Discussion Documents: REVIEW OF FINANCIAL REPORTING BY ISSUERS - CYCLE 4


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REVIEW OF FINANCIAL REPORTING BY ISSUERS - CYCLE 4

FINDINGS UNDER NZ EQUIVALENTS TO INTERNATIONAL FINANCIAL REPORTING STANDARDS

31.

Issuers have three years within which they can choose to adopt NZ IFRS. Issuers have until periods beginning on or after 1 January 2007 to make this change.

32.

As part of Cycle 4 the Commission reviewed nine NZ IFRS financial statements. This is the first review of NZ IFRS financial statements and they relate to the reporting period ended 31 December 2005 to 31 March 2006.

33.

The aim of these reviews is to gather information on the early implementation of NZ IFRS and enable the Commission, where appropriate, to provide feedback to later adopters of NZ IFRS. The Commission will seek to maintain an appropriate balance between education and enforcement during the initial adoption of NZ IFRS.

34.

The Commission considers that the level of compliance with NZ IFRS for the early adopters was generally good. However, it did find a number of common non-disclosures by many of the NZ IFRS issuers. These relate primarily to disclosures required by NZ IAS 1 Presentation of Financial Statements, which are discussed below at paragraph 59.

35.

Issuers are reminded of the two Practice Notes that the Commission has published dealing with IFRS policy expectations in respect of prospectuses. These are available on the Commission's website www.seccom.govt.nz:

Practice Note No 2/2005: Prospective financial information in offer documents prepared in periods prior to adoption of NZ IFRS in historical financial statements; and
Practice Note No 3/2005: Historical financial information in offer documents prepared in accordance with NZ IFRS.

36.

The significant matters found from reviewing financial statements prepared using NZ IFRS were:

a.: quality of explanation of transition to NZ IFRS;
b.: share-based payment transaction not identified and not disclosed;
c.: the presence of a liability component in a convertible note; and
d.: common non-disclosures.

Quality of explanation of transition to NZ IFRS

37.: In Cycle 4, all entities applying NZ IFRS for the first time included reconciliations required under NZ IFRS 1 First-time Adoption of New Zealand Equivalents to International Financial Reporting Standards. These reconciliations explained how the transition from previous NZ GAAP to NZ IFRS affected reported financial position, financial performance and cash flows.
38.: The Commission reminds issuers that only adjustments arising from applying NZ IFRS for the first time should be included in the reconciliations required under NZ IFRS 1.
39.: The Commission is of the view that all other adjustments, including those arising from correction of prior period errors or change in accounting estimates must be disclosed as a separate note. For example, such changes could be included in the statement of changes in equity note as required by NZ IAS 1 paragraph 97.
40.: Separate disclosure ensures that readers are not confused as to the reasons for the adjustments.
41.: An entity's explanation of transition to NZ IFRS should be sufficiently clear so that a reader is able to understand the changes and their financial impact from reading the financial statements.
42.: The Commission noted instances where it is not clear whether the adjustments included in the entity's NZ IFRS 1 transition explanation were in fact arising from a change in accounting policies on adoption of NZ IFRS.
43.: The Commission noted one entity had incorrectly included adjustments arising from correction of prior period errors in the same note that was seeking to explain the impact of NZ IFRS as a result of their transition from previous NZ GAAP to NZ IFRS as required by NZ IFRS 1.
44.: Through the review of the issuer's NZ IFRS 1 transition explanation the Commission noted the entity had not applied FRS-36: Accounting for Acquisitions Resulting in Combinations of Entities or Operations (FRS-36) in the financial year immediately before its adoption of NZ IFRS in relation to its accounting for a reverse acquisition transaction.
45.: The entity concerned incorrectly presented this adjustment as a change in accounting policies arising on adoption of NZ IFRS, specifically NZ IFRS 3 Business Combinations (NZ IFRS 3), in the opening and closing consolidated balance sheet of the comparative year, when it was a correction of a prior period error.
46.: The Commission believe that the disclosure of the change as a transition adjustment created an incorrect view of the adjustment in the entity's current year's consolidated financial statements as readers would be given the impression that the adjustments had arisen due to differences in accounting policies between previous NZ GAAP and NZ IFRS, when in fact it was a correction of prior period error.
47.: The Commission is of the view that had the reverse acquisition been correctly accounted for under FRS-36 it would not have given rise to a transition adjustment to equity on transition to NZ IFRS.
48.: The entity agrees with the Commission's position but states that it was common practice to account for reverse acquisitions using 'conventional acquisition accounting'.
49.: The Commission is concerned that 'common' accounting practices exist that do not comply with the principles set out in an approved financial reporting standard, in this case FRS-36.
50.: The guidance in FRS-36 as to the identification of the investor in an acquisition transaction and its accounting treatment is sufficiently similar to that set out in NZ IFRS 3 (Appendix B).
51.: The Commission reminds issuers who have entered into reverse acquisition transactions to review their accounting and ensure that they meet the principles and requirements under FRS-36.
52.: The Commission also urges issuers who have incorrectly accounted for any reverse acquisition transactions under previous NZ GAAP to clearly distinguish these corrections from adjustments that have resulted from a change in accounting policy arising from the adoption of NZ IFRS.
53.: The Commission acknowledges that a great deal of effort has gone into NZ IFRS transition but reminds entities to be more thorough in their assessment of the key differences in accounting policies between NZ IFRS and previous NZ GAAP to avoid confusing them with adjustments arising from correction of prior period errors and changes in accounting estimates.
54.: The Commission reminds entities to clearly identify and explain the key changes arising from differences in accounting policies between NZ IFRS and previous NZ GAAP.

Share-based payment transactions not identified and not disclosed

55.: The Commission noted one entity had overlooked that a transaction was a share-based payment transaction within the scope of NZ IFRS 2 Share-based Payment (NZ IFRS 2) and failed to disclose the transaction and the accounting policy describing the measurement of this transaction.
56.: The Commission reminds preparers of financial statements to review all business transactions to ensure that any share-based payment transactions within the scope of NZ IFRS 2 are identified and disclosed.

The presence of a liability component in a convertible note

57.: The Commission noted one entity had overlooked separately classifying the equity and liabilities component in a convertible note. This separate classification is required under NZ IAS 32 Financial Instruments: Presentation (NZ IAS 32).
58.: The Commission reminds issuers to evaluate the terms of the financial instruments to determine whether it contains both a liability and an equity component and to separately classify those components as financial assets, financial liabilities or equity instruments in accordance with the substance of the arrangement and the definitions of a financial liability, a financial asset and an equity instrument set out in NZ IAS 32.

Common non-disclosures

59.

The Commission noted several common non-disclosures by entities applying NZ IFRS:

NZ IAS 1 Presentation of Financial Statements

a statement as to whether an entity is a profit-oriented entity or a public benefit entity (NZ IAS 1: NZ13.1(b));
a statement that the financial statements have been prepared in accordance with NZ GAAP, together with a description of the financial reporting standards applied by that entity (NZ IAS 1: NZ13.1(d));
for an entity whose financial statements comply with IFRS, an explicit and unreserved statement of such compliance in the notes (NZ IAS 1.14);
each component of the financial statements to be identified clearly, in particular, the name of the reporting entity or other means of identification, which has to be repeated if necessary (NZ IAS 1.46(a));
the entity's presentation currency and the level of rounding used in presenting amounts in the financial statements (NZ IAS 1.46(d) and (e));
a statement, in the summary of significant policies or other notes, about the judgements, apart from those involving estimations, management has used in the process of applying the entity's accounting policies that have the most significant effect on the amounts recognised in the financial statements (NZ IAS1.113); and
key assumptions concerning the future and other key sources of estimation uncertainty at the balance date that have significant risk of causing material adjustment to the carrying amounts of assets and liabilities within the next financial year (NZ IAS 1.116).

NZ IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors

disclosure of a new NZ IFRS and/or new New Zealand Equivalents to IFRIC Interpretations (NZ Interpretations) which had been issued but not yet effective, that the entity had not applied (NZ IAS 8.30).

60.

Many issuers omitted some of the above required disclosures and one issuer omitted all of the above required disclosures. The Commission considers that all the above disclosures should be made as a matter of course in adopting NZ IFRS.

61.

The Commission expects the judgements management have applied in financial reporting, including key assumptions and estimates, and their effects on accounting policy choices be disclosed in the financial statements. A one-line statement that management had applied judgements and made estimates about the future is not sufficient to meet the requirements under NZ IAS 1 paragraphs 113 and 116. Generic disclosures are not useful to readers of financial statements.

62.

Key assumption and estimate disclosures are very important disclosures particularly for organisations with complex operations. The Commission believes that it is good business practice that the Boards of entities consider the assumptions and estimates that have a significant risk of causing material adjustment in the carrying amount of assets and liabilities before finalising the financial statements. It is the intention of NZ IAS 1 that entities disclose these assumptions and estimates that require management's subjective or complex judgements. NZ IAS 1 also requires entities to disclose the nature of assets and liabilities affected by key assumptions and estimates together with their carrying amount as at the balance date.

63.

As stated in paragraph 22, the Commission's policy is to write to issuers whose reporting raises matters of significance. When the Commission writes to these issuers it also includes details of other minor matters that it found.

64.

Minor matters identified and raised with issuers applying NZ IFRS are:

NZ IAS 1 Presentation of Financial Statements

the omission of an accounting policy for contingent consideration relating to the acquisition of an associate;
the non-disclosure of the monetary amount for shares issued during the year;

NZ IAS 7 Cash Flow Statements

the appropriateness of reconciling operating profit before financing costs with cash generated from operations rather than presentation of a reconciliation of operating profit after taxation with net cash flows from operations;

NZ IAS 10 Events after the Balance Sheet Date

the treatment of certain transactions relating to performance targets being achieved by associates during the year as non-adjusting events when it appeared that the conditions for the events existed at balance date;

NZ IAS 16 Property, Plant and Equipment

the non-disclosure of certain information relating to revalued properties and the appropriateness of the use of "open market existing use basis" in place of fair value for valuing properties;

NZ IAS 31 Interests in Joint Ventures -

the inconsistent treatment of joint ventures with the corresponding disclosed accounting policy;

NZ IAS 32 Financial Instruments: Presentation

the non-disclosure of redeemable preference shares in the financial statements;
the non-disclosure of an interest rate swap facility;
the non-disclosure of the significant terms and conditions affecting the amount, timing, and certainty of cash flows;

NZ IAS 36 Impairment of Assets

the non-disclosure of reversals of impairment losses recognised in the period in the segment report;
the non-disclosure that goodwill allocated to cash generating units is not material;

NZ IAS 37 Provisions, Contingent Liabilities and Contingent Assets

the appropriateness of certain provisions relating to managed properties;
the non-disclosure, for each class of provision, of the nature of the obligation, the expected timing of any resulting outflows of economic benefits, uncertainties about the amount or timing of the outflows and information related to any expected reimbursements;

NZ IAS 38 Intangible Assets

the non-disclosure of the remaining amortization period for certain intangible assets;

NZ IAS 41 Agriculture

the non-disclosure, in the reconciliation of changes in the carrying amount of biological assets between the beginning and end of the current period, of increases due to purchases, decreases due to harvest, increases due to business combinations and net exchange differences.

65.

Many of these issues have been resolved with issuers or are under discussion with the issuers. The Commission is pleased that many issuers acknowledged the comments that the Commission has made and have resolved to address particular matters in their subsequent annual reports.

66.

To be useful, the accounting policies stated should be relevant, specific and targeted at the operations and transactions that the company undertakes.

67.

Other than more detailed disclosures in many of the Standards that already exist in New Zealand, NZ IFRS also contains Standards in some areas previously not included specifically in separate New Zealand Standards. Issuers are advised to be aware of new or extended disclosures in areas such as intangible assets, impairment testing, related party disclosures, share based payments, income tax and financial instruments.

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