On 9th June 2014, the UK Financial Reporting Counsel (FRC) published their ‘Guidance on the Strategic Report’ (Guidance). The Guidance replaces the ‘Reporting Statement: Operating and Financial Review’ published by Accounting Standards Board.

The Guidance is persuasive rather than mandatory and its objectives are to:

  • ensure that relevant information that meets the needs of shareholders is presented in the strategic report;
  • encourage companies to experiment and be innovative in the drafting of their annual reports, presenting narrative information in a way that enables them to best tell their story whilst remaining within the regular true framework; and
  • promote greater cohesiveness in the annual report through linkage between information within the strategic report and in the rest of the annual report.

Section 414A of the Companies Act 2006 (the Act) requires all companies that are not small (as defined in the Act) to prepare strategic reports. Section 415 of the Act also requires all companies to prepare a directors’ report which contains information specified by the Act and its associated regulations. Both the strategic report and the directors’ report are integral parts of the annual report.

The Guidance:

  • focusses on the application of the requirements relating to the strategic report and the role of the strategic report in the context of the annual report as a whole;
  • identifies the principal components of an annual report but highlights that the components have linked objectives;
  • states that the purpose of the strategic report is to provide shareholders with information that will enable them to assess how the directors have performed their duties to promote the success of the company;
  • states that the strategic report should focus on those matters that are material to an understanding of the development, performance, position or future prospects of the company when taken as a whole; and
  • states that a strategic report’s three main content-related objectives are (i) to provide insight into the company’s business model and strategy and objectives (ii) to describe the principal risk the company faces and (iii) to analyse the company’s past performance.

Materiality is an entity-specific aspect and requires directors to apply judgement based on their assessment of the relative importance of the matter to the entity’s development, position or future prospects. Materiality will change over time and accordingly should be assessed annually. The needs of all significant shareholder groups should be considered when determining if a matter is material.

Materiality cannot be applied to disclosures that are required by the Act and associated regulations unless explicitly permitted. Unlike the strategic report, most of the requirements for the directors’ report are required irrespective of the directors’ view of materiality.

The strategic report should address the positive and negative aspects of the development, performance, position and future prospects of the entity openly and without bias. Industry-specific terms should be clearly defined and used consistently.

The strategic report should not concentrate solely on a single time frame but should give regard to the short, medium and long term implications of the fact or circumstance being described.

The Guideline emphasise that the relationship and interdependencies between the information that is required to be disclosed in the annual report should be highlighted and explained. This will provide a greater insight into the company’s business. As another requirement of the Guidelines is to keep the report concise, priority should be given to the relationships and interdependencies that are most relevant to the assessment of development, performance, position or future prospects of the business.

Three main categories of content: strategic management, business environment and business performance should be covered by the strategic report.

Disclosures that are included in the strategic report by cross reference to another part of the annual report must also be sent to shareholders along with the main body of the strategic report. It may, however, be useful for a company to include additional summaries of information contained in the full annual report if considered appropriate.

Closing conclusions
The Guidance highlights the need to communicate material messages to shareholders but in a concise form. We hope that the section on what is meant by materiality will assist directors to make the report shorter but more relevant and to encourage the directors to remove boilerplate sections.

By Shveta Nehra