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All large companies are now required to include in their strategic report a statement explaining how the directors have complied with their duties under section 172 of the Companies Act 2006 (a s172(1) statement). Listed companies tend to have systems in place for preparing complicated narrative reports. However, private companies without the same resource or experience have found the new statement much more challenging. The purpose of this article is to suggest a structured approach to make the process easier and the statement itself more effective in communicating the board’s key decisions.
First, let’s deal with the statutory obligation – contained in s414CZA of the Companies Act. Essentially, the statement must explain how the directors have had regard to six factors when performing their duty under section 172, being:
- the likely consequences of decisions in the long term;
- the interests of employees;
- business relations with customers, suppliers etc;
- the impact of the business on the community and environment;
- the reputation for a high standard of business conduct;
- acting fairly between members.
A good s172(1) statement does not quote the legal requirements or deal only in generalities. Instead, it reflects the company: its strategy, decision-making and communication. It is relevant, focussed and consistent with the rest of the annual report.
How can private companies create a statement that ticks those boxes? One way to approach it is to work through the steps below.
Step one – identify who your stakeholders are.
Obvious stakeholders are the company’s members or investors, but it also encompasses lenders, customers, suppliers, and employees among others. For a property rental business for example, tenants may be included. With the increased focus on sustainability, those affected by, or benefitting from, the company’s environmental activities may also be included, particularly if the company presents itself as having “green” or “sustainable” credentials. A company’s impact on “the community” is not simply a form of Corporate Social Responsibility reporting; if the business interfaces with lots of ancillary businesses or is a significant local employer it could have real commercial focus.
Step two – consider how you engage with those stakeholders.
For a wholly owner-managed business members may be involved on a day-to-day basis with practical operational decisions in their capacity as directors, but for other large private companies interaction might be more formal, via a general meeting. Engagement with employees might be through a regular programme of surveys, staff meetings, business update presentations or an employee committee that liaises with the board. Engagement with other stakeholders might be more dependent on how individual relationships are managed eg, many companies will have regular communication with their lenders, including presenting management accounts or submitting confirmations of covenant compliance.
Step three – pinpoint what your key business decisions were during the year.
In the face of COVID-19, key decisions may have related to whether to seek additional finance via a government support scheme or whether to offer temporary rent concessions. For companies impacted by Brexit key decisions may relate to securing supply lines or establishing a place of business in a new jurisdiction. Key decisions might also include not taking an action: for example, suspending planned capital investment or not paying a dividend to protect the business’ cashflow position.
Step 4 – make the link
Link the key decisions to the relevant stakeholders and explain how the company’s engagement with the stakeholder impacted on the decision. For example, furlough might be a key decision. Explain how the furlough process was implemented, such as by holding discussions with employees to identify what functions needed to be maintained and who would be furloughed.
Finally, think about how your s172(2) statement relates to the rest of your narrative reporting; is it consistent with the Review of Business, for example? Companies with more than 250 employees must include a section on employee engagement in their directors’ reports. If a key decision relates to employees, consider cross referencing between the s172(1) statement and the employee engagement disclosure to link the two and minimise repetition.
Presentation and audit
The legislation does not prescribe how to present a s172(1) statement so consider how to make the analysis clear and engaging. While some companies prefer a simple narrative statement, using bullet points and sub-headings, others use an introductory narrative to set the scene, identifying stakeholders and outlining the engagement process, followed by a table to explain the key decisions and how they were mediated.
Auditors are required to report on whether the company has complied with legislation on narrative reporting and whether the information is consistent with their knowledge derived from the audit. Discussing your proposed s172(1) statement with your auditor at an early stage in the audit process will minimise the risk of problems later on.
Some private companies found their first s172(1) statement challenging because of its unfamiliarity and because it took time to identify relevant information. Unlike listed companies, many large private companies don’t have a formal structure to their board minutes to record how decisions were made and how different section 172 elements were addressed. The company’s s172(1) statement can’t simply be rolled forward from year to year: it must reflect the key business decisions specific to each year and these will inevitably change. To make the process less onerous in future, it is worth considering how you can capture key decisions in board minutes and record your engagement processes at the time so that the building blocks for your statement are already in place at the year end.
This article was originally written for By All Accounts, the publication of the Financial Reporting Faculty © ICAEW 2021.