Meeting the fair, balanced and understandable challenge

1 Meeting the fair , balanced and understandable challenge Make your corporate reporting count September 2013. Is your annual report and accounts fair , balanced and understandable ? Do you know what that would look like? If not, then action is required in order to meet tougher corporate governance requirements. Directors of premium listed companies which are subject to the UK. Corporate Governance Code1 take note: new fair , balanced and Insider challenge understandable ' (FBU) requirements are in force. Listed company Whilst an outsider can form a view on whether the ARA is directors will have to state in their annual report and accounts understandable , only the board, management and auditor can (ARA) that they consider their ARA to be FBU, and that the ARA judge fairness and balance.

2 Boards and management teams provides the information necessary for shareholders to assess the must consider the concepts of fairness and balance when company's performance, business model and strategy'. identifying, writing and approving the ARA. The chairman, CEO, CFO and chairs of other board committees need to take personal responsibility for this content; if they do, their sections and the It is a matter for judgement whole ARA are more likely not only to be FBU, but also to have a much more positive impact on readers. This is a new requirement of the UK Corporate Governance Code, affecting reporting periods beginning on or after 1 October The FBU reporting requirement is not the only new challenge 2012. It poses a few challenges for listed company reporters: facing company reporters, however.

3 Other regulatory changes will regulators have not defined exactly what they mean by FBU and require 2013 ARAs to contain additional or revised content, such no further guidance is Management and the boards of as a new Strategic Report and a two-part Directors' Remuneration listed companies therefore need to apply their own judgment to Report. FBU principles must be applied to this material as well. decide what FBU means to them and their company's reporting. In fact the whole ARA has to be FBU not just the narrative. In forming this view, we would encourage them to refer to existing International Financial Reporting Standards can lead to helpful guidance issued by the Financial Reporting Council (FRC). complexity in financial reporting, but the ARA still needs to and others on what makes for good corporate explain that complexity in a way that is understandable by non-accounting experts.

4 1 Hereafter listed companies'. 2 In August 2013, the Financial Reporting Council issued draft guidance on the strategic report, with reference to FBU, but it remains to be seen whether further detail will be added on FBU in this or the 2014. review of the UK Corporate Governance Code. 3 Cutting clutter, combating clutter in annual reports', FRC, 2011. Louder than words, principles and actions for making corporate reports less complex and more relevant', FRC, 2009. The Financial Reporting Review Panel, Annual Report 2012. FRC, 2012. 1 Meeting the fair , balanced and understandable challenge Make your corporate reporting count FBU insights reporting in an informative way, and linking the business model, strategy and KPIs. Good examples include: Given the challenge facing companies, we reviewed the most A chairman's statement discussing not only company recent ARAs of a few listed companies across a range of sectors, achievements, but also setbacks such as the industrial action assessing key sections for their ease of understanding.

5 We also at two operations that led to the division making a loss. attempted to assess the ARAs for their fairness and balance, whilst recognising that only company boards and management can truly A CEO's review being honest about the control issues faced by judge this. We identified FBU indicators, drawing both on FRC the company and giving a flavour of what these were, such as publications and our own experience. significant losses on a major project, inconsistent group-wide application of accounting policies and inadequate forecasting Our findings represent our own judgment of what makes for FBU. in light of deteriorating trading conditions. reporting. Though not scientific, they offer insight for companies in terms of what they can do to enhance FBU in their reporting, Openness about negative feedback from employees on the to comply with the new requirements but also to enhance company's approach to performance management, personal communication with shareholders.

6 Development and career management, and actions taken in response. fair and balanced : good examples, An audit committee report discussing specific accounting and auditing issues. but room for improvement Information provided on a significant environmental event, The concepts of fair ' and balanced ', though different, including process, status and financial impact in 2012, with are interlinked: an ARA cannot be fair if it is not balanced . details of the significant uncertainties and how these will We therefore considered these two attributes together. impact the company, and links given to other relevant sections In identifying the features of an ARA that would indicate of the ARA. appropriate fairness and balance, we highlighted openness and Achievement against KPIs reported honestly, including a clear honesty the reporting of weaknesses, difficulties and challenges graphical depiction of which ones were met, on track and as well as successes.

7 Consistency between different ARA sections not met. including between the narrative and the financial statements, is Clear explanation of how and why a safety KPI was changed also suggestive of a fair and balanced approach. So too are clear during the year. explanations of key performance indicators (KPIs), strong linkage of KPIs to strategy and consistent measures of progress over time. Clear linkage from strategy to KPIs and a clear track record in Important ideas or messages also need to be introduced upfront, terms of KPI achievement. and followed through in ensuing ARA sections. Presentation of adjusted and unadjusted figures, with both Did we find indications of fairness and balance in the 15 ARAs we used consistently in the company's analysis. reviewed? Yes.

8 Many listed companies are delivering elements of a fair and balanced ARA, giving appropriate weighting to setbacks, Meeting the fair , balanced and understandable challenge Make your corporate reporting count 2. Room for improvement does exist, however, in relation to fair Good examples include: and balanced reporting. For example, some chairmen's and Company strategy being presented by means of an analogy . CEO's statements fail to address missed targets or significant engaging the reader and bringing the strategy to life, with uncertainties affecting the business, leaving readers to discover case studies used to demonstrate achievements against these later in the ARA. Some listed companies use inconsistent the strategy. KPIs, or different sets for different purposes in different ARA.

9 Sections. Others fail to explain why particular KPIs are used, A personal letter from the chair of the Remuneration or make no use of non-financial KPIs. We also found situations Committee, showing his passion for his role and desire for where companies identify factors which are key to their business readers to understand the remuneration report. or strategy such as sustainability or their people but then A performance section providing a clear and concise fail to follow through in the rest of the ARA how these factors explanation of all KPIs, including how they are measured, contributed to their success. results and targets. A governance section clearly mapping out how governance understandable : the good and decisions are made, project by project. not so good Primary statements accompanied by commentary to help readers understand movements between years.

10 What characteristics of an ARA help it to be understandable by readers? Again drawing on FRC guidance and our experience, we Individual disclosure notes having a headline' explaining in identified a range of indicators. These include simple explanations simple terms what the disclosure shows. of business models, strategies and accounting policies, using Again, substantial opportunities exist for listed companies to make precise and clear language. Reader understanding is also their ARAs more understandable . For example, some business supported where narrative is broken up by quotes, tables, case model descriptions fail to explain clearly what the company does, studies and other graphics. The more understandable ARAs also or use boilerplate wording or jargon. Some listed companies tend to have a consistent tone across all sections and provide clear confuse the presentation of their strategy and business model, or signposting to where additional information can be found.