On 10 May 2005 the Accounting Standards Board (ASB) published its final reporting standard on the Operating and Financial Review (RS1). Generally, few changes have been made to the Exposure Draft published on 30 November last year. But some (mainly clarificatory) amendments have been made in response to comments the ASB received about the Exposure Draft.
The OFR Regulations (Regulations) were published in their final form on 20 April. They require all UK quoted companies to produce an Operating and Financial Review (OFR) and all UK large and medium-sized unquoted companies to produce an expanded directors' report for financial years starting on or after 1 April 2005. Companies with a financial year end of 31 March will therefore have to produce an OFR or expanded directors' report for the first time in Summer 2006, and those with a 31 December year end in Spring 2007. Other than minor drafting changes, the final regulations were in the same form as the draft regulations published on 20 January.
RS1 specifies a number of key principles for directors to apply when preparing an OFR, and provides a number of key elements of a disclosure framework to apply in order to meet the requirements of the Regulations. The principles make it clear that the OFR is to reflect the directors' view of the business, and to focus on matters relevant to members. The principles also require the OFR to have a forward looking orientation, to complement and supplement the financial statements, to be comprehensive and understandable, balanced and neutral, and comparable over time.
Main differences between the Reporting Standard (RS) and the Exposure Draft
- Application of the RS. As well as applying to UK quoted companies which are required to produce an OFR, the RS also applies to any entity that purports to produce an OFR, by use of the words 'Operating and Financial Review'. Such entities are expected to comply with the RS or to explain the particulars of, and reasons for, any departure.
- Addressed to members of the company. The OFR should be prepared so as to enable the ''members of the company'' to assess the strategies adopted and the potential for those strategies to succeed. The reference in the Exposure Draft to ''investors'' has been dropped in response to concerns that it could significantly increase the potential liability of directors to a level equivalent to that for the issue of a prospectus - with the result that directors would be far more cautious in their disclosures.
But the RS does make clear that directors are expected to take a broad view of the interests of all stakeholders, and that the OFR should not be seen as a replacement for reporting to a wider stakeholder group, for example on Corporate Social Responsibility (CSR).
- Health warnings for forward-looking information. Although the Government declined to include in the Regulations any safe harbours for forward-looking information, the RS follows the Regulations in suggesting that companies could include a 'health warning' advising members of the need to treat with caution good faith judgements, in particular those relating to future events or prospects.
- Grounds for withholding information. Under the Regulations directors need not disclose information about impending developments or matters in the course of negotiation if the disclosure would ''in the opinion of the directors, be seriously prejudicial to the interests of the company''. This is reflected in the RS. However, the ASB emphasises that the carve-out should not be used as a means to avoid full and frank disclosure: it refers to a similar carve-out under paragraphs 5.18(c) and 12.58 of the Listing Rules, which currently allow the UKLA to authorise an issuer to omit certain information from listing particulars or a half-yearly report if (i) the issuer considers that its disclosure would be "seriously detrimental" and (ii) its omission would not be likely to mislead investors about any facts and circumstances crucial to assessing the securities in question. The ASB notes that requests for such omissions are rare, and states that in its view "a similar high level test should be applied to the non-disclosure of information in the OFR".
- Sources of information. Directors are now required to explain not only the source of the information disclosed in the OFR but also the degree to which the information is objectively supportable. This is designed to allow members to assess its reliability for themselves.
- Risk management. In terms of the information that should be included about the company's ''principal risks and uncertainties'', the ASB has agreed to work with the Turnbull Review Group to see whether the RS should be amended to cross-refer to disclosures required by the Turnbull Guidance on Internal Control.
- Key performance indicators. Because there are differing views on what is meant by the term ''key performance indicators'' (KPIs), and whether or not entities should be required to report on specific indicators, the RS does not specify any particular KPIs that entities should disclose, or the number of KPIs that are appropriate. These are matters for the directors, based on their judgement about what is required for an understanding of the business.
- Implementation guidance. The Exposure Draft was accompanied by 'implementation guidance', containing suggestions and illustrations of the type of information and KPIs that could be included for each element of the OFR, depending on the type of company and its strategic objectives. For example, a pay TV company aiming to achieve revenue growth could measure the number of its subscribers, disclosing in the OFR how subscribers are defined, why this measure is a key driver for the business, and the percentage change year-on-year. In the RS, the implementation guidance has been retained and expanded by the addition of further illustrative examples.
The ASB states that it will keep RS1 under review to reflect further developments, such as the work of the Review of the Turnbull Guidance on Internal Control.
RS1 and the accompanying ASB press release can be found here.