Attachment 1 to 15-380MR: Findings from 30 June 2015 financial reports

1. Asset values and impairment testing

ASIC continues to identify concerns regarding assessments of the recoverability of the carrying values of assets, including goodwill, exploration and evaluation expenditure, and property, plant and equipment. The largest number of ASIC’s enquiries at 30 June 2015 relate to assets in the extractive industries.

Findings include:

1. Determining the carrying amount of cash generating units: There are cases where entities:
   1. appear to have identified cash generating units (CGUs) at too high a level despite cash inflows being largely independent, resulting in cash flows from one asset or part of the business being incorrectly used to support the carrying values of other assets
   2. did not include all assets that generate the cash inflows in the carrying amount of a CGU, such as inventories and trade receivables and tax balances, and
   3. incorrectly deducted liabilities from the carrying amount of a CGU.
2. Reasonableness of cash flows and assumptions: There continue to be cases where the cash flows and assumptions used by entities in determining recoverable amounts are not reasonable or supportable having regard to matters such as historical cash flows, economic and market conditions, and funding costs.
   
   In particular, ASIC found cases where:
   1. assumptions derived from external sources were not assessed for consistency and relevance, and
   2. the entity’s forecast cash flows did not appear reasonable and had exceeded actual cash flows for a number of reporting periods.

3. Fair value assessments of recoverable amounts: ASIC is still seeing entities using discounted cash flow techniques to determine fair value where the calculations are dependent on a large number of management inputs. Where it is not possible to reliably estimate the value that would be received to sell an asset in an orderly transaction between market participants, the entity may need to use the asset’s value in use as its recoverable amount.

4. Impairment indicators: Some entities are not having sufficient regard to impairment indicators, such as significant adverse changes in market conditions, and reported net assets exceeding market capitalisation.

5. Disclosures: ASIC is still finding that there a number of entities not making necessary disclosure of:

1. sensitivity analysis where there is limited excess of an asset’s recoverable amount over the carrying amount and where a reasonably possible change in one or more assumptions could lead to impairment
2. key assumptions, including discount rates and growth rates, and
3. for fair values, the valuation techniques and inputs used.

These disclosures are important to investors and other users of financial reports given the subjectivity of these calculations/assessments. They enable users 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.

This item includes matters arising from the finalisation of impairment matters identified in our reviews of 31 December 2014 financial reports.

2. Revenue recognition

ASIC is following up eight matters concerning the recognition of revenue, including the recognition of construction contract income as a result of claims, the treatment of deferred income and the timing of bringing the revenue to account.

This item includes comments regarding matters arising from revenue recognition matters identified in our reviews of 30 June 2014 financial reports.

3. Tax accounting

ASIC is making enquiries of four entities concerning their accounting for income tax, and in particular, the substantiation of their tax expense positions. This included where there appeared to be unusual reconciling items between accounting profit and tax expense/benefit that resulted in either significant tax benefits or tax expenses.

ASIC also made enquiries of an entity as to whether it is probable that future taxable income will be sufficient to enable the recovery of deferred tax assets relating to tax losses.

4. Deferred expenses

ASIC is making enquiries of three entities in relation to the deferral of expenses as assets. An example is expenses relating to tendering for construction contracts that are yet to be awarded.

5. Classification of liabilities

ASIC is making enquiries of two entities in relation to the classification of debt as non-current when there are indicators that the borrowings may meet the definition of current liabilities. Entities should have regard to the circumstances surrounding their borrowings as at the balance date and in particular what arrangements exist to refinance or rollover. In addition, entities should evaluate whether they hold rights that allow them to defer settling the liability for at least 12 months.

6. Estimates and accounting policy judgements

ASIC observed instances where entities needed to improve the quality and completeness of disclosures in relation to estimation uncertainties, and significant judgments in applying accounting policies. The disclosure requirements are principle-based and should include all information necessary for investors and others to understand the judgements made and their effect. This may include key assumptions, reasons for judgements, alternative treatments, and appropriate quantification.

These disclosures are important to allow users of the financial report to assess the reported financial position and performance of an entity.

Following the approval of a new international auditing standard, auditors will be required to disclose information on key audit matters in future audit reports. Directors should ensure that relevant information is already disclosed in the financial report and in the operating and financial review.