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REVIEW OF FINANCIAL REPORTING BY ISSUERS - CYCLE 2

Debt versus equity classification

One issuer was asked why a financial instrument had been classified as equity.
There is debate 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.
The Commission believes that best practice, in accordance with NZ GAAP, is for many of these instruments to be re-classified as debt.
The Commission expects issuers to be guided by GAAP 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 GAAP.

Format of the Statement of Movements in Equity

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 (TRRE) line.
The SoME is a primary financial statement. FRS-2 Presentation of Financial Reports paragraph 7.1 indicates that one of the objectives of the SoME is as a measure of comprehensive income. To this end FRS-2 paragraph 7.3(a) requires disclosure of a TRRE line in the SoME. Therefore this line should be disclosed in a SoME.
Although all of the components making up TRRE are disclosed in the SoME, meaning that a knowledgeable reader could calculate the figure, the Commission believes that it is important that the TRRE figure is also disclosed.
Six issuers had multiple figures making up TRRE. However, even for other issuers where TRRE only comprises Net Surplus, best practice is to disclose a TRRE line in the SoME.
This issue is easy to remedy and issuers will be able to adjust the format of the SoME in future financial reports where this is necessary.

Actual versus Prospective Financial Information comparison

The Commission considers that the actual versus prospective financial information (PFI) 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.
In a number of instances either the financial statements did not include a comparison of actual or PFI when this would be required, or no explanations of major variations between PFI and actual results were disclosed. Inclusion of a comparison and explanations is required by FRS-9 Information to be Disclosed in Financial Statements paragraph 5.4.
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.

Dating and signing of financial statements and annual reports

During both this and the previous Cycle reviews the Commission observed that many financial statements and/or annual reports do not meet the Financial Reporting Act and Companies Act 1993 sign-off and dating requirements. These sign-offs are important because they indicate that the directors have reviewed all the material in those documents, and inform investors of the date on which the parts of the document were signed.
The Commission encourages issuers, as a matter of best practice, to date the various components of the annual report (the financial statements, the Chairman's report, the Chief Executive's report, and any substantial security holder information) as well as dating the report as a whole.
The date of the annual report might be later than the date and signing of the financial statements because of the need to assemble and include other annual report material. For example, substantial security holder information must be recorded as at a date not earlier than 3 months before the annual report is sent out (under section 26(1) of the Securities Markets Act 1988).
Auditors have a responsibility to ensure that there is no other information in the annual report that conflicts materially with the financial statements (paragraph 14 of Auditing Standard AS-518 as issued by the New Zealand Institute of Chartered Accountants). As required by paragraph 15 of AS-518, either the auditor arranges to see other material before they sign the audit report or else the guidance in paragraphs 28-33 is followed where the other annual report material is produced after the auditor signs the audit report.

Other significant matters followed up with issuers

Other significant matters followed up with issuers were:
1. an apparent overstatement of value of a property intended for sale.
  
  Despite the existence of a sale agreement and price the carrying value of a property intended for sale was being maintained at a higher figure. An explanation for the lack of a write-down in the value of the asset was sought from this issuer.
2. disclosure of an intangible under a separate heading in addition to current and non-current assets.
  
  The intangible asset had been disclosed under a separate heading in the Statement of Financial Position of an issuer and not under current assets or non-current assets. FRS-2 (para. 8.5) states that the Statement of Financial Position shall separately disclose Current Assets and Non-current Assets, it does not anticipate any other asset groupings.

Other Matters

Various other matters were identified which, although of lesser significance, warrant greater attention by those who prepare annual reports. Most of the matters are similar to those matters identified during Cycle 1. More details on these matters are available in the Cycle 1 Report of August 2005.

FRS-3

A range of matters relating to revalued property, plant and equipment were identified. Examples of these are:
1. non-disclosure of the name of the valuer;
2. misleading disclosure regarding the transfer of revaluation deficits to retained earnings upon disposal; and
3. incorrect inclusion of a revaluation movement as part of the unrealised net change in the value of investment properties line item.

Employee share ownership plans

Employee share ownership plan (ESOP) disclosures should include all matters required by FRS-30 Reporting Share Ownership Arrangements Including Employee Share Ownership Plans.
As in the Cycle 1 review, areas where disclosure of ESOP did not fully comply with the requirements of FRS-30 were identified in this review.
Where issuers have an ESOP they need to ensure that their financial statements fully comply with the requirements of FRS-30.

Financial instruments

FRS-31 Disclosure of Information About Financial Instruments requires disclosures to be made in respect of financial instruments.
The findings were largely similar to results from Cycle 1. The review indicated that improvements could be made in the general quality of disclosures required by this standard. Some disclosures appeared to be fairly generic and sometimes incomplete. In many instances financial instrument disclosures for the issuers reviewed appeared to not comply with some of the detailed requirements of FRS-31.
Examples of findings in respect of financial instrument disclosures were:
1. the accounting policy disclosure on financial instruments did not cover the basic types of financial instruments;
2. a lack of interest rate sensitivity information disclosure in respect of, e.g. short-term deposits, term deposits, bank overdraft and convertible notes; and
3. disclosures not being given in the parent accounts for financial transactions between the parent and its subsidiaries.

Disclosure about related parties

SSAP-22 Related Party Disclosures requires disclosure of the relationships between the reporting entity and its related parties and of transactions with those parties.
Similar to Cycle 1 the adequacy and quality of disclosure by issuers could be improved. The identification and disclosure of related party transactions are material matters for investors.
Most of the matters identified in this area related to the inadequacy of disclosures in respect of transactions between the parent entity and its subsidiaries and associates. For example:
1. a lack of detail about the identity of the related parties for which there have been transactions
2. a total was given for related parties as a group rather than for each related party; and
3. the outstanding balance of transactions at balance date were not given.
SSAP-22 requires full disclosure of such transactions in the parent company accounts even though it acknowledges that eliminated group transactions are not required to be disclosed in the group accounts (SSAP-22, para. 4.17).

Miscellaneous

Other comments raised for issuers to consider as part of the preparation of their future financial statements were:
1. the need to provide reasons for an accounting policy change (FRS-1, para. 5.11);
2. disclosure of a total operating revenue figure (FRS-9, para. 6.6);
3. consideration be given to disclosing exceptional risks of operating (FRS-9, para. 8.14);
4. appropriate inclusion and clarity of disclosure for cash flows from investing;
5. further disclosure in respect of contingent rental payments; and
6. calculation and disclosure of the interest unwind on a longer term provision (FRS-15, para. 8.2). The interest unwind occurs where discounting has been used and the carrying amount of a provision increases each period to reflect the passage of time. The increase is an interest expense.

Market Matters

The Commission raised several matters relating to disclosures in respect of directors and officers relevant interests, substantial security holder information, and waivers.
Most matters in respect of directors' and officers' interests and substantial security information disclosures have been resolved.

Directors' and officers' relevant interests disclosures

Section 19T of the Securities Markets Act 1988 requires directors and officers of a public issuer who have a relevant interest in a security of the issuer to disclose that interest to the NZX and in the interests register of the public issuer.
Details of new entries in a public issuer's interest register are then required to be disclosed in the issuer's annual report.

Substantial security holder information

The review identified some inconsistencies in the substantial security holder disclosures. The Commission expects compliance with these requirements.
Section 26(1) of the Securities Markets Act 1988 requires every public issuer to publish a list of all substantial security holders recorded in the company's file kept under section 25 of the Act. The disclosure under section 26 of the Securities Markets Act must include the total number of voting securities of the public issuer as at the date of the record.
Issuers and substantial security holders should take care to ensure that they comply with the various substantial security holder information disclosure requirements.

NXZ waivers

During Cycle 2 two instances were found of non-disclosure in an annual report of an NZX waiver.
The issuers had obtained waivers from the NZX in respect of NZX Listing Rules. The condition associated with the granting of these waivers was that the issuers disclose the waiver in their annual report.
These matters have been referred to the NZX.
The non-disclosure of a waiver identified during Cycle 1 was considered by the NZX Regulation (NZXR) who decided that the matter was not sufficiently serious to put to NZX Discipline. However, the NZXR decided not to provide relief in the form of a retrospective waiver to correct previous mistakes, and has required that the issuer seek shareholder ratification of the matter at the issuer's next annual meeting.
The NZXR has reminded issuers that waivers subject to conditions will be void if the conditions are not adhered to.

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