Directors' know how: what you should know about the upcoming changes
24 November 2016

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Directors' know how is a monthly article, which highlights key rule changes, proposed changes and market updates so that you know what is coming down the track.

FRC Financial Reporting Lab confirms the importance of business model reporting

The FRC Financial Reporting Lab has published its report on Business Model Reporting. The report, which forms part of the FRC’s Clear & Concise reporting initiative, assesses the importance of business model information to investors and the type of information they are seeking.

The Lab found that, according to most investors:

  • Business model information is fundamental to investors’ analysis and understanding of a company, including its performance, position and prospects;
  • A lack of good disclosure on a company’s business model raises concerns over the quality of management;
  • The linkage and consistency between the business model and other sections of the annual report needs to be improved;
  • Companies need to provide more detail to investors. Disclosures are often lacking information that indicate the key revenue and profit drivers of the business, the key asset and liability items that support the business model and the company’s competitive advantage;
  • Business model information should be positioned near the front of the Strategic Report, as it provides context to the other information in the annual report;
  • Where a company operates multiple business models, investors want to see each significant business model disclosed, together with the rationale for having the different businesses within one company;
  • Business model descriptions should be written in plain, clear, concise and factual language. Promotional and aspirational language and statements should be avoided; and
  • Business model information is best communicated through a combination of narrative, infographics, tables and charts.

ESMA sets enforcement priorities for listed companies’ 2016 financial statements

ESMA has published its annual Public Statement on European Common Enforcement Priorities. Aimed at listed companies and their auditors, it identifies the areas ESMA and national enforcers will focus on when they examine listed companies’ 2016 financial statements, in order to promote a consistent application of IFRS Standards across the EU.

The common priorities for 2016 financial statements include:

  • Presentation of financial performance – Companies should provide clear and high quality information on their financial performance in a transparent and consistent way, both within the primary financial statements and in the documents accompanying financial statements.
  • Financial instruments: distinction between equity instruments and financial liabilities – Companies are reminded that the general principle for distinguishing liabilities from equity issued by an entity is whether an entity has an unconditional right to avoid delivering cash or another financial asset to settle the contractual obligation.
  • Disclosures of the impact of the new standards on IFRS financial statements – Companies should start preparing for the new IFRS Standards regarding Financial Instruments (IFRS 9), Revenue from Contracts with Customers (IFRS 15) and Leases (IFRS 16), as some aspects may affect the recognition, measurement and presentation of assets, liabilities, income, expenses and cash flows.

The Public Statement also highlights the need for transparency in disclosing any potential impacts of Brexit on a company’s business activities. Companies will be expected to disclose more information when the precise date of Brexit is known.

FRC publishes review of companies’ tax reporting

As part of its Corporate Reporting Review, the FRC has published a review of companies’ tax reporting. Its objective is to encourage more transparent reporting of the relationship between tax changes and accounting profit, and the factors that could affect that relationship in the future.

The FRC found evidence of improvements in the transparency of tax disclosure included in strategic reports. Good practice was characterised by companies providing more information on material tax matters that are important to investors and discussing the role of the effective tax rate.

The review encourages companies to:

  • Consider carefully whether there are significant judgements and estimation uncertainties relating to tax – the FRC will question whether the disclosure of quantified risk specifically relating to the next year is clear, if estimation uncertainties are repeated year-on-year; and
  • Determine the most useful information regarding judgements and estimation for users of the accounts – investors value being able to understand the judgements made and estimations applied by management, including where that judgement sits within a range of possible or acceptable outcomes.

Investment Association updates its Principles of Remuneration

The Investment Association has published amendments to its Principles of Remuneration. These have been issued to reflect the recommendations made by the Executive Remuneration Working Group in its July 2016 report. The revision is aimed at encouraging companies to consider how to respond to their investors’ needs ahead of any planned changes to their remuneration policies in 2017.

The main changes to the principles include:

  • Remuneration structures – A company’s remuneration committee should adopt a structure that is most appropriate for implementing their business strategy. Although it is important that a structure is simple and transparent, companies do not need to be limited to the standard model of one annual bonus and one long-term incentive scheme.
  • Executive shareholding requirements should continue after termination of employment – This would ensure that executives are also affected (positively or negatively) by the consequences of their actions when employed at the company.
  • Shareholder consultation – Companies and shareholders should engage in more useful dialogue that addresses the strategic issues facing the company, rather than the detail of particular proposals. If more than 20% of shareholders oppose the remuneration proposals, remuneration committees should seek to understand the reasons for this, and explain how they will respond to those concerns.
  • Annual bonuses – Companies should disclose how performance is measured for annual bonuses, including stating specific target ranges for financial measures, and a detailed rationale for personal or strategic objectives. Executives are expected to defer part of their bonuses into shares.
  • Restricted share awards – Companies adopting restricted share schemes should reduce the award sizes by at least 50% to allow for the greater likelihood of the awards vesting. Awards should vest over a period of at least three years, followed by annual vesting over a period of time. Companies should also impose substantial shareholding requirements on executives who have received restricted shares.