A failure to reflect the risk variability in either the cash flows or the discount rate, or doing the opposite by double counting the risk, has been flagged up by the FRC as a common mistake in the reporting of discount rates, according to analysis of annual reports conducted by the regulator.

The  FRC’s review of the reporting of discount rates focuses on the requirements in IAS 36 'Impairment of Assets' and IAS 37 'Provisions, Contingent Liabilities and Contingent Assets' but also considered the quality of disclosures in relation to discount rates in IAS 19 'Employee Benefits' and IFRS 13 'Fair Value Measurement'.

Inflation is also identified as an area worthy of attention, particularly in the current environment of low nominal interest rates and relatively high inflation. The report also highlights a general lack of understanding around the requirement to use a pre-tax discount rate in value-in-use calculations and the challenges in converting a post-tax rate to a pre-tax rate.

Although discount rates have not previously featured in the Corporate Reporting Review team’s ‘top 10’ areas requiring improvement, it remains a challenging topic due to the level of complexity and high estimation uncertainty in determining an appropriate rate. The difficulty is further increased due to the differing reporting requirements relating to discount rates across IFRS Standards.

Commenting on the quality of disclosures in this area, the FRC says in the report that despite numerous instances of good practice, there is still room for improvement. Although most companies do disclose the discount rate used, there is often little detail provided on how the discount rate is estimated. The FRC said it expects preparers to explain how the discount rate is calculated where this has a material effect on the financial statements, even where there is no specific disclosure requirement to do so.

The FRC report also highlights the need for quality disclosure where significant judgement has been applied and/or estimation uncertainty exists. In particular, it emphasises the importance of high-quality management commentary, particularly where changes in the discount rate have had a material impact on the financial statements.

“The FRC’s thematic review is a useful read and illustrates the different challenges companies face when determining a discount rate,” says Kate Beeston, Technical Manager in ICAEW’s Financial Reporting Faculty. “The report also offers guidance on key concepts related to discounting that are particularly relevant in the current economic environment, including the time value of money, the term structure of interest rates, and real versus nominal interest rates.”

The FRC reminds IFRS preparers of the importance of obtaining third party advice where the choice of discount rate is material to the financial statements and little internal expertise exists. The regulator believes seeking advice on this area could significantly reduce the number of errors it identifies.

Read the full FRC report on Discount Rates which aims to help preparers, auditors and investors better appreciate the reporting implications of sustained negative real interest rates.

The Financial Reporting Faculty has a range of resources on IFRS requirements available at icaew.com/ifrsstandards