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REVIEW OF FINANCIAL REPORTING BY ISSUERS - CYCLE 3

Parent financial statements materially incorrect

45.

An issuer in its parent financial statements incorrectly included dividends received from a subsidiary through the Statement of Movements in Equity rather than through the Statement of Financial Performance as required by NZ GAAP.

46.

The effect was to materially understate parent revenue. Although the transaction eliminates at the group financial statement level the Financial Reporting Act does require parent financial statements to fully comply with NZ GAAP.

47.

The Commission indicated to the issuer that it expects this error to be corrected in their 2006 financial statements.

Retention of a provision where no present obligation existed

48.

One issuer set up a fund for the purpose of defending certain legal issues but no significant issues relating to the defence were noted at year end. The issuer was asked to provide explanations for the significant provision when there appeared to be no present obligation.

49.

FRS-15: Provisions, Contingent Liabilities and Contingent Assets says:

5.1

A provision must be recognised when:

1. an entity has a present obligation (legal or constructive) as a result of a past event;
2. It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and
3. A reliable estimate can be made of the amount of the obligation.

If these conditions are not met, a provision must not be recognised.

50.

The Commission reminds issuers to ensure that all the conditions of FRS-15 paragraph 5.1 are met before any provision is recognised in the financial statements.

Classification of convertible instruments insufficiently clear

51.

One issuer was asked about the classification of convertible instruments in their financial statements. It was not clear whether the instruments were debt or not as they had not classified them as either current or non-current liabilities.

52.

Although companies in the past have sometimes relied on a "mezzanine type" presentation, more recently companies have moved to classify, and in many cases correctly classify, such instruments.

53.

Moreover, being uncommitted in the classification of such financial instruments does not help readers of financial statements to assess: "the nature amounts and liquidity of available resources as required under FRS-2 Presentation of Financial Reports.

54.

FRS-2 (para 8.5) requires all items in the Balance Sheet to be classified as either equity, asset (current or non-current), or liability (current or non-current).

55.

The Commission acknowledge that there are debates within the accounting profession about whether certain financial instruments, e.g. preference shares and convertible notes are debt or equity. The debate has been refocused because of available overseas GAAP in this area, and the move towards adoption of NZ IFRS.

56.

The Commission expects issuers to be guided by NZ GAAP, including relevant overseas guidance, when issuing new instruments, and to review any pre-existing arrangements and their current accounting treatment for such instruments in the light of any new guidance.

Non-disclosure of an actual versus prospective financial information comparison

57.

The Commission considers that the actual versus prospective financial information comparison disclosure requirement is important to give investors feedback on the relative reliability of prospective financial information, including reasons for variances which are subject to audit. This disclosure is not optional.

58.

In one instance the financial statements did not include a comparison of actual or prospective financial information when this was required. A comparison and explanations is required to be included by FRS-9 Information to be Disclosed in Financial Statements paragraph 5.4.

59.

FRS-9 says:

5.4

Where an entity has published prospective financial information other than prospective financial information expressed solely in general terms, for the period of the financial report, the entity shall present a comparison of the prospective financial information previously published with the actual financial results being reported. Explanations for major variations shall be given.

Lack of a total recognised revenues and expenses line in the Statement of Movements in Equity

60.

The format of the Statement of Movements in Equity (SoME) in many financial reports did not comply with NZ GAAP in that they did not disclose a total recognised revenues and expenses line.

61.

The Statement of Movements in Equity is a primary financial statement. FRS-2 Presentation of Financial Reports paragraph 7.1 indicates that one of the objectives of the Statement of Movements in Equity is as a measure of comprehensive income. To this end FRS-2 paragraph 7.3(a) requires disclosure of a total recognised revenues and expenses line in the Statement of Movements in Equity. Therefore this line should be disclosed in a Statement of Movements in Equity.

62.

Although all of the components making up total recognised revenues and expenses are disclosed in the Statement of Movements in Equity, meaning that a knowledgeable reader could calculate the figure, the Commission believes that it is important that the total recognised revenues and expenses figure is also disclosed.

63.

Six issuers had multiple figures making up total recognised revenues and expenses. However, even for other issuers where total recognised revenues and expenses only comprises Net Surplus, best practice is to disclose a total recognised revenues and expenses line in the Statement of Movements in Equity.

64.

Cycle 3 review found six instances where the Statement of Movements in Equity did not show the total recognised revenues and expenses line. The instances of non-compliance have not declined compared with Cycle 2.

65.

This issue is easy to remedy and the Commission expects issuers to adjust the format of the Statement of Movements in Equity to include the total recognised revenues and expenses line in future financial reports where this is necessary.

Failure to date the financial statements

66.

In Cycle 3 the instances of failure to date the financial statements as required by the Financial Reporting Act 1993 and Companies Act 1993 have decreased. One instance of non-compliance was found compared to 4 and 3 for Cycles 2 and 1 respectively. The Commission views the decrease in instances of non-compliance as a positive development.

Non-disclosure of a significant future commitment

67.

One issuer disclosed what appeared to be a significant commitment in their Chairman's report but not in their financial statements. Although the particular commitment may not be viewed as a capital commitment (which would require disclosure under FRS-9) for the financial statements to give a fair presentation, the issuer should have disclosed this commitment, given the significant amount involved.

68.

The Commission encourages issuers to consider whether significant commitments, other than those traditionally viewed as capital, need to be disclosed in their financial statements.

Accounting for an unconditional sale of properties

69.

Two issuers were asked whether there had been inappropriate early recognition of a purchase/sale of properties. The issuers had accounted for a purchase/sale of properties at the point when the unconditional contracts were signed but before the legal ownership had transferred.

70.

The Commission acknowledges that some parts of the accounting profession may view that accounting for a purchase when a contract is unconditional is acceptable. However, the Commission's view is that recognition should only occur when the risks and rewards of ownership have transferred, and this needs to be fully considered by issuers and their auditors. Prima facie this occurs when legal ownership transfers.

71.

IAS 18 Revenue (Appendix A, paragraph 9) deals with accounting for real estate sales. It states that:

Revenue is normally recognised when legal title passes to the buyer. However, in some jurisdictions the equitable interest in a property may vest in the buyer before legal title passes and therefore the risks and rewards of ownership have been transfrred at that stage.

72.

The Commission expects issuers to ensure that risks and rewards of ownership have transferred before recognising a purchase of properties.

Accounting treatment for recognition of reclaimed lands

73.

The Commission sought explanations from two issuers about their accounting for reclaimed land and whether or not such land should be classified as an asset.

74.

Satisfactory answers have been received from these issuers.