In its media release MR 17-162, the Australian Securities and Investments Commission (ASIC) once again re-iterated its views regarding directors’ responsibilities for the financial report, particularly that:
Being in the middle of the listed entity reporting season, this article serves as a reminder to all directors and CEOs about their responsibilities regarding their financial reports, as well as key issues to look out for when reviewing the reports.
Our ‘top 10’ key issues to consider (i.e. areas directors and CEOs commonly overlook), are as follows:
These are discussed in more detail below.
For 30 June 2017 financial reports, your audit report will look different. In particular, it will include an outline of key audit matters (KAMs), which are the matters, which in the auditor’s judgement, are of most significance in the audit of the financial report for the current period. KAMs may relate to significant accounting estimates, as well as judgements about appropriate accounting policies.
Key issue 1
Ensure that KAMs involving key estimates and judgements have been clearly disclosed in the financial report as required by AASB 101 Presentation of Financial Statements, paragraphs 122 and 125.
In particular, ASIC are looking to see more detailed information disclosed regarding items subject to material estimation.
Users of financial statements, and in particular investors and analysts, have indicated that they are particularly interested in the amount and timing of revenue recognised in the financial report.
Key issue 2
Ensure that the accounting policies adequately describe, in Plain English, how revenue is recognised so that it can easily be understood by users of the financial report.
A Plain English, bespoke ‘revenue’ accounting policy will assist you in understanding the policy, and in turn ensures that revenue is recognised in accordance with currently applicable accounting standards, and the substance of the underlying transactions.
To assist you in this process, we recommend you review management’s accounting papers outlining the appropriate accounting treatment for each revenue stream based on authoritative guidance in accounting standards AASB 118 Revenue, AASB 111 Construction Contracts and other relevant interpretations dealing with revenue recognition.
Other than when an entity prepays for a good or service in advance, AASB 138 Intangible Assets only permits deferral of expenses as assets in very limited circumstances.
Key issue 3
For each new asset type on the balance sheet, enquire which accounting standard governs its recognition (e.g. AASB 102 Inventories, AASB 116 Property, Plant and Equipment, AASB 140 Investment Property and AASB 139 Financial Instruments: Recognition and Measurement).
For all other assets, ensure that they meet the recognition criteria as an intangible asset under AASB 138, noting that the following cannot be capitalised:
The diagram below illustrates the appropriate accounting standards dealing with the impairment requirements for financial and non-financial assets:
|Type of asset|
|Impairment indicators – AASB 136, paragraph 12:||Objective evidence of impairment - indicators – AASB 139:|
Non-financial assets are often significant assets of an entity, with the value attributed to these assets affecting not only the entity’s reported financial position, but also its reported performance. Calculations to determine the recoverable amount often rely on discounted cash flows and can be complex.
The Attachment to ASIC’s media release, MR 17-162 outlines in more detail items for directors to look out for when reviewing impairment models, including ensuring that:
Financial assets such as receivables carried at amortised cost, and available-for-sale investments with negative fair value movements recorded in other comprehensive income, also need to be tested for impairment if there are impairment indicators of the type listed in the diagram above. Even though available-for-sale (AFS) investments are recognised at fair value in the balance sheet, any negative balance in the AFS reserve should be reclassified as an impairment loss in profit or loss if there is a ‘significant or prolonged decline in fair value’.
Key issue 4
Ensure that impairment indicators for financial and non-financial assets have been considered under the correct accounting standard (AASB 136 for non-financial assets and AASB 139 for financial assets).
Review management’s impairment models for all material non-current assets or cash-generating units requiring an impairment test under AASB 136 Impairment of Assets (including goodwill, intangible assets with an indefinite life, and assets with impairment indicators).
Paying attention to items to consider outlined in the ASIC Media release, you need to review management’s cash flows and assumptions, having regard to your knowledge of the business, the economic environment, the assets and future business prospects, to satisfy yourself that the recoverable amount of these assets exceed their carrying amount.
Ensure that impairment losses have been recognised in profit or loss for all AFS investments with negative balances in the AFS reserve that represent a significant or prolonged decline in fair value.
While you may be familiar with the accounting treatment for last year’s transactions and balances, there is a risk that new transactions and agreements entered into during the current year are incorrectly accounted for in your June 2017 financial report.
As directors and CEOs, you are best placed, based on your knowledge of transactions and agreements, to determine whether these transactions and agreements have been correctly accounted for.
Key issue 5
For each new significant agreement or transaction stream, review management’s accounting papers outlining the appropriate accounting treatment based on authoritative guidance in accounting standards. Examples to consider include:
Users are particularly interested in earnings and therefore the statement of profit or loss and other comprehensive income. In this regard, it is important the entity appropriately calculates and presents statutory profit and earnings per share (EPS).
Key issue 6
Review the presentation of the profit number in the statement of profit or loss and other comprehensive income, ensuring that any profit subtotals such as EBITDA are not presented in bold.
It should be noted that if you present expenses ‘by function’, i.e. including cost of sales (COGS), it is not usually appropriate to present a subtotal EBITDA because some amounts for depreciation and amortisation will be included as part of COGS, meaning that describing a subtotal as EBITDA is not an accurate description of the relevant line item.
Also ensure that EPS has been correctly computed, particularly diluted EPS for the effect of dilutive options. Entities with losses do not have diluted EPS as the impact of any dilutive options would be, in fact, antidilutive. Also note that the effect of out-of-the-money options on diluted EPS is also antidilutive and therefore is not disclosed. In-the-money options only impact diluted EPS to the extent of the number of shares that would be issued for no consideration.
Reclassifying items of OCI
Ensure that gains on disposal of items subject to revaluation or fair value adjustments in other comprehensive income (OCI) are correctly accounted for, for example:
Directors should be mindful of the disclosure requirements when an entity has not applied a new Australian Accounting Standard that has been issued but is not yet effective (AASB 108 Accounting Policies, Changes in Accounting Estimates and Errors, paragraphs 30-31). The entity is required to disclose known or reasonably estimable information relevant to assessing the possible impact that application of the new Australian Accounting Standard will have on the entity’s financial statements in the period of initial application.
As at 30 June 2017, the following five Australian Accounting Standards have been issued but they are not yet effective:
AASB 9 Financial Instruments
The main impacts of AASB 9 are that:
AASB 15 Revenue from Contracts with Customers
The core principle of AASB 15 is to recognise revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. AASB 15 introduces a five-step revenue model to determine when to recognise revenue and at what amount.
AASB 16 Leases
AASB 16 introduces a single lessee accounting model (all leases, finance and operating leases, will be accounted for in the same way) and requires a lessee to recognise assets and liabilities for all leases. A lessee will now be required to recognise a right-of-use asset representing its right to use the underlying leased asset and a lease liability representing its obligation to make lease payments.
Not-for-profit entities only: AASB 1058 Income of Not-for-Profit Entities and AASB 1059 Service Concession Arrangements: Grantors
AASB 1058 establishes principles and guidance that apply to transactions where the consideration to acquire an asset is significantly less than fair value principally to enable a not-for-profit entity to further its objectives, and the receipt of volunteer services.
AASB 1059 outlines the appropriate accounting treatment for infrastructure projects of public sector entities conducted via public-private partnerships.
AASB 17 Insurance Contracts
AASB 17 will replace AASB 4 and requires all insurance contracts to be accounted for in a consistent manner, making financial statements more comparable for users. Insurance obligations will be accounted for using current values, instead of historical cost.
AASB 17 will generally not apply to normal trading entities that have entered into insurance contracts for assets and other business purposes. It will only apply to insurance companies and entities issuing insurance and reinsurance contracts and holding reinsurance contracts.
Key issue 7
These new Australian Accounting Standards come into effect over the next two to four years. You should therefore ensure that the notes to your June 2017 financial statements disclose the impact on the future financial position and results.
Please note the following when reviewing these disclosures:
Interpretation 23 Uncertainty over Income Tax Treatments
It is also worth noting that the AASB recently issued Interpretation 23, which could result in significant increases in current tax liabilities for entities with transfer pricing and other uncertain tax positions. Although its recent release means there is unlikely to be expectation from ASIC or users to quantify the impacts in your June 2017 financial report, you will need to consider whether this interpretation could have a potential impact in future and disclose narrative information accordingly.
While not technically part of the audited financial statements, directors are nevertheless responsible for preparing the ‘other information’ contained in the Directors’ Report and the Operating and Financial Review (OFR).
This ‘other information’ should be consistent with amounts recognised, measured and disclosed in the financial statements. Audit reports for 30 June 2017 for the first time will include a section on ‘other information’. Any material inconsistencies identified between the ‘other information’ and the financial statements that have not been rectified will be described in the audit report (ASA 720 The Auditor’s Responsibility Relating to Other Information).
Key issue 8
Ensure that all discussion and analysis in the OFR is consistent with the way transactions and balances have been recognised, measured and disclosed in the financial report. For example:
Although forming part of the directors’ report, the remuneration report for listed companies required by s300A of the Corporations Act 2001 is audited and then voted upon by members at the annual general meeting (albeit via a non-binding vote under s250R(3)). It is therefore a key piece of information used by shareholders to assess the reasonableness of director and key management personnel (KMP) compensation.
While ‘materiality’ applies to transactions and balances recognised and measured under Accounting Standards, the Corporations Act 2001 includes no such concept. This means that even though Regulation 2M.3.03(5) refers to definitions in accounting standards to determine how much compensation is disclosed for KMPs, there is no materiality threshold. Therefore, details of all amounts paid or payable to KMPs, shares/options/loans to KMPs, as well as transactions with KMPs must be disclosed.
It should be noted that analysts and shareholder groups are also becoming increasingly vocal regarding disclosure of KMP compensation. In many cases, the remuneration report and KMP long-term incentives may be voted down simply because the performance conditions are not adequately or clearly disclosed. Indeed, the descriptions of performance conditions in some reports is either too high level (e.g. a generic statement that performance conditions are ‘based on personal targets’, without including a description of the targets), or too detailed and complicated that it almost appears as if the disclosure has been constructed so that users are unable to understand the terms.
Key issue 9
Review the remuneration report to ensure that information disclosed for KMPs is complete and accurate, including KMP non-cash compensation.
Ensure that performance conditions for KMP long-term and short-term incentives are clearly explained, in Plain English.
In line with ASIC’s expectations that directors are responsible for the quality of the financial report, including providing useful and meaningful information for investors and other users of the financial report, entities are encouraged to ‘declutter’ their financial statements and apply judgement when deciding which mandatory disclosures are relevant to users, and which are not.
Key issue 10
Review all accounting policies and ensure:
To make the financial report even more user-friendly, you may also want to consider:
The above recommendations will not only assist users’ understanding of the financial report, but will enable a more efficient and effective process for your own reviews.