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Retail sector focus findings
Appendix 2: Retail sector focus findings
Retail has been a priority sector in the last six review cycles. Priority sectors are considered by the FRC to be higher risk, for corporate reporting and audit, by virtue of economic or other pressures. Industry sector is one risk factor amongst many which the FRC takes into account when selecting reports and accounts for review.
This year, CRR has conducted research into issues where accounting and reporting may be unusually complex, contentious or subject to divergence in practice, and that are of particular relevance to retailers. This work included limited-scope reviews of a selection of annual reports and accounts, and discussions with audit firms and companies in the sector. The reviews focused on areas identified from these discussions as being of particular interest to preparers and users of retail companies' financial reporting. Findings from these reviews are set out below.
We expect preparers of financial reporting in the retail sector to consider whether these points are relevant to the company's reporting and, if so, ensure that material accounting policies, and any significant judgements, are appropriately explained with company-specific information, and as required by the relevant standards. We have provided some examples of good practice disclosures that we identified during our work; companies will need to consider the materiality of these matters based on their own facts and circumstances in determining what information, and in how much detail, to disclose. The points raised in this section should be considered in this context.
Impairment testing of property, plant and equipment, intangibles and goodwill
Impairment of assets has consistently been in our top ten topics on which we write to companies, as highlighted in section 5.1. In particular, we often ask about key inputs and assumptions used to determine recoverable amounts and related sensitivity analysis.
Impairment: identification of CGUs and allocation of online revenues
Individual physical stores are normally identified as cash generating units (CGUs). However, where there are material online sales, consideration is needed as to how these sales are incorporated into the impairment assessment of store CGUs and the effect of this on their recoverable amounts.
Certain retailers are now allocating a proportion of online sales to individual stores, while others judge that they lack sufficient data to do so systematically. The factors that are typically considered in determining the methodology applied and relevant supporting data include those noted on the next page.
Touchpoints between online sales and stores
'Click and collect' is the most common example; stores may also deliver online orders locally.
Customers making an initial in-store purchase and later purchases online.
In-store ordering from the online range.
Customers browsing in-store products or consulting store staff before ordering online.
Where there is a lack of clear evidence of a touchpoint between an online sale and a store, it is harder to justify an allocation of the related revenue.
Sources and reliability of supporting data
A store is directly involved in the transaction.
Transaction histories of online customers who previously shopped in-store.
Data from in-store devices/kiosks used to order online.
Customer surveys indicating the importance and frequency of store visits before purchasing.
It may be difficult for management (and auditors) to get comfortable with the reliability of such data, especially where results have been extrapolated from limited data.
Related assets and expenses
Online operations will typically be reliant upon infrastructure involving the company's own assets (software and hardware) or third-party costs of cloud computing. Online activities will also have their own costs related to, for example, employees, sales and marketing, and distribution.
It would be inappropriate to allocate an element of online revenues without also apportioning related costs (including cost of goods sold) and assets.
Good practice descriptions of accounting policies and impairment assessment may include:
- clear identification/explanation of the CGUs and any allocated assets
- explanation of when and how online revenues are allocated to individual stores as part of impairment assessments
- the basis for allocating online revenues (for example, based upon what touchpoints between the online transactions and individual stores)
- an indication of the amount of online revenues that are allocated
- any considerations about the nature and reliability of underlying data
- explanation of how relevant costs, such as website or other IT costs, have been included in the impairment assessment, and the method of allocation
- any significant judgements involved
Alternative performance measures (APMs)
From routine reviews, we have observed greater use of 'like-for-like' and 'pre-IFRS 16' APMs in retail businesses than in others. This reflects the importance of leased premises and of changes in the property estate from year to year. In addition, a 52/53-week financial year is common in the retail sector. We identified some inconsistency around the extent and nature of adjustments to profit in presenting 'underlying' or 'core' performance.
Like-for-like (LFL) measures
These include adjustments for one or more year-on-year variables, with no standard method of calculation. The differences in approach makes it difficult for users to compare apparently equivalent measures without additional information about the method of calculation and key drivers for change.
We found instances of apparently inconsistent definitions of a LFL measure in different parts of individual annual reports and accounts. While companies provided definitions, it was unusual to find a calculation of the measure or reconciliation of LFL sales to reported IFRS 15 revenue.
The following are examples of disclosures that may help clarify how the relevant LFL measures have been calculated and reconcile to amounts within the financial statements:
- LFL across estate: number of branch premises opened / closed in the current and prior years
- LFL across brands or fascias: acquisitions and disposals excluded from the calculation in each year
- LFL across variable reporting periods: basis of the calculation, for example pro rata or by excluding a discrete part of the longer period
- LFL constant currency rates: which exchange rates have most significant effect; how the adjusted performance is calculated
Adjusted profit measures
Some stakeholders have expressed concern that APMs of adjusted profit are not comparable and may exclude costs that most consider to be normal business expenses.
For example, some companies treat costs of opening and closing branches as 'restructuring' and property impairments as exceptional, but others see them as inherent expenses of managing their store estate.
Good practices we identified in applying the European Securities and Markets Authority's Guidelines on Alternative Performance Measures included an explanation of the rationale for specific adjustments, reconciliation to IFRS figures and the flagging of potential differences from peers' APMs. Further guidance is available in our 2021 and 2017 thematic reviews on APMs.
Pre-IFRS 16 measures
Profit measures excluding right of use asset depreciation and finance charges may continue as established internal metrics, or be required for loan covenants or other purposes.
Where the measure is expected by a specific stakeholder group but not used for internal purposes, it is helpful to explain this.
Leased property
Many retail businesses have a large portfolio of leased properties from which they operate. Rental expenses are a significant cash outflow and were, for operating leases before IFRS 16, a major profit and loss charge. Features such as indefinite tenancies, variable rents based on turnover, periodic rent reviews and incentive arrangements, as well as the sheer volume of contracts to assess, made adoption of IFRS 16 challenging.
Lease term
IFRS 16 requires companies to determine the lease term, taking account of the minimum enforceable period and options to terminate or extend it. Judgement is often involved in assessing the likelihood of renewing leases or remaining in premises with indefinite lease terms. This affects not only lease accounting – whether the short-term lease exemption is applicable, or how to quantify the lease liability – but also fixed asset accounting.
We found different approaches to accounting for leases beyond the end of their contractual term, where occupation continues, including when the Landlord and Tenant Act 1954 applies. Preparers should be clear about the policy they have selected and consider whether this decision involves a significant judgement that should be disclosed.
- Some companies treated such leases as short term, expensing the rental cost where they have taken the relevant exemption.
- Others treated the tenancy as a term lease, on the same basis as the expired lease, where eventual renewal is considered reasonably certain. The approach was not explained by all companies, although not all had ongoing tenancies.
Accounting policies for determining the lease term in other circumstances tended to be boilerplate, without company-specific disclosure of factors affecting whether the company was reasonably certain to continue in occupation beyond the effective dates of renewal or termination options.
- In some cases, it was unclear whether exercise of options was a default assumption or the disclosure simply repeated wording from IFRS 16.
- Some companies also referred to remeasuring lease liabilities when relevant circumstances changed in the year, without indicating the extent of this (for example, a change affecting a significant number of properties) in the current or prior period.
Explicit and specific disclosure of these factors, of how continuing tenancies are treated, and of any related significant judgements, would assist users' understanding of the company's position and aid comparability of accounting policies despite the differing circumstances.
Fixed asset accounting for right of use assets and owned assets installed in the premises
Lease term, asset life for deprecation and value-in-use forecast assumptions should generally be consistent. Where differences are required by IFRS or specific circumstances, these should be clearly explained.
Impairment testing in some instances was based on projected cash flows beyond the end of the term of store leases, but some companies taking this approach did not explain the basis for doing so or the period over which cash flows were extrapolated.
Supplier income arrangements
Supplier income arrangements are commonly included in contracts between a retailer and its supplier, although they are not exclusive to the retail industry. Examples of supplier income include discounts, volume rebates, reimbursement of promotional or advertising costs, margin or price protection, fees in return for giving a product advantageous placement in a physical or online store (slotting fees), and fees to enter into a contract. Historically, some of these arrangements have been complex, and the FRC has emphasised the need for relevant information to be disclosed when amounts involved are material (press release December 2014).
Judgements, estimates and other disclosures
Retailers have indicated that supplier income arrangements have generally become less complex in recent years. Contracts tend to be clear, reducing the need for judgement and giving a sound basis for estimating amounts receivable at the reporting date. However, despite the contractual terms in place, in practice there may be a degree of negotiation in determining the amounts actually paid.
When supplier income is material, we expect to see an accounting policy, explaining the types of income recognised, how amounts are determined and where they are reported.
When significant judgements and/or major sources of estimation uncertainty are involved, companies should make the disclosures required by IAS 1. This could, for example, explain the judgement over the period to which the income related, based on consideration of all the conditions attaching to the payment.
Grocery retailers disclosed supplier income receivables in the balance sheet, but income statement disclosures were less common. Material amounts that may require disclosure include the amount of supplier income recognised in the income statement (with the line items in which it is included), and any receivable amounts offset against accounts payable.
Recognition and presentation
All the companies in our selection disclosing supplier income recognised it as a reduction in either cost of sales, the cost of inventory, or other expenses.
In some cases, contractual terms will clearly indicate that payments relate to goods purchased or the reimbursement of operating expenses (such as for marketing or advertising contributions).
In other cases, further consideration may be required to determine when and how some amounts are recognised and presented, for example:
- whether a reduction in the purchase cost of goods requires allocation between items sold and those in inventory
- how a fee that is not explicitly a discount or reimbursement should be presented. Such a fee should generally be deducted from the cost of purchases if it is integral to the purchase contract with the supplier and, in substance, a discount.
Any allocation of amounts between inventory, cost of sales and any other line item (if relevant) should reflect a reasonable estimate of the transactions and products to which they relate.
We would not normally expect supplier income to qualify as revenue under IFRS 15.