them were the virtues and challenges of narrative reporting. The survey found strong evidence of high level commitment to producing high quality narrative reports, and strong evidence of a move among preparers, in the wake of the 2007-8 financial crisis, to develop the focus of their reports so as to provide more information on risk management. It also found, however, that for a clear majority of CFOs (65%), the potential of narrative reporting for adding value was not being realised because of excessive prescription and not enough freedom to present their reports in a way which flowed from their own particular circumstances and strategic frameworks. In our view, therefore, the correct way forward is to produce an amended version of the ASB's current RS1, revised as appropriate to reflect the agreed structure of the proposed new statements. This new guidance should of course reflect the new statutory disclosure requirements, including the overriding rationale for each of the new statements, and also seek to serve the interests of comparability by setting out a standard reporting skeleton. It could additionally offer a voluntary framework setting out basic information that investors are considered to look for in narrative reports, perhaps drawing on BIS's recent consultations with investor groups. Such a framework could, for example, underline the following desirable features of a strategic report:

1- the report should discuss the company's current and future strategy in a way which explains effectively how the company plans to achieve its financial and other objectives in the short and longer terms.

2 - all content should be discussed in the context of the communication of headline strategy, and performance against strategy; individual content should be characterised by clarity of expression, coherence, conciseness, transparency and materiality.

3 - the company should be forthcoming about the (material) risks that the company faces and how they are being managed

4 - the report should cover the company's key human resources, at board level and below, and discuss how they are remunerated and incentivised.

5 - it should discuss corporate governance and sustainability issues in a way which links them with the company's strategic goals and performance against those goals.

6 - there should be a discussion of how the board has worked effectively together.

7 - Tone from the top: the report should reflect a commitment to communicating the company's message from the highest level.

Within this sort of broad framework, we consider that guidance should encourage companies to deliver a story about their strategic plans and performance activities in a way which they think would best communicate a fair representation to investors. Accordingly, detailed prescription should be avoided in favour of broadly-based guidance.

Q34: Do you agree that the guidance should remain voluntary?

Yes, in the interests of flexibility and encouragement to innovate. If, as suggested above, the revised guidance is framed on the basis that it represents a broad benchmark of what it is considered investors wish to see, then a voluntary guidance statement would be likely to amount to a market standard and thereby encourage 'compliance'.

Q35: Do you agree that understanding of the profile and working practices of the FRRP should be enhanced, but that the remit of the FRRP should remain unchanged?

Yes: as the consultation document says, the FRRP has thus far proved perfectly capable of influencing companies' reporting behaviour without having to take companies to court, and a more rigid enforcement approach could have the undesirable effect of inhibiting practice.