Discounted cash flows and discount rates are commonly used under IFRS. Determining an appropriate discount rate is a complex area of financial reporting and can be an area of significant estimation uncertainty and a source of errors in financial reporting.

The FRC’s review found that assumptions used for discount rates and cash flows should be internally consistent, and care should be taken to avoid double-counting risks. When nominal rates are used, the effects of inflation on the cash flows should not be overlooked; particularly in the current interest rate environment of low nominal interest rates and relatively high inflation.

It also discovered that there is general scope for improvement in the usefulness of the disclosures provided by many companies, with high quality disclosures including both the discount rate used, and an explanation of how it was determined.

Furthermore, it found that companies may need to consider whether specialist third party advice is required when valuing a material item, and where there is no internal expertise.

The review includes some case studies, based on issues the FRC finds in its routine monitoring of corporate reporting, to illustrate some of the challenges which companies may face in this area.

To encourage improvement in the general quality of company disclosures, the review also includes examples of good practice where companies have clearly described the factors they considered in determining the discount rate; for example, explaining whether risk and inflation were included in the cash flows or the discount rate.

The full review is available here.