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REVIEW OF FINANCIAL REPORTING BY ISSUERS - CYCLE 2

EXECUTIVE SUMMARY

The Commission has established a financial reporting surveillance programme to review financial reporting practices of issuers. The aim is to encourage New Zealand issuers to improve the quality of their financial reporting.

In Cycle 1 of the programme the Commission reviewed the financial reports of 40 issuers with balance dates from 31 March to 31 July 2004. The Commission published a report on Cycle 1 in August 2005.

In Cycle 2 the Commission reviewed the financial reports of 46 issuers with balance dates from 31 December 2004 to 31 March 2005. The purpose of the Cycle 2 review was to identify the level of compliance with Financial Reporting Standards and other elements of Generally Accepted Accounting Practice and to assess the overall quality of financial reporting.

This report on the Cycle 2 Review provides market participants with the Commission's findings from this review, and gives some guidance on the Commission's expectations of disclosure by issuers.

Cycle 2 findings were similar to Cycle 1 results in that few serious problems were identified, but a number of issuers need to raise the standard of their financial reporting. Reports of 19 issuers of the 46 reviewed had matters that need to be addressed. We wrote to these issuers.

Some of the matters found were:

large differences between actual and prospective information in one instance;
inadequate actual versus prospective financial information comparisons and explanation;
lack of a total recognised revenues and expenses line in the Statement of Movements in Equity;
failure to date and/or sign the financial statements;
apparent overstatement of value of a property intended for sale; and
disclosure of an intangible under a separate heading in addition to current and non-current assets.

The Commission has been pleased with the cooperation from issuers and their willingness to improve the quality of their financial reporting.

The review also identified some inconsistencies in directors' and officers' relevant interests and substantial security holder disclosures that required us to write to issuers and security holders. Some non-disclosure of NZX waivers were identified and referred to the NZX.

The Commission will continue its Financial Reporting Surveillance Programme. The financial reports of early adopters of New Zealand equivalents of International Financial Reporting Standards with a 31 December 2005 balance date will be reviewed early in 2006. This will be part of the Commission's plan to review disclosures and adjustments made by issuers as they move to NZ IFRS.

INTRODUCTION

Financial Reporting Surveillance Programme

The Securities Commission is required under section 10(c) of the Securities Act 1978, "to keep under review practices relating to securities, and to comment thereon to any appropriate body".
As part of its work to carry out this function the Commission has established a financial reporting surveillance programme to review financial reporting practices of public issuers.
The Financial Reporting Act 1993 requires issuers to prepare financial statements that comply with New Zealand Generally Accepted Accounting Practice (NZ GAAP) and give a true and fair view of the matters to which they relate.
The aim of the Commission's programme is to encourage New Zealand issuers to improve the quality of their financial reporting so that:
1. issuers' financial report disclosures are clear and comprehensive;
2. investors can have confidence in the credibility of financial information provided by issuers; and
3. high quality financial reporting will contribute to the integrity of New Zealand's securities markets.

Cycle 2 Review of Financial Reporting by Issuers

In the second cycle of the programme the Commission reviewed the financial reports of 46 issuers with balance dates from 31 December 2004 to 31 March 2005.
The reports were reviewed against NZ GAAP. Financial statements comply with NZ GAAP only if they comply with:
1. applicable Financial Reporting Standards (FRS) approved by the New Zealand Accounting Standards Review Board; and
2. where there are no such standards, accounting policies that:
  1. are appropriate to the circumstances of the reporting entity; and
  2. have authoritative support within the accounting profession in New Zealand. This includes Statements of Standard Accounting Practice (SSAP).
The purpose of the review was to form a view on:
1. the level of compliance with NZ GAAP by issuers in their financial statements prepared under the Financial Reporting Act 1993;
2. whether any breaches of GAAP identified in those financial statements were likely to cause the financial statements to not show a true and fair view, or were likely to be materially misleading to users in the context of information disclosure (for investment decision-making) as envisaged under the Securities Act 1978 and therefore require enforcement action; and
3. the overall quality of financial reporting practices by issuers.
Although the main focus of the review was the financial statements, other sections of the annual report and continuous disclosure notices for the period were also considered. These were not comprehensively reviewed, although any obvious issue related to continuous disclosure, directors' and officers' relevant interests disclosure or substantial security holder disclosure was followed up.
Financial reporting requires the exercise of professional judgment. The Commission took this into account when reviewing the financial reports and determining which matters to follow up.

Background and Work Undertaken

The Commission reviewed the audited full-year financial reports of 46 companies with balance dates from 31 December 2004 to 31 March 2005. To gain a complete view of financial reporting practices we also reviewed:
1. financial information in any current prospectuses;
2. substantial security holder information;
3. continuous disclosure notices; and
4. sections of the annual reports (e.g. the chairman's report).
The review of the wider information was to identify any inconsistencies between the various documents, which in turn helped assess the adequacy of GAAP compliance.
The selection of 46 issuers was made up of:
1. 35 issuers listed on the NZX;
2. 5 issuers listed on the NZAX;
3. 1 issuer whose shares are traded on Unlisted, and
4. 5 other non-listed issuers.
We made further enquiries of some issuers. In some instances this was because it was not possible to assess whether NZ GAAP had been fully complied with from the information provided in the financial statements and other documents.

Purpose of this Report

This report on Cycle 2 of the Commission's Review of Financial Reporting by Issuers aims to provide market participants with the Commission's findings from this review. It also provides some guidance on the Commission's expectations of disclosure by issuers.

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