The annual report has become a “vehicle of convenience for ever-more information, however, this has undermined their purpose and usability” according to Mark Babington of The Financial Reporting Council (FRC).
2020 was no exception in terms of the increasing amount of information required to be included in the annual report. We have seen the introduction of the s172 statement (the duty to promote the success of the company) for companies already preparing a strategic report, in addition to corporate governance statements for the very largest private companies. Further, large companies and LLPs must now report their carbon emissions as part of the directors’ report.
Whilst the requirements for private companies are significantly less than those for listed companies, the information needs of stakeholders are nevertheless increasing. The annual report as a means of communication is becoming more unwieldy and a minefield of legislative requirements for all sizes of business.
At the start of October, The FRC published a discussion paper outlining its blueprint for a new approach to corporate reporting. This is a long-awaited thought leadership piece that explores potential changes to the system of corporate reporting with a view to making it more effective and engaging. The report identifies the current challenges of corporate reporting:
- Stakeholder expectations of companies have changed; reporting is expected to be more than a compliance exercise.
- Corporate reporting is dispersed, containing fragmented and sometimes incoherent content
- The annual report is serving multiple purposes and audiences.
- The interests of investors have broadened, with the boundaries between shareholders and other stakeholders becoming increasingly blurred.
- Non-financial reporting has evolved, with multiple frameworks now guiding its form and content.
- Technology has transformed how information is communicated, yet the annual report remains a paper-based document.
The FRC’s proposals are for the annual report to be replaced with a network of interconnected reports, each with its own objective, which would be centred on a stakeholder-neutral business report. The business report would be similar to a concise strategic report and would include both financial and non-financial information. There would be a series of additional ‘network reports’ that would sit alongside this and include a combination of mandatory and voluntary reports. The three mandatory elements proposed are:
The business report
This would provide information that enables users to understand how the company creates long-term value in accordance with its stated purpose. It would focus on matters that are of strategic importance to the company, provide the board’s view of the development, performance, position, cash flows and future prospects. It would be forward-looking whilst still providing historical information.
Full financial statements
Financial statements would be prepared in accordance with the applicable financial reporting framework and, subject to audit, would be presented in a standalone mandatory network report.
A public interest report
This would provide information to enable users to understand how the company views its obligations in respect of the public interest, how it has measured its performance against those obligations and provide information on future prospects in this area. It would include information about the impact of the business on the company’s stakeholders and society, including employees, suppliers, customers and the community. It would also include information on environmental, human rights, anti-corruption and anti-bribery matters and incorporate existing mandatory reports on gender pay gap reporting, supplier payment and modern slavery in one place.
In addition to network reports, other content may include information on corporate governance, risk and resilience and audit related information.
Although the new reporting network was developed with public interest entities in mind, the model can be applied by entities beyond this group. It is proposed that the business report be prepared by medium and large companies, consistent with the requirements for the current strategic report. The public interest report would initially be considered only for the very largest companies, as it is believed it would pose a conceptual challenge and burden for smaller companies.
The paper represents a fresh approach by the FRC, starting from scratch rather than adding piecemeal to the existing reporting process. It acknowledges that the annual report is trying to do too many things for too many people.
Whether the project remains an exercise in thought leadership or whether the proposals are actioned is another matter entirely. As is the question of assurance and whether this will increase the scope and remit of the audit. Changes of this scale and nature would take time, support from stakeholders and commitment from government. The audit profession and the regulator itself are facing a complete overhaul, so it is hard to see that this project will be at the top of the agenda for 2021. However, along with hopes for life getting back to normal post-Covid-19, there are positive signs that the change process is underway. Comments are requested by the FRC by 5 February 2021.
