Brexit and beyond - Narrative and financial reporting disclosures

Given the very challenging and uncertain environment that companies are currently experiencing because of the Covid-19 pandemic, the impact and reporting of the UK’s exit from the EU is, not unsurprisingly, taking a back seat for many companies.

In our previous Brexit and Beyond article, we discussed how the impact of the UK’s exit from the EU should be taken into consideration when determining and measuring assets and liabilities within the financial statements. This article builds on those requirements by looking into the narrative and financial reporting disclosures that are required, and expected, to be provided in forthcoming annual reports. 

Priorities for 2020/21

Given the very challenging and uncertain environment that companies are currently experiencing because of the Covid-19 pandemic, the impact and reporting of the UK’s exit from the EU is, not unsurprisingly, taking a back seat for many companies (and, undoubtedly, this is echoing the government’s dealings).

Nevertheless, for companies there is still the increasingly time-pressure necessity to deal with the business and operational changes required (which are continuing to unfold as we get closer to the transition period deadline on 31 December 2020), and hence the reporting of the impact of such changes on the business.

Furthermore, the Financial Reporting Council (“FRC”) has announced its priorities for 2020/21; one of those being the disclosures addressing the uncertainties surrounding the UK’s EU exit. However, with the other two focus areas being the ongoing economic and social impact of Covid-19 and climate-related matters, companies face a hard task ensuring that the annual report remains relevant and useful for users. Namely, ensuring that the disclosures:

  • are specific and tailored to the company’s circumstances, rather than being too broad and general;
  • clearly differentiate between the impact and actions of the three issues, rather than merging aspects together and applying a broad-brush approach; and
  • focus on the aspects that are key, and have the most significant impact on the business, for users.

Requirements for FRS 102 reporters

There are three core areas that FRS 102 reporters will need to consider when disclosing information about the impact of the UK’s exit from the EU. These are regarding:

  1. The principal risks and uncertainties facing the business and likely future developments within the strategic and director reports;
  2. The significant judgments and key sources of estimation uncertainty applied within the financial statements; and
  3. The going concern assessment within the financial statements.

Principal risks and uncertainties facing the business and likely future developments within the strategic and directors’ reports

Principal risks and uncertainties

When preparing the strategic report, companies (unless subject to the small companies’ exemption in accordance with company legislation) are required to provide “a description of the principal risks and uncertainties facing the company”.  The description (which is often disclosed as a list of the risks along with detailed explanations) should include only those that are principal, or key, to the business. This therefore may not include the impact of the UK’s EU exit where it is considered that the impact is negligible or not significant to the business. However, that said, it may still be helpful for companies to explain this fact and the basis for the conclusion, given the importance of the issue as a whole to the economy.

Likely future developments

The directors’ report is also required to provide “an indication of likely future developments in the business” (noting that this disclosure may be presented in the strategic report in accordance with Section 414C (11) of the Companies Act). As such, the impact of the UK’s EU exit may also influence the disclosures provided in this regard, for example where changes are made to the business model that affects segmental and/or geographical reporting, and/or where changes are made to the business environment that affects suppliers and employees.

Significant judgements and key sources of estimation uncertainty

FRS 102 (paragraphs 8.6 and 8.7) requires information about significant judgements and key sources of estimation uncertainty to be disclosed. In relation to judgements taken, disclosure should be provided of those that have been made in the process of applying the company’s accounting policies and that have the most significant effect on the amounts recognised in the financial statements. Conversely, in relation to key sources of estimation uncertainty, the key assumptions and estimates that have been applied in determining the carrying amounts of assets and liabilities and which have a significant risk of causing a material adjustment to those carrying amounts within the next financial year must be disclosed.

Accordingly, disclosures specific to the impact that the business and operational changes have had on the preparation of the financial statements must be provided. For instance, the main areas where these disclosures would be expected to be seen relate to impairment testing of goodwill, other intangible assets and fixed assets, recoverability of debtors, stock provisioning and fair value measurement.

It is important, again, that the disclosures are specific to the company, for example explaining that the estimated future costs within the impairment review have been increased by x% to take account of the anticipated increase in oversea tariffs and customer duties in the event of a ‘no deal’ agreement. Or, for example, explaining that the estimated future selling prices of ABC stock items within the stock provision testing are expected to increase by x% as a result of increased supplier costs and changing certain suppliers.

Whilst there is no stated level of detail that must be provided, the greater the degree of impact and the extent of estimates and assumptions made, the more specific the disclosures will need to be so that they are transparent and beneficial to users. Additionally, with so much uncertainty, this unavoidably compounds the number of judgements likely to be involved.

Going concern assessment

The significance of the going concern assessment and the associated disclosures within the financial statements has never been so great with the need to consider the impact of Covid-19 and the UK’s EU exit on a company’s ability to continue as a going concern.  FRS 102 (paragraph 3.8) requires companies to “make an assessment of the entity’s ability to continue as a going concern”.

For companies who have reported their annual, or interim, results since March 2020, we are seeing significantly more detailed explanations and disclosures regarding the assessments that have been carried out by the directors, including the factors, assumptions, estimates and judgements applied, the actions taken, and details about the sensitivity analyses carried out.

Leading up to the end of the transition period, and assessing the post-transition period impact, is complicating all the factors that need to be considered when carrying out the going concern assessment. For example, the impact on critical customer relationships or the continuity of critical supplier viability may need to be taken into account.  Nevertheless, in making the going concern assessment, all available information about the future, which is at least 12 months from the date that the financial statements are authorised for issue, must be considered and disclosures made to aid transparency for users.

Specifically, during these uncertain times, enhanced and transparent disclosures will provide context and confidence to users, irrespective of whether they are positive or negative about the company’s circumstances.

What should ‘good disclosures’ look like?

Taking all the above requirements and best practice into account, we consider that good disclosures are therefore expected to:

  • Explain company-specific risks and uncertainties;
  • Where applicable, describe the potential variances if there is a no deal agreement;
  • Describe the potential implications on different parts of the business;
  • Set out the actions (current and expected) taken by the company to deal with the impact and, where possible, explain the mitigating effects of those actions; and
  • Explain the effects on the financial statements, including significant judgements, key sources of estimation uncertainty, amounts at risk, ranges of potential outcomes, and of course the going concern assessment.

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