In its review of discount rates issued Monday, UK regulator the Financial Reporting Council (FRC) set out expectations for companies' use of discount rates.
Discounted cash flows, and discount rates, the FRC report explained, are commonly used when applying International Financial Reporting Standards (IFRS). Determining an appropriate discount rate is a complex area of financial reporting, which can also be a source of significant estimation uncertainty, it said.
The FRC set out in the report, Thematic Review: Discount Rates, eight expectations of companies.
They are to:
- Ensure that assumptions used for discount rates and cash flows are internally consistent.
- Ensure risks are not counted twice. In many cases, it will be easier to risk-adjust cash flows.
- Use a real risk-free rate as the starting point for constructing a discount rate, if cash flows are not adjusted for inflation.
- Use a pre-tax discount rate and cash flows for value-in-use calculations or where companies apply post-tax discount rates to post-tax cash flows to assess whether this will provide an answer that is materially similar to one that uses a pre-tax basis. And disclose the equivalent pre-tax discount rates.
- Obtain specialist third-party advice, when the choice of discount rate has a material effect on the measurement of assets or liabilities, and where no internal expertise exists.
- Provide high-quality disclosures when judgement has been exercised or discount rates are a source of significant estimation uncertainty.
- Disclose the discount rate used, as well as an explanation for how it was determined.
- Ensure that management commentary, both in the financial statements and strategic report, is clear and consistent with other disclosures in the financial statements, for example, where changes in discount rate assumptions have or could have a material impact.
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