Narrative reporting and introduction of OFR is an important development in corporate responsibility.The introduction of mandatory OFR made several companies race to meet with the requirements of the law.Subsequently, the OFR was made non mandatory again but awareness has been created.
Every investor knows that he should look at the OFR of a company he seeks to invest in. If the OFR is missing it raises doubts about the credibility and the intentions of the company .In future even though the mandatory clause has been withdrawn, companies are likely to produce more comprehensive and informative OFR than ever before.
Narrative reporting concentrates on presenting events and actions in certain order so that complications and problems are understood. Narrative reporting concentrates on the descriptions, events and facts that pertain to events, identifying the personnel who are involved and the manner in which the sequence of events took place. The OFR (Operating and financial review) is a report included in a company’s annual report and accounts that is published to meet the requirement of corporate governance that enumerates the operating activities and financial affairs of the company.
In the UK the Operating and Financial Review was introduced with the purpose of increasing corporate responsibility. The purpose of this requirement was that social and environmental issues would be described in the OTR and this would provide a wider level of information to the shareholder. In addition, it was expected that the OTR would in a way compel companies to carry out external audit of these issues. Specifically it was intended that the OFR would provide better information to the investors on the likely performance of the companies during the financial year.
The contents of the OFR should have an overview of the capital structure of the company and the financial characteristics of the company. In addition, the OFR was required to provide the main risks and uncertainties that faced the company. Further, the OFR was required to have descriptions of the brand strength, market strengths, company reputation and R&D, that is the resources that the company enjoyed in the market. Most importantly, the OFR required the companies to disclose the objectives and strategies of the company (Financial Reporting Council 2007).
The OFR also required the companies to disclose its relationships with suppliers, customer and employees. In other words the company was required to disclose its relationship with the stakeholders of the company. The company was also required to comment on the reputation of the company, especially in relation to the society and the environment. Moreover, the company was required to comment on the impact the reputation would have on the future performance of the company (Yeldar. R. 2007).
In the UK the OFR disclosures have been left to an extent to the directors of the company. Their views on the different points are critical in making the disclosure useful to the company. Moreover, the government has focused on the OFR to fill the lacunae in reporting that traditional financial statements left in the annual reports (Morris. G, McKay. S & Oates. A, 2006). If the board is so inclined, then the OFR can simply be relegated to a public relations activity of the company.
The point is that if companies choose not to include corporate responsibility issues in their OFR then there may be a need for a mandatory inclusion of corporate responsibility indicators in the OFR. Even though OFR is driving the companies to disclose corporate responsibility issues, the final decision to disclose remains with the companies (Gee. P, 2006). The OFRs are required to honestly disclose the performance, development and the position of the company to help the investor make better decisions. In addition, the OFRs are required to provide the salient factors and the important trend that affect the present financial performance and the future status of the company. It is believed that not too many boards of directors will be eager to make an honest disclosure of these trends.
To assess the current state of narrative reporting in the UK let us take a look at the review of narrative reporting published by the ASB on January 15, 2007. The report gives some areas of improvement that is the key performance indicators are missing in narrative reporting, the companies are not careful in their description of the principal risks and uncertainties and do not mention their approaches in mitigating these risks and uncertainties. What is most important is that forward looking information is not disclosed in the narrative reports.
The review lauds the companies for reporting an increasing number of environmental, employee and social issues, the companies are giving good description of current developments and present performance and that the companies are providing more or less good descriptions of their current business, markets, strategic plans and objectives (Ploix. H, & Charkham. J 2005). The auditors are currently required to comment on whether the OFR is consistent with their knowledge of the Annual Report and accounts. However, it is often seen that currently the companies in their OFR often give spin over substance.
The companies over emphasize their favorable performance and avoid mentioning their areas of weaknesses. It is expected that now the companies will be required to product a broader annual report and specify their non financial performance and plans for future. For example, Shell is the biggest emitter of greenhouse gases in the UK and has a share of 23% of all emissions from FTSE 100 companies but this is not mentioned in the OFR of the company. There are no specific plans either to reduce emissions. Similarly, BP and Scottish Power are responsible for 17% of the emissions but this is not clearly mentioned in their annual reports.
The lacuna in the law is that the auditor is required to compare the OFR statements with the financial reports and accounts and check if the statements in the OFR are in agreement with financial reports and accounts.This does not require the auditor to mention the omissions that have been made from the OFR nor does the audit of the narrative statement require the board of directors to make statements that disclose the weaknesses of the company. It is clear that in case of Shell, BP and Scottish Power if their emission levels of greenhouse gases are mentioned and the weaknesses in their future plans of reducing these emissions are clearly delineated in their annual reports, then several ethical investors may decide to stay away from these companies (Cowan. N, 2006, p 137).
The recent history of the OFR is that the OFR was first introduced in 1993 by the ASB. At that time it was not mandatory. The Companies Act 1985(Operating and Financial Review and Directors’ Report etc.) Regulations 2005 required quoted companies to prepare a compulsory OFR and other companies to include in their Directors’ Reports a business review. Small companies were exempt from the requirements of this regulation.
The Accounting Standards Board issued an accompanying Reporting Standard that those companies that complied with the Reporting Standard 1 would be presumed to have met the OFR Regulations. In November, 2005 the Chancellor announced that the government wanted to do away with the need for quoted companies to prepare an OFR. In January 2006 the Repeal Regulation of 2005 came into force that did away with the need for quoted companies to make an OFR.
The Reporting Standard 1 was converted into a Reporting Statement. This remains just as a guiding statement for companies that decided to produce an OFR (Vilers. C, 2006). In the next month that is February 2006 the government requested suggestions and comments on improving the narrative reporting requirements. In May 2006 the government publicized amendments to the Business Review legislation. Finally, in November 2006, The Companies Act was given the final assent. and the Business Review requirements are now given legal sanction.
Gordon Brown’s decision to abandon the mandatory nature of the OFR has been supported by two arguments. First, the government claims it wants to reduce bureaucracy. Second, government feels that the new requirements for business review meet the EU requirements for narrative reporting. This is the official line of the government.. However, there are other reasons that are being given as the reason for the abolition of the compulsory clause. It is claimed that the abolition of the mandatory requirement is offered as an incentive to business to remain in the UK and to attract new businesses to the UK. It is a part of the race to make UK attractive to business investors.
Several environmental organizations like Friends of Earth and NGOs have decided to file a law suit against the government to force it to see reason. They see the withdrawal of the mandatory clause as signal to the business sector to continue with their environmentally baneful expansion plans. These organizations had been earlier clamoring for mandatory social and environmental reporting for businesses. From this perspective it seems that Gordon Brown’s decision is not a good one.
There are other reasons given to support Gordon Brown’s decision. The claim is that more than 80% of the listed companies will voluntarily comply with the requirements of Reporting Statement and generate OFR statements. Those that do not will face investor reaction and comply with the Reporting Statement requirements. Those that persist in not producing an OFR voluntarily will be perceived as not transparent by the investing public. In addition, the proponents of the abolition of mandatory OFR aver that the size and the complexity of the annual reports daunting to most investors. In 2005 the average length of the annual reports was 71 pages. Adding to this only confuses the shareholders.
Finally, the materiality get out clause has made the compulsory OFR ineffective. This has also allowed companies to get out of the need to report their weaknesses. However, we should not write off the OFR as dead. Every business knows that it should have an OFR to inform its shareholder. The need for qualitative, non-financial information has been created in the investors. If a company does not produce an OFR the investor may suspect it several faults. The end result will be that the shareholders will find it prudent to stay away from companies that do not produce a comprehensive OFR. There will be reputed persons who will stay away from the boards of companies that do not produce an OFR that meets the standard prescribed by the ASB.
The OFR lives in the business review. The government is not compelling the companies to produce an OFR but the shareholders, investors and other stakeholders will compel the companies to produce and OFR. Environmental organizations and NGOs will take up the matter with companies that do not report on social and environmental issues. Companies that refuse to make OFRs may be shunned by ethical investors, high profile employees and environmentally conscious business partners. The awareness has been created, guidelines have been drafted and the importance of corporate responsibility has been emblazoned. The OFR has taken on a life of its own and even without compulsion it will feature in the annual reports of most UK companies.
As the consciousness of investors increases, as the top employees become choosier and as corporations become more environmentally sensitive, OFR will continue to thrive. There is no need to revive the mandatory clause. Enough consciousness has been created to make the corporate sector aware and alive to its reporting responsibilities, the Business Review is adequate for this purpose. Those companies that do not behave in a responsible manner will suffer because they will not be able to sustain the interests of stakeholders that matter.
To sum, there are a number of reasons given in support of the abolition of the mandatory clause and a number of reasons are being given for the reintroduction of mandatory requirements for OFR However, the importance of the OFA has been driven home to the companies, the investors and other stakeholders. Financial reporting alone does not give enough information to make a decision and he knows that an OFA is important. The OFA continues to live in the UK corporate world even after the mandatory clause has been abolished.
Cowan. N, 2006 Risk Analysis and Evaluation, Lessons Professional Publishing..
Financial Reporting Council 2007 ‘ASB Publishes Review of Narrative Reporting’. Retrieved on January 30, 2007 from http://www.frc.org.uk-
Gee. P, 2006 UK GAAP for Business and Practice, Elsevier
Morris. G, McKay. S & Oates. A, 2006 Finance Director’s Handbook, Elsevier.
Ploix. H, & Charkham. J 2005 Keeping Better Company: Corporate Governance Ten Years on, Oxford University Press.
Vilers. C, 2006, Corporate Reporting and Company Law, Cambridge University Press. 205 -209
Yeldar. R. 2007 Accounting Standards Board Publishes Review of Narrative Reporting, Retrieved on January 30, 2007 from: http://ry.com/news/news/?id=3345