Azaria Murray, Technical Assistant at TMF Group, explains the impact of the new strategic report on narrative reporting in the UK.
From October 2013 the Companies Act 2006 (Strategic Report and Directors’ Report) Regulations 2013 will come into effect. These regulations detail new requirements about narrative reporting in annual reports. For companies with financial year-ends ending on or after 30 September 2013, and from then on, it will become obligatory to include a separate strategic report alongside a streamlined directors’ report (except for small companies). The strategic report will largely replace the business review. The objective is to enhance the quality of narrative reporting by cutting clutter and to foster investment by providing shareholders with a meaningful picture of a company’s position.
Content
The purpose of the strategic report is to aid shareholders’ assessment of how directors have performed their duty to promote the success of the company. As with the annual report on the whole, the strategic report should only contain information that is material to an understanding of the development and performance of the company’s business and position of future prospects - in other words, information of strategic importance.
The report must include a fair review of the company’s business which should be in the form of an analysis of the development and performance of the business during the financial year and the position of the business at the end of that year. Where applicable, this analysis ought to be linked to discussion of the company’s financial and (except for medium-sized companies) non-financial key performance indicators.
For all companies it is also obligatory to include a description of the principal risks and uncertainties facing the company. Hence, the directors’ report no longer needs to feature a discussion of the principal activities of the company.
To adhere to the objective of producing more concise and relevant reporting, the review should be succinct and balanced, including both negative and positive aspects.
Additional requirements for quoted companies
Quoted companies must provide additional information in their strategic reports. The main trends and factors likely to affect the future development, performance and position of the company’s business must be identified. This includes a description of the company’s major markets and its competitive position within those markets. As well as macroeconomic environments which affect the company, discussion should extend to the assessment of internal trends.
Additionally, information about the policies, and their effectiveness, relating to environmental matters and social, community and human rights issues must be included.
For assessment of diversity within a company, the strategic report must contain a breakdown showing, at the end of the financial year, the number of persons of each sex who were i) directors ii) senior managers and iii) employees of the quoted company, thus implementing the recommendations of the “Women on Boards” report. Unlike the business review, however, the company is not required to disclose information about persons with whom it has contractual arrangements.
A further requirement for quoted companies is to describe their strategy and business model to help shareholders understand the structure and markets of the business; this aligns the requirements with the UK Corporate Governance Code. Directors may, however, omit information about impending developments where disclosure would be harmful to the interest of the company.
Abolition of summary financial statements
It is currently common practice for companies to send shareholders a summary financial statement in place of the full annual report if they so agree. However, this option will be removed and instead shareholders can agree to receive the strategic report with supplementary information.
Provisions and preparation
On the whole, all Companies Act provisions that apply to the business review will apply to the strategic report; the strategic report must be approved by the board and signed on behalf of the board by a director or the company secretary then filed with Companies House alongside the accounts. Also, it must be stated in the auditors’ report whether the information in the strategic report is consistent with the accounts. With regards to preparation, it is essential that directors and company secretaries keep adequate records in relation to the strategic report. This is especially apt in the case of parent companies which will have to publish a consolidated report relating to the undertakings of the group.
TMF Group’s recommendations for action
Make sure that information included in the strategic report is both material and relevant for shareholders.
Brief your design agency and find ways of presenting information, eg in tables and charts, which make it more accessible to shareholders.
Ask yourselves whether the information you are including in the strategic report passes the best practice communication test - is it entity specific, are links included to where other supplementary information can be found, is it forward looking, concise, fair, balanced and understandable?
Quoted companies should discuss internally, for instance with HR, the method of data collection they will establish to provide a gender breakdown of directors, senior managers and employees.
Internal methods of assessing the effectiveness of policies, whether quantitative or qualitative, should be established for quoted companies.
FRC Guidance
The FRC has published an Exposure Draft of the Guidance on the Strategic Report which is open to comments until 15 November 2013 and will be finalised in January 2014. This draft can be found here.