The directors report in

Transcription

1 The directors report in The directors' report in the the spotlight spotlight An An English English summary summary of the of Dutch the Dutch publication: Het publication: bestuursverslag Het in bestuursverslag de schijnwerpers in de schijnwerpers

2 Page 2 At a glance The directors' report in the spotlight New rules for the risk section 1 General Running a business means taking risks. Effective from the 2015 financial year, listed, large and/or medium-sized entities are required to disclose the level of risk their business is willing to accept, amongst other things. Using a more detailed risk section in the directors report, an entity is required to disclose the risks it is exposed to and how those risks are controlled. These amendments to the legislation are not isolated events, but are a response to stakeholders criticism and requests for more adequate information about risks and risk management. The amendments apply to listed, large and medium-sized entities, and result from a number of new provisions added to Dutch Accounting Standard (DAS) 400 Annual report. New authoritative statements have been included in DAS 400 that are regarded as normative. This means that listed, large and medium-sized entities are, in principle, bound by the new requirements, unless there are valid reasons not to comply. Hereafter a summary of the amendments is provided. Risk section: new requirements The risk section of a directors report is based on section 391, Book 2, of the Dutch Civil Code (Burgerlijk Wetboek), which provides that the mandatory directors report contain a description of the main risks and uncertainties an entity faces. With effect from the 2015 financial year, listed, large and medium-sized entities are required, on the basis of new provisions laid down in the DAS, to considerably expand the risk section in the directors report. This expansion is regarded as an elaboration of the already existing statutory provisions. Entities were already obliged to disclose information on risks in their directors reports, given that a description of the most significant risks and uncertainties facing the entity was to be disclosed. In identifying the main risks and uncertainties, the following categories are in any case relevant. (These are not mandatory categories; entities may decide on another classification that better suits their business). Strategy Operating activities Financial position Financial reporting Laws, rules and regulations

3 Page 3 The new provisions have been laid down in DAS c and require, apart from the already existing requirement to disclose information on risks: A general description of the willingness to assume risks and uncertainties (the risk appetite). The level of the entity s risk appetite constitutes guidance as to whether the entity would or would not take measures to control such risks and uncertainties. A description of the measures taken to control the main risks and uncertainties, if possible with a qualitative description of the expected effectiveness of those measures. If no control measures have been taken for one or more of the main risks and uncertainties, this fact must be explained. A description of the expected impact on the entity s results and/or financial position if one or more of the main risks and uncertainties were to materialize, if possible based on sensitivity analyses. A description of the risks and uncertainties that had a significant impact on the entity during the past financial year, and the consequences thereof for the entity. Whether improvements have been or will be made to the entity's risk management system and, if so, which ones. Preferably, the entity should indicate how its risk management system (both the policies and procedures) is embedded in the organization and what measures (soft controls) it has taken to influence the culture, conduct and motivation of its employees. The level of detail of the information will be influenced by the size and complexity of the entity, its activities and the risks and uncertainties related thereto. In summary With effect from the 2015 financial year, supplementary requirements apply to listed, large and medium-sized entities in relation to the risk section included in the directors' report. On the grounds of existing rules and regulations, entities were already obliged to include a description of the main risks and uncertainties facing the entity. Under the new standard, which elaborates the statutory provisions, entities are required to describe in the risk section of the directors report: 1. Their risk appetite with respect to significant risks and uncertainties. 2. The control measures taken. 3. The expected impact on their results and/or financial position if the risks or uncertainties were to materialize; with the recommendation that such impact be quantified on the basis of a sensitivity analysis. 4. Risks and uncertainties that had a significant impact during the past financial year, and the consequences thereof. 5. Whether improvements have been or will be made to the entity s risk management system. 2 Case - Background We have drawn up a practical case to illustrate the new annual reporting requirements for the risk section set out by the Dutch Accounting Standards Board (DASB) 1. The case describes two companies that differ from each other in terms of size and complexity. These differences are highlighted in the examples in the following sections, illustrating this elaboration of the new annual reporting requirements. 1 This publication only describes the new DAS provisions that apply to the management report. The example included in this publication was drawn up to illustrate the new annual reporting requirements and for that reason only covers a selection of risks, control measures and risk appetite. Therefore the publication does not provide a complete picture, nor a complete description of all the risks and control measures of the fictitious enterprise, nor does not it set out all the requirements that a management report must comply with.

4 Page 4 A complex entity called Complex Coffee produces and sells coffee products. Sales agents are among the sales channels that Complex Coffee uses to sell its coffee. Complex Coffee has a minority share in two large and important sales agents to safeguard the business relationship. The price, quality and origin of raw materials are important factors for coffee products. The fiercer competition in the coffee market (coffee pods/instant coffee, etc.), the price volatility of raw materials and consumables and the higher expectations for corporate social responsibility have a major impact on the success of Complex Coffee. To control these risk factors, the enterprise relies on its risk management framework. Complex Coffee is a large legal entity. Simply Sales Coffee, a less complex entity, is a Complex Coffee sales agent. Simply Sales Coffee receives a percentage of commission from Complex Coffee based on the quantity of coffee sold. Simply Sales Coffee only sells coffee products supplied by Complex Coffee. Simply Sales Coffee has a good financial position and it has no external financiers. The enterprise has sales contracts covering obligatory offtake with the majority of its customers. Simply Sales Coffee is a medium-sized business. 3 Complex Coffee In compliance with the new provisions in Dutch Accounting Standard 400, Complex Coffee has drawn up elements of its risk section as follows. Risk section Methodology The risk management policies and procedures is key to ensuring the proper management of Complex Coffee. All layers of our organization understand that risk management is an important process. The risk management system is embedded in the organization from the level of the Supervisory Board and the Executive Board ("tone at the top") to the operations and finance departments (soft controls); all employees contribute to identifying risks and the associated control measures. The Governance, Risk and Compliance department holds workshops and facilitates self-assessments on a quarterly basis for the relevant business units and processes at Complex Coffee. Risk management is a fixed item on the agenda of board, management and team meetings. Contributions to improving risk management are recognized and rewarded in the people performance process. 3.1 The most significant risks and the risk reduction measures taken Complex Coffee analyses and controls its risks by dividing them into categories (strategic, operational, financial and compliance). The control measures are subsequently defined for each identified risk. Where possible, a qualitative description is included of the expected effectiveness of the measures taken. Complex Coffee has put measures in place for the majority of the risks and uncertainties identified. The control measure relating to the price risk of the coffee raw materials encompasses the policy of covering price risk based on a two-year horizon, in which the percentage of risk coverage gradually declines from 100% to 0% over the course of this period. An example of a risk that is not covered is the impact of the price volatility of consumables. Complex Coffee has chosen to accept the risk of price rises for consumables on account of the negligible impact of the historic and expected price volatility. Price volatility levels are constantly assessed in combination with a predefined, maximum acceptable deviation bandwidth.

5 Page Appetite for significant risks The current risk profile is determined on the basis of this risk analysis and the control measures. The current risk profile is assessed and compared with the desired risk profile. Action plans are drawn up for each risk if the current profile is graded at a higher level than the desired risk profile to further control/reduce the existing exposure. Example of explanatory note on the difference between the current and desired risk profile The fiercer competition in the coffee market has heightened the production innovation risk position. To prepare for the future, the current risk profile must be scaled back from the current medium 2 to the desired risk profile of medium 1 by investing in both the innovation team and the innovation process. The innovation team has been expanded gaining six FTEs, the innovation process lead time has been reduced as a result of using new methods and software, and the approval cycle has been significantly shortened. Concretely, this means greater innovation capability (quantity and quality) and a stronger focus on streamlining and improving the innovation processes to reduce the risk of a lack of product innovation (and product innovation quality) compared with the company's competitors.

6 Page 6 Example of a qualitative description of the expected effectiveness of the measures taken The control measures relating to supplier compliance with the Complex Coffee Code of Conduct are expected to be effective. If suppliers fail to adhere to the Code of Conduct, Complex Coffee faces the risk of being stripped of its ISO certification. The company has, therefore, put the following control measures in place. It is mandatory for new suppliers to sign the Code of Conduct. Suppliers receive training on the requirements set out in the Code of Conduct. The Code of Conduct has been published on the website and Intranet. Q&As have been posted on the website, including a reporting centre. The issues reported are recorded and reported to the Executive Board and the Supervisory Board. A random check is carried out each year on compliance with the provisions of the Code of Conduct. These measures have shown that barring the odd exception, suppliers are aware of, and act in accordance with the Code of Conduct.

7 Page 7 Risk impact and trends Complex Coffee assesses the potential impact of each risk on the organization and the probability of the risk occurring. The impact includes financial and non-financial factors (such as reputation) and a trend analysis is made against the previous year.

8 Page Quantification of the impact on the result and financial position if the risks materialize Dependence on regions Complex Coffee sells its products in north-west Europe and depends for 80% of its total turnover on coffee consumption in this region. Should this market collapse, Complex Coffee's turnover would fall considerably. However, only a portion of the company's operating costs are variable. As a result, a sharp fall in prices or sales in this region will negatively affect the results of Complex Coffee. Should the northwest European market contract by 50%, this would bring about a 50 million decrease in turnover, with EBITDA declining from 37.5 million to 15.5 million. Sensitivity analysis (DASB recommendation) The turnover for this year is 125 million, of which 100 million (80%) is derived from north-west Europe. The total costs for this year are 87.5 million, excluding depreciation and interest, of which 17.5 million is not dependent on changes in the operating activities and 70 million is dependent on operating activities. The variable costs will change in direct proportion to a drop in sales (80% of the variable costs relate to the activities in north-west Europe). 2 Decline in turnover north-west Europe Total turnover Total costs (excl. depreciation and interest) Current results % decline in North European market % decline in North European market % decline in North European market Total EBITDA Sensitivity analysis of raw materials (DASB recommendation) In line with the company's risk coverage policy, around 75% of the expected raw materials purchases are covered for the next 12 months. If the price of coffee raw materials rises by 20%, and on the assumption that Complex Coffee cannot pass on the price increase to its customers within 12 months, this is expected to have a negative effect of 2 million on the operating result. Product quality Complex Coffee produces coffee for human consumption. This means that the production process must meet the requirements imposed by the Food and Consumer Product Safety Authorities. Periodic inspections are carried out in which the production process is reviewed against the applicable requirements. If the authorities identify shortcomings, sanctions will be imposed. The sanctions may take the form of a penalty (1%-5% of turnover, our current turnover is 125 million, the penalty will, therefore, be between 1.3 million and 6.3 million); in the worst case our licence will be revoked. 2 Due to the nature of Quality Control, the sensitivity analysis is of a technical nature. This does not apply to all businesses/sectors.

9 Page Risks and uncertainties having a major impact in the past financial year, and the consequences Complex Coffee is currently facing problems in maintaining production quality at the desired level in Columbia, one of the world's main coffee-producing countries. Part of the coffee production in Colombia has failed due to incessant rainfall. The resulting quality of the coffee produced is inferior to the required quality standard. Complex Coffee is grappling with efficiency issues in an effort to restore the quality of the production process. Furthermore, a potential decrease in sales cannot be ruled out. These factors will negatively affect the result. There also is a remote chance that a sanction in the form of a penalty will be imposed. It is highly unlikely, however, that the production licence will be revoked. If a penalty is imposed, this will have a further negative effect on the result. As illustrated in the risk impact diagram, production innovation risk has risen against the previous year. Complex Coffee is conscious of the fiercer competition in the coffee market, particularly in the capsules/instant coffee product group. As a result of the growing competition, market share in this product group has dropped by 6%. In response to this development Complex Coffee has invested in both the innovation team and the innovation process. The innovation team has been expanded gaining six FTEs, the innovation process lead time has been reduced as a result of using new methods and software and the approval cycle has been significantly shortened. Concretely, this means greater innovation capability (quantity and quality) and a stronger focus on shortening innovation tracks. As the improvement of product innovation is viewed as a structural change in the company's competitive position, this risk will have a prolonged effect on the coffee market and Complex Coffee. 3.5 Current or planned improvements in the risk management system In view of the expected long-term effect of product innovation risk, in addition to the investments made in the innovation team and in the innovation process, Complex Coffee has adjusted the methodological timeline of the risk management process from three to five years. The risks and corresponding investments have thus been set out more clearly in time and the impact and probability assessment will improve. This longer timeline moreover provides a more solid basis for investing in control measures to reduce/eliminate risks.

10 Page 10 4 Simply Sales Coffee In compliance with the new requirements, Simply Sales Coffee has drawn up its risk section as follows. Risk section Methodology The risk management system meets the requirements of company management. Risks are analysed on a quarterly basis and any new risks are assessed, documented and incorporated in the risk management system. Risk management is mainly carried out by the organization's executives. The company secretary is responsible for risk management and holds quarterly risk workshops for the Simply Sales Coffee management board and supervisory officers. 4.1 The most significant risks and the risk reduction measures taken Simply Sales Coffee analyses its risks on a quarterly basis. The control measures are subsequently defined for each identified risk. 4.2 Appetite for significant risks The current risk profile is determined on the basis of this risk analysis and the control measures. The current risk profile is assessed and compared with the desired risk profile. Action plans are drawn up for each risk if the current profile is graded at a higher level than the desired risk profile to further control/reduce the existing exposure.

11 Page Quantification of the impact on the result and financial position if the risks materialize Dependence on regions Simply Sales Coffee sells its products mainly in the Netherlands and Belgium. 80% of its total turnover is generated by coffee sales in this region. Should this market collapse, the turnover of Simply Sales Coffee would fall considerably. However, only a portion of the company's operating costs are variable. As a result, a sharp fall in prices or sales in this region will negatively affect the results of Simply Sales Coffee. Should the Dutch and Belgian markets contract by 50%, this would bring about a 10 million decrease in turnover, with EBITDA declining from 5 million to 1.4 million. 4.4 Risks and uncertainties having a major impact in the past financial year, and the consequences The risk relating to the dependence on Complex Coffee has had a significant impact in the course of the past financial year. The contracts with Complex Coffee expired at the end of this financial year. These contracts are crucial for the continuity of Simply Sales Coffee. In the course of the financial year the contracts were renewed and extended by five years. The partnership with Complex Coffee was further expanded in these contracts. Based on its excellent relations with its customers, Simply Sales Coffee will contribute to product innovation at Complex Coffee particularly for new products. 4.5 Current or planned improvements in the risk management system The risk management methodology meets the wishes and requirements of the management of Simply Sales Coffee. A decision was taken in the course of the year to invest in a new risk management tool to simplify and improve the risk management reporting process and assess the risks. More information As shown in this publication, various adjustments have been made which could have far-reaching consequences. If you have any questions on the use of this publication or on any other aspects of the accounting and reporting regulations, please contact your accountant, who will be pleased to provide further information. November 2015 Professional Practice Department Telephone: directoraat.vaktechniek.am@nl.ey.com