The forthcoming requirement to produce an operating and financial review will significantly extend the reporting responsibilities of large UK companies
So what is an operating and financial review?
An OFR is a narrative report that quoted companies will make annually to shareholders, setting out the principal drivers of their performance both past and future, says the Department of Trade and Industry.
Haven’t they been around for years? There’s one in mortgage bank Abbey’s latest annual report
There is. But the government has now published draft regulations that enjoin the directors of around 1290 listed companies to produce an OFR or face stiff penalties, up to and including unlimited fines. An OFR will no longer be a matter of best practice but a statutory requirement. It will be a section in the annual report, just like the directors’ report and the remuneration report.
Any connection with CSR reports?
An OFR will ‘be complementary to, and not a substitute for’ corporate social responsibility and sustainability reports, the government says, whether these are stand-alone or incorporated in the annual report.
Why is the government doing this?
It accepted the company law review’s recommendation that large companies be compelled to publish OFRs. It is responding to demands for greater transparency and says directors need to ‘explain their stewardship to their shareholders’.
Any other reasons?
The government has to implement before January 2005 a European Union directive requiring companies to improve their disclosure practices and wants to ‘dovetail’ the OFR with this. Article 1.14 of the EC Accounts Modernization Directive specifically requires large listed companies to report on the principal risks and uncertainties facing their business, and where appropriate to include ‘non-financial key performance indicators relevant to the particular business, including information relating to environmental and employee matters’. So the UK government decided to lump these requirements into a new section of the annual report and also proposed refinements of its own.
Will only quoted companies have to produce an OFR?
That depends on the outcome of the consultation, which ends on 6 August. The company law review recommended that large private firms should also make OFRs. The government initially agreed, but has since changed its mind. So at present we don’t know.
As things stand, what information does an OFR have to provide?
An account of the company’s objectives, strategies and key drivers, the principal risks and uncertainties facing the business, and, where appropriate, non-financial key performance indicators relevant to the particular business, including information relating to environmental and employee matters. ‘This list is not intended to be exhaustive,’ the government says. ‘Directors should include all indicators that are relevant to their particular business.’
Who decides what to include?
The directors. The question of whether they need to declare that they have nothing to report on a particular issue is out to consultation. The Accounting Standards Board is developing a standard for the OFR and if companies follow this, they will be presumed to have complied with their statutory duty. A working group has produced a document on how directors should decide what to include in their OFR.*
What about auditing the OFR?
This is still subject to consultation. At issue is the legal standard to which auditors will have to work. They will have to express an opinion on whether the directors have prepared the OFR after ‘due and careful enquiry’ – a more stringent legal standard than the ‘true and fair’ view required of statutory accounts. Knowingly or recklessly approving an OFR that does not comply with the law will be a criminal offence, so this is critical. The government’s preferred formulation ‘due and careful enquiry’ may not survive the consultation process.
And the timetable?
The government proposes that OFRs be produced for financial years starting after 1 January 2005, so in practice that means the 2006 reporting season. The details may not be cut and dried, but the timetable is tight and managements need to start thinking about the issues now. Companies with established CSR reporting and risk management systems should find producing an OFR relatively straightforward, although directors will still have to make difficult judgements.
Will it mean fewer questionnaires?
Probably not, though the information contained in the OFR will be a useful source to which a company can direct inquirers.
*The operating and financial review: practical guidance for directors