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Wednesday 31 May 2017

17-162MR ASIC calls on preparers to focus on the quality of financial report information

ASIC has continued to call on companies to focus on giving information for users of financial reports that is useful and meaningful.

Announcing its focus areas for 30 June 2017 financial reports of listed entities and other entities of public interest with many stakeholders, ASIC highlighted key areas to address.

ASIC Commissioner John Price said, 'As with previous reporting periods, directors and auditors should focus on values of assets and accounting policy choices. ASIC continues to see companies use unrealistic assumptions in testing the value of assets or apply inappropriate approaches in areas such as revenue recognition.'

As part of ASIC's Financial Reporting Surveillance Program, financial reports are selected for review, based on risk-based criteria and at random, to determine compliance with the Corporations Act and accounting standards. 

The role of directors and management

Directors are primarily responsible for the quality of the financial report. This includes ensuring that management produces quality financial information. Companies must have appropriate processes and records to support information in the financial report rather than simply relying on the independent auditor.

Companies should apply appropriate experience and expertise, particularly in more difficult and complex areas such as accounting estimates (including impairment of non-financial assets), accounting policies (such as revenue recognition) and taxation.

While ASIC does not expect directors to be accounting experts they should seek explanation and advice supporting the accounting treatments chosen and, where appropriate, challenge the accounting estimates and treatments applied in the financial report. They should particularly seek advice where a treatment does not reflect their understanding of the substance of an arrangement.

Information should be produced on a timely basis and be supported by appropriate analysis and documentation for the independent audit.

This will support the quality of financial information in the market and enable auditors to focus on their role in providing independent assurance on the financial report.

Further information can be found in ASIC Information Sheet 183 Directors and financial reporting (INFO 183) and ASIC Information Sheet 203 Impairment of non-financial assets: Materials for directors (INFO 203).

New accounting standards

The introduction of some major new accounting standards will have the greatest impact on financial reporting since the adoption of International Financial Reporting Standards in 2005.

It is important that directors and management plan for these new standards and inform investors and other financial report users of the impact on reported results.  This includes making required disclosures on the impact of the standards in notes to the financial report.  This may well mean quantification of the impacts for the reporting date that coincides with the start of the first comparative period that will be affected in a future financial report.  Subject to transitional arrangements, that is 30 June 2017 for new standards on revenue and financial instrument valuation.

Further information can be found in ASIC media release Companies need to respond to major new accounting standards (refer: 16-442MR) 

Enhanced audit reports

Auditors of listed entities are required to issue enhanced audit reports. These audit reports will outline key audit matters - those matters that required significant auditor attention in performing the audit. Preparers and directors should be mindful that these matters may relate to accounting estimates and significant accounting policy choices that also require specific disclosures in financial reports, as well as matters relating to the business that should be covered in the Operating and Financial Review.

Auditors should describe key audit matters and their work in those areas in a clear and understandable manner, having regard to the broad audience of investors and other users of financial reports.  The description of key audit matters and the work performed should be specific to the circumstances of the company and the audit. 

Material disclosures

ASIC’s surveillance continues to focus on material disclosures of information useful to investors and others using financial reports, such as assumptions supporting accounting estimates and significant accounting policy choices.

ASIC will not pursue immaterial disclosures that may add unnecessary clutter to financial reports; efforts should be made to communicate information more clearly in financial reports. 

Client monies

Australian financial services licensees should ensure that client monies are appropriately held in separate, designated trust bank accounts, and that monies are applied in accordance with client instructions and the requirements of the Corporations Act. Auditors are reminded of the importance of audit testing to obtain assurance that assets and liabilities are not materially misstated, that monies are dealt with appropriately and that breaches are reported to ASIC in accordance with that Act and Regulatory Guide 34 Auditors' obligations: Reporting to ASIC (RG 34)

Operating and financial review

Listed companies should continue to disclose information on matters that may have a material impact on the future financial position of the entity. This could include, for example, matters relating to climate change or cyber-security. 

Proprietary companies

ASIC continues to review the financial reports of proprietary companies and unlisted public companies, based on complaints and other intelligence. We proactively identify and follow up where such companies have not met their obligation to lodge financial reports with ASIC. It is their responsibility to do so and ASIC will take all necessary steps to see this done. 

More information

More detailed information on focus areas for 30 June 2017 is provided in the following attachment to this media release.

Attachment to 17-162MR: ASIC calls on preparers to focus on the quality of financial report information

Focuses for 30 June 2017 financial reports

Accounting estimates

1. Impairment testing and asset values

The recoverability of the carrying amounts of assets such as goodwill, other intangibles and property, plant and equipment continues to be an important area of focus.

It is important for directors and auditors to ensure:

(a) cash flows and assumptions are reasonable having regard to matters such as historical cash flows, economic and market conditions, and funding costs. Where prior period cash flow projections have not been met, careful consideration should be given to whether current assumptions are reasonable and supportable;

(b) discounted cash flows are not used to determine fair value less costs of disposal where forecasts and assumptions are not reliable. Fair value less costs to sell should not be viewed as a means to use unreliable estimates that could not be used under a value in use model;

(c) value in use calculations:

  • use sufficiently reliable cash flow estimates
  • do not use increasing cash flows after five years that exceed long term average growth rates, and without taking into account offsetting impacts on discount rates, and
  • do not include cash flows from restructures and improving or enhancing asset performance

(d) cash flows used are matched to carrying values of all assets that generate those cash flows, including inventories, receivables and tax balances;

(e) different discount rates are used for cash generating units (CGUs) where the risks are different and the CGUs are located in different countries, and that similar discount rates are used where the risks are similar;

(f) CGUs are not identified at too high a level, including where cash inflows for individual assets are not largely independent;

(g) CGUs for testing goodwill are not grouped at a higher level than the operating segments or the level at which goodwill is monitored for internal management purposes;

(h) corporate costs and assets are allocated to CGUs on an appropriate basis where it is reasonable to allocate them; and

(j)  appropriate use of fair values for testing exploration and evaluation assets during the exploration and evaluation phase.

Further information can be found in ASIC Information Sheet 203 Impairment of non-financial assets: Materials for directors (INFO 203).

Particular consideration may need to be given to values of assets of companies in the extractive industries or providing support services to extractive industries, including assets during the exploration and evaluation phase.

In addition to considering asset values in the extractive industries, directors and auditors should also focus on the adequacy and treatment of any liabilities required for mine restoration and closure costs.

Asset values may also be affected by the risk of digital disruption.

Focus should also be given to the pricing, valuation and accounting for inventories, including the net realisable value of inventories, possible technical or commercial obsolescence, and the substance of pricing and rebate arrangements.

Directors and auditors should focus on the valuation of financial instruments, particularly where values are not based on quoted prices or observable market data. Fair values should be based on appropriate models, assumptions and inputs. This includes the valuation of financial instruments by financial institutions.

Accounting policy choices

2. Revenue recognition

Directors and auditors should review an entity’s revenue recognition policies to ensure that revenue is recognised in accordance with the substance of the underlying transactions. This includes ensuring that:

(a)   services to which the revenue relates have been performed;

(b)  control of relevant goods has passed to the buyer;

(c)  where revenue relates to both the sale of goods and the provision of related services, revenue is appropriately allocated to the components and recognised accordingly;

(d)  assets are properly classified as financial or non-financial assets; and

(e) revenue is recognised on financial instruments on the basis appropriate for the class of instrument.

The appropriate timing of revenue recognition may also need careful consideration in industries with complex sale and licensing arrangements that may include continuing obligations, such as software providers.

3. Expense deferral

Directors and auditors should ensure that expenses are only deferred where:

(a) there is an asset as defined in the accounting standards;

(b) it is probable that future economic benefits will arise; and

(c)  the requirements of the intangibles accounting standard are met, including:

(i)  expensing start-up, training, relocation and research costs;

(ii)  ensuring that any amounts deferred meet the requirements concerning reliable measurement; and

(iii) development costs meet the six strict tests for deferral.

4.  Off-balance sheet arrangements

Directors and auditors should carefully review the treatment of off-balance sheet arrangements, the accounting for joint arrangements and disclosures relating to structured entities.

5.  Tax accounting

Tax effect accounting can be complex and preparers of financial reports should ensure that:

(a)  there is a proper understanding of both the tax and accounting treatments, and how differences between the two affect tax assets, liabilities and expenses;

(b) the impact of any recent changes in legislation are considered;  and

(c)  the recoverability of any deferred tax asset is appropriately reviewed.

Key disclosures

6. Estimates and accounting policy judgements

Disclosures regarding sources of estimation uncertainty and significant judgements in applying accounting policies are important to allow users of the financial report to assess the reported financial position and performance of an entity. Directors and auditors should ensure disclosures are made and are specific to the assets, liabilities, income and expenses of the entity.

Disclosure of key assumptions and a sensitivity analysis are important. These enable users of the financial report to make their own assessments about the carrying values of the entity’s assets and risk of impairment given the estimation uncertainty associated with many asset valuations.

Preparers should be particularly mindful to make these disclosures as this information may be revealed under key audit matter disclosures in the new enhanced audit reports for listed entities.  Preparers should note that the key audit matter disclosures may also refer to matters that should have been discussed in the Operating and Financial Review.

7. Impact of new revenue, financial instrument, lease and insurance standards

Directors and auditors should ensure that notes to 30 June 2017 financial statements disclose the impact on future financial position and results of new requirements for recognising revenue, for valuing financial instruments, and accounting for leases. New accounting standards in these areas will apply to future financial reports and may significantly affect how and when revenue can be recognised, the values of financial instruments (including loan provisioning and hedge accounting), and assets and liabilities relating to leases.  The International Accounting Standards Board has also issued a new accounting standard for insurance companies.

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Last updated: 19/06/2017 09:21