Narrative reporting during coronavirus

The requirement for a company’s front end to tell the full story of the business has never been more important. Due to coronavirus users of the financial statements will require forward-looking information which provides an insight into the board’s assessment of business liquidity, viability and solvency as well as the methods, assumptions and judgements underlying that assessment.

What does the Companies Act say?

The Strategic Report

All companies not entitled to the small companies exemption are required to include in their Strategic Report:

• a fair review of the company’s business; and
• a description of the principal risks and uncertainties facing the company.

The Financial Reporting Council Guidance on the Strategic Report explains:

“Principal risks should be disclosed and described irrespective of whether they result from strategic decisions, operations, organisation or behaviour, or from external factors over which the board may have little or no direct control.” (Para 7A.29)

“Principal risks should include, but are not necessarily limited to, those risks that could result in events or circumstances that might threaten the entity’s business model, future performance, solvency or liquidity, or result in significant value erosion. In determining which risks are the principal risks, entities should consider the potential impact and probability of the related events or circumstances arising and the timescale over which they may occur.” (Para 7A.30)

The Companies Act

The Companies Act 2006 and the Companies (Miscellaneous Reporting) Regulations 2018 require the following for financial years starting on or after 1 January 2019:

Employee engagement

For companies with more than 250 UK average monthly employees, the employee statement in the Directors’ report should describe:

• actions taken to consult with employees; and
• how the company has engaged with its UK employees; taken account of their interests and what effect this has had on company’s principal decisions.

Section 172 Companies Act

All large and many small companies are required to include a separately identifiable statement in the Strategic Report on how the directors have promoted the success of the company for the benefit of the stakeholders in accordance with Section 172. This applies to:

• all large companies (ie companies meeting two of: turnover above £36m; balance sheet assets above £18m; more than 250 employees);
• any small company which is ineligible to apply the small companies regime;
• any company which is not eligible to be medium sized (eg investment businesses); and
• any listed or public limited company.

The Financial Reporting Council updated its Guidance on the Strategic Report for years commencing on or after 1 January 2019 to reflect the requirements on compliance with Section 172.

Business relationships

Large companies are required to include a statement in their Directors’ report on how the directors have had regard to the need to foster the company’s business relationships with suppliers, customers and others and the effect of that regard including on the principal decisions taken by the company.

Practical impact and interpretation for preparers

Companies will need to consider the impact of coronavirus when preparing their strategic reports.

• Companies should refer to the impact in their disclosures of principal risks and uncertainties and report any mitigating actions which may be taken alongside a description of the risk.
• Management should be clear about the assumptions they have used when considering the safeguards against any risks identified as a result of coronavirus.
• The position of the company at the year-end should be discussed with reference to any impairment assessments that have been performed.
• The impact of coronavirus, and the measures taken by directors to ensure the long-term success of the company should be reported.

If a company has had to make a significant decision due to coronavirus eg to delay investment or to sell any key assets in order to protect cashflows, the directors should consider and explain how this might impact the success of the company in the long term.

Post year-end impact should also be explained in the strategic report, highlighting any positive or negative impacts of the pandemic. Preparers should however consider the timing and treatment of any impacts and refrain from the urge to front load all bad news into the financial year in question.

Business conduct is, and will continue to be, an area of public interest as companies navigate a way out of the lockdown process and try to resume a sense of normality. Directors should explain how their actions have contributed to their continued reputation of high standards of business conduct.

Companies’ dealings with employees has been a hot topic in the media, with many having opinions on the morality of large companies furloughing their staff. Directors should explain how they have had regard to the interests of the employees during the period of the pandemic.

Directors should disclose how they have maintained good relationships with suppliers and customers during the lockdown period, and during the easing process.

Businesses should disclose any activities undertaken which have impacted on communities and the environment eg Marks and Spencer developing t-shirts with profits to be distributed to the NHS, British Gas using company vans to distribute food to vulnerable people and EE offering free mobile data to NHS workers.

Companies may wish to discuss dividend and remuneration policy during the pandemic to explain how any financial impact has been dealt fairly amongst the shareholders, and high earning management. 

Our advice

• Ensure you are aware of which Companies Act requirements apply to the business.
• Review the Strategic Report requirements and the Financial Reporting Council’s Guidance on the Strategic Report in light of the impact of coronavirus.
• Consider including coronavirus information in narrative reports, even if it is not a Companies Act requirement, to assist users of the financial statements, including investors.
• Prioritise preparing the strategic report in the year end process to ensure all requirements are covered in sufficient detail.
• Narrative disclosures should be specific to the entity and not boiler plate.

For more information please contact Paul Merris and Lee Marshall.