David Matthews believes that narrative information in an annual report should be subject to independent assurance.
One of the first comments we received on Restoring Trust emphasised the relative importance of the narrative sections of an annual report, in particular those elements that describe a company’s strategy, business model and risks.
“Words speak louder than a morass of immaterial numbers. What has happened is far less important to investors than what will happen, and it is much more important that corporate reporting gives a lucid description of the prospects, aims and ambitions for the future.”
Audited financial statements provide important confirmatory information (though they can be improved - a debate for another day), but there is valuable quantitative and qualitative information in the narrative sections of companies’ annual reports. Information in narrative reports that is important to investment decisions should inspire a similar degree of confidence as the financial statements – and therefore should be subject to independent assurance, regardless of its nature or positioning in the annual report. It is surely an anomaly that some of the information most valued by investors is subject to the least scrutiny.
On 1 October 2013, the Audit and Assurance Faculty of ICAEW published "The journey: assuring all of the annual report?" ICAEW is right to describe the process of developing new forms of assurance over narrative reporting as “a journey”. There seem to be two possible routes:
Some think that the UK needs a regulatory requirement if the scope of assurance is to be expanded. But regulation can be a blunt tool if not wielded carefully.
My hope is that market demand will beat the regulators and target the information that matters more effectively, whether that is KPIs on which management and users focus or disclosures of risks and governance that tell the story of future prospects. This view seems to be shared by ICAEW in its conclusion:
“A compliance requirement that does not fit the situation is likely to lead to increasing volumes of boilerplate disclosures from the business, and an assurance report that creates significant costs without adding practical value. Instead we should be working towards a situation in which assurance creates a climate of trust and openness that permits everyone to do business with confidence.”
Targeted to areas that matter, the process of assurance can itself enhance the quality of the narrative information and its explanation. Whereas large companies now have a continuous year-round process generating the numerical information that goes into the financial statements, many still compile the narrative reporting elements annually on an ad hoc basis. Assurance forces greater rigour.
Ultimately, an assurance process means that users receive the narrative information in the knowledge that it has been subjected to independent scrutiny; similar to the audited financial statements.
If companies are prepared to make the investment to improve the transparency and quality of narrative reporting and the robustness of the processes that generate it, it is reasonable to expect auditors to make that journey with them, providing assurance over the output to investors. I believe that this is achievable. Some areas such as KPIs may be easier than others, for example risk disclosures. But companies, audit committees and auditors need to start the journey towards improved, trusted, narrative corporate reporting. Some companies are already seeking assurance over certain elements of their narrative reporting. A signal from investors and stakeholders would increase the momentum.
I believe that the information in the narrative sections that is of greatest value to the users of corporate reporting should be subject to independent assurance, regardless of its nature or positioning in the annual report. What do you think?
David Matthews is a Partner at KPMG in the UK
This article represents the views of the author only, and does not necessarily represent the views or professional advice of KPMG in the UK.