Insight
The talk in UK boardrooms and within the finance fraternity over the last few months has been all about two pending pieces of legislation which are set to dramatically alter the transparency of company activities, and improve communication to shareholders and stakeholders: the Operating and Financial Review (OFR) and the International Financial Reporting Standards (IFRS).
If 2002 and 2003 were about setting out governance guidelines for the role and structure of boards as well as executive pay arrangements (most notably The Combined Code and Sarbanes Oxley), then 2004 has been about reporting and transparency.
The Operating and Financial Review
In 2002, the DTI commissioned an independent group of experts headed by Rosemary Radcliffe, to produce guidance for company directors on publishing an OFR, as part of the Government’s July 2002 White Paper on Modernising Company Law. The proposition was that all of the UK’s 1290 Listed companies were to produce an OFR, ‘a balanced and comprehensive analysis’ of:
The development and performance of the business of the company and its subsidiary undertakings during the financial year; The position of the company and its subsidiary undertakings at the end of the financial year; The main trends and developments underlying performance and position of the company; The main trends and factors likely to affect future development, performance and position.
To be included in the OFR is a description of potential risks and uncertainties facing the company and its subsidiary undertakings, which may include environmental, social and community matters, as well as analysis of key performance indicators relating to environmental and employee matters.
Two years on, and a formal consultation later, the DTI and Patricia Hewitt now have draft regulations on the OFR. The Accounting Standards Board (ASB) now has the task of issuing best practice guidance, but the issue of this guidance has been fraught with delay and vocal debate from a number of quarters, notably the accounting profession and the CBI.
Originally intended to become statute on 1st January 2005, listed companies will have to prepare a statutory OFR for financial years beginning on or after 1 April 2005. The intention was to introduce the OFR alongside the European Accounts Modernisation Directive, the European Unions attempt to encourage large EU companies to improve communication to shareholders by reporting on business development, performance, risks and uncertainties.
However, due to disputes over the content of the wording and content of the OFR guidance, this has not been possible. The biggest bone of contention surrounding the OFR has been in whether directors should need to sign off an OFR with ‘due and careful inquiry’. Many believed that this placed an unnecessarily high quasi legal burden on directors, the consequence of which would be that few would include information in an OFR which would put them in danger of litigation for future shortcomings. As a result of lobbying, the terminology has been changed in line with the accounting principle of ‘true and fair view’, which is recognised as having a lower legal expectation than due and careful inquiry.
Despite this change, some quarters are still pushing for safe harbours to be put in place to protect the interests of directors. Auditors have already been exempted from needing to provide a statement on whether the OFR was prepared with due and careful inquiry, and now directors want safeguards to ensure that they do not become financially liable for failure to meet OFR criteria.
Whatever the final outcome of last minute attempts by business and lobby groups to influence the final content of the OFR guidance, one thing is certain - companies will be legally required to produce OFR’s from April 2006 (indeed, many are already doing so) which should mean more transparent, consistent and informed communication to shareholders and stakeholders, and therefore greater accountability of the largest corporations, to society.
International Financial Reporting Standards
“IFRS is not only a technical accounting issue. The effects are far reaching and encompass all areas of the business, including training technical staff, managing the conversion process, investor communications and embedding changes culturally within the organisation. Don’t underestimate the impact that this new reporting language will have on your business.” PricewaterhouseCoopers.
IFRS is set to become the single biggest change to have taken place in the accounting profession for over a generation, fundamentally changing the way numbers are reported, affecting all areas of reporting. Its aim is simple: to promote a single and harmonised accounting standard for Europe.
Yet the technical aspects of the IFRS are far more complicated - the guidance documents contain some 3000 pages. It is more than just technical issues however that provides the greatest concern for boards and those responsible for governance within large corporations.
One of the major issues of concern for accountants, boards and governance champions is that the new accounts prepared using IFRS must contain reconciliation back to the previous years published accounts. In the event that ‘material errors’ appear in previous statements, accounts must be completely restated, a far more severe measure than the UK’s current Generally Accepted Accounting Principles (GAAP), which for require restatement only in cases where accounts are found to be fundamentally wrong.
Whilst improving the accuracy of reporting, and transparency of internal controls, many companies fear that this will lead to reduced investor confidence, particularly with a prevailing assumption that small problems are symptomatic of larger fundamental issues in governance. Companies will also be exposed to greater risk since increased disclosure will uncover financial and commercial information that was previously ‘hidden’ to competitors.
Ultimately, whilst the IFRS may be providing companies with a severe headache and slight twitchiness about what the accounts will show up come their year end after 1st January 2005, the greatest benefits will accrue to the shareholder (and stakeholder) who will be able to see a new side to the governance of the organisation, previously hidden.
Assuming investor relations are managed effectively by the corporations, there is no reason why investor confidence need drop so drastically. However, it is also fair to make the assumption that there will be a number of companies who are not readily prepared, and as a consequence, will experience a very public flogging over their ability to handle the implementation of the IFRS.
Through the looking glass
With the OFR and IFRS set to dramatically transform how and on what companies report, we are set for a culture change in corporate shareholder/stakeholder relations. Not quite a looking glass but more a darked out window into the internal workings of the companies we own and have a vested stake in.
The reforms set out in the Combined Code on Corporate Governance, Sarbanes Oxley, and the numerous other codes across the world introduced since the days of Enron and WorldCom should provide a stronger foothold for companies in which to handle this new stakeholder/shareholder dynamic. Notably, increased director’s independence and independently functioning audit committees should serve to improve the scrutiny of internal controls before OFR’s and financial statements are released to the public.
Greater consistency in regulations and guidance will also offer opportunities to compare governance practice across and within industries. The OFR may not have gone as far as legally mandating companies to report on social, ethical and environmental criteria and performance, but the ability to compare like with like will raise the game for those companies who have previously been able to escape the public gaze.
Sources:
- Sunday Times IFRS Special
- DTI publications on the OFR
- Minister’s retreat on company reporting: Financial Times, 17th November 2004, page 1
- Corporate reporting shake-up faces delay: Financial Times, 14th October 2004, page 1
- Warning of accounting chaos: The Guardian, 16th November 2004, page 21
Also in this feature:
© Article 13 2004
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