Reading an annual report
What is in a listed company’s annual report, where auditors and analysts look first, and a checklist to use on any report.
ACCA exams this helps with: FR Financial Reporting AA Audit and Assurance SBR Strategic Business Reporting See the ACCA map
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Every listed company publishes an annual report: a long document that explains how the business did, how it is run, and its full audited accounts. Nobody reads it cover to cover. Professionals know which few sections to read first, and that is what this page teaches.
Example. Before a job interview, reading the auditor’s key audit matters for that firm’s clients, or for the company you are applying to, tells you in five minutes where the tricky accounting judgements are.
Key words
- Annual report
- The document a company publishes once a year. It contains a written review of the business, reports on how it is run, and the audited financial statements.Example: A listed company’s annual report is often more than 200 pages. The audited accounts are near the back.
- Auditor’s report
- The auditor’s written opinion, near the front of the financial statements, on whether the accounts give a true and fair view.Example: “In our opinion, the financial statements give a true and fair view…” is an unmodified (clean) opinion.
- Key audit matter (KAM)
- An area the auditor judged most important in the audit, described in the auditor’s report with what they did about it.Example: “Carrying value of goodwill in the Homeware division” as a key audit matter.
- Alternative performance measure (APM)
- A profit figure (or other figure) that a company defines itself. It is not defined by the accounting rules (IFRS). Companies often call it “adjusted” or “underlying” profit.Example: Statutory profit is £20m. The company adds back £5m of restructuring costs and reports “adjusted profit” of £25m.
- Headroom
- The amount by which an asset’s recoverable amount is higher than its value in the accounts. Small headroom means a small change could cause an impairment.Example: Goodwill of £84m and recoverable amount of £90.2m gives headroom of £6.2m (about 7%).
Learn
A listed company’s annual report is often more than 200 pages long. Few people read it front to back. Auditors, analysts and investors go straight to a few sections, then use the notes to dig into the numbers.
What is in it
| Section | What you’ll find |
|---|---|
| Strategic report | The business model, strategy, key performance indicators (KPIs), the financial review, and the principal risks and uncertainties |
| Governance | The directors’ report, corporate governance report, audit committee report and directors’ remuneration report |
| Financial statements | The independent auditor’s report, the primary statements (group and parent company) and the notes |
| Other information | Shareholder information, glossaries, and definitions of alternative performance measures (APMs) |
Where to look first
| An auditor looks at… | An analyst or investor looks at… |
|---|---|
| The auditor’s report and key audit matters | Headline KPIs and the financial review |
| Accounting policies, judgements and estimates | Adjusted profit and how it reconciles to statutory profit |
| Going concern and events after the year end | Segment results: which parts are growing |
| Provisions, contingent liabilities, related parties | Cash flow, net debt and dividends |
| The audit committee report | The outlook and the principal risks |
The auditor’s report
For a UK listed company it normally contains:
- Opinion: whether the accounts give a true and fair view. Unmodified is the normal result.
- Basis for opinion: confirmation that the audit followed International Standards on Auditing (UK) and that the auditor is independent.
- Conclusions on going concern, and a separate material uncertainty section if there is significant doubt.
- Key audit matters (KAMs): the areas the auditor considered most significant.
- Materiality: the level used and how it was worked out.
- Scope: which parts of the group were audited in full.
- Other information, and the responsibilities of the directors and the auditor.
Key audit matters
Each KAM explains three things: what the risk is, how the auditor responded and, often, what they found. Common KAMs include revenue recognition, goodwill impairment, inventory valuation, provisions and going concern. KAMs are not problems in themselves. They show you where the judgement in the accounts is.
The accounting policies note
Usually note 1 or 2. Look for two headings required by IAS 1: critical accounting judgements (choices management made) and key sources of estimation uncertainty (numbers that could change materially next year). These often match the KAMs.
Adjusted profit and APMs
Many companies show an “adjusted” or “underlying” profit that leaves out items such as restructuring costs, impairments or amortisation of acquired intangibles. These are alternative performance measures. They must be reconciled to the statutory IFRS figure. Check the size of the gap and whether “one-off” items come back every year.
Warning signs
- A modified audit opinion or a material uncertainty about going concern.
- A change of auditor, or a qualified opinion last year.
- Adjusted profit far above statutory profit, year after year.
- Profit rising while operating cash flow falls.
- Receivables or inventory growing much faster than revenue.
- Small goodwill headroom that disappears with a small change in assumptions.
- Debt due soon, or covenants close to being breached.
- Changes in accounting policies or estimates that increase profit.
Where to find reports
On the company’s investor relations website, on the FCA’s National Storage Mechanism for UK listed companies, and on Companies House for any UK company.
Checklist for any listed company’s report
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Watch it explained
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Videos from YouTube tutors
These videos are made by independent tutors on YouTube, not by Trial Balance. Some use US terms or older exam names (for example F7 for FR), but the principles are the same.
Worked example
Here is a key audit matter from the report on Marlow Retail Group plc, a fictional company, with notes on how to read it.
The risk. The Homeware division has had falling sales for two years. Its goodwill is tested for impairment using forecast cash flows discounted at 11.5%. The test is sensitive to the forecast sales growth and the discount rate. The directors have concluded that no impairment is needed, with headroom of £6.2m.
Our response. We compared the forecasts with board-approved budgets and past accuracy. We used our valuation specialists to assess the discount rate. We ran sensitivity analysis on the key assumptions and reviewed the disclosures in note 14.
Our observations. The assumptions are within an acceptable range. A fall of 1.5 percentage points in forecast growth, or a rise of 0.9 points in the discount rate, would remove the headroom. This is disclosed in note 14.
| What it says | What it tells you |
|---|---|
| Falling sales for two years | The division is under pressure, so the forecasts may be optimistic. |
| Headroom of £6.2m on £84.0m | Only about 7% headroom. That is small. |
| 1.5 points of growth removes the headroom | A modest miss in the forecast would mean an impairment charge. |
| Assumptions “within an acceptable range” | The auditor accepted the numbers, but the judgement is close. |
| Disclosed in note 14 | Read note 14 next for the full sensitivity figures. |
A reader would conclude that the accounts are fine for now, but an impairment of the Homeware goodwill next year is a real possibility.
Practice questions
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