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Financial reporting surveillance programme Cycle 2 [2006] NZSecCom 1 (20 February 2006)
Last Updated: 10 November 2014
Financial Reporting Surveillance Programme
REVIEW OF FINANCIAL REPORTING BY ISSUERS
CYCLE
2
20 February 2006
TABLE OF CONTENTS
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:
- issuers'
financial report disclosures are clear and comprehensive;
- investors
can have confidence in the credibility of financial information provided by
issuers; and
- 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:
- applicable
Financial Reporting Standards (FRS) approved by the New Zealand Accounting
Standards Review Board; and
- where
there are no such standards, accounting policies that:
- are
appropriate to the circumstances of the reporting entity; and
- 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:
- the
level of compliance with NZ GAAP by issuers in their financial statements
prepared under the Financial Reporting Act 1993;
- 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
- 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:
- financial
information in any current prospectuses;
- substantial
security holder information;
- continuous
disclosure notices; and
- 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:
- 35
issuers listed on the NZX;
- 5
issuers listed on the NZAX;
- 1
issuer whose shares are traded on Unlisted, and
- 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.
RESULTS OF THE REVIEW
- Few
serious problems were identified in the Cycle 2 review as was the case with
Cycle 1. However, the review indicates that a number
of issuers need to raise
the standard of their financial reporting.
- Most
of the identified issues can be remedied by greater attention to detail in
respect of the requirements of NZ GAAP.
Follow-up
Action
- Reports
of 19 issuers were found to have matters that the Commission considers should be
addressed. Letters were sent to these 19
issuers asking them to clarify some
matters, and/or to address specific shortcomings when preparing their next
financial reports.
- The
Commission's approach is to write to those issuers whose reporting raises
matters of significance. In these letters any minor
matters were also drawn to
their attention. We view a matter as "significant" if further clarification or
information is needed.
- A
copy of the letter was sent to the issuer's auditor. Auditors have an important
role in encouraging companies to comply not only
with the statutory requirements
but also with best practice. The Commission encourages auditors to be vigilant
in the audit of financial
statements. High quality external auditing is critical
to integrity in financial reporting. Investors rely heavily on the external
assurance of an issuer's financial reporting.
Outcome of
Matters Raised
- Thirty-six
percent of the matters raised in letters to issuers were viewed by the
Commission as significant. This compares with fifty-two
percent for Cycle
1.
- Table
1 on page 8 outlines the outcome of matters raised with issuers.
Table 1: Outcome of matters raised in letters to issuers
|
Notes
|
Outcome
|
"Significant"
|
%
|
Other
|
%
|
Total
|
%
|
(1)
|
Resolved
|
6
|
|
19
|
|
25
|
|
(2)
|
Point taken/change agreed
|
14
|
|
19
|
|
33
|
|
|
Agreement reached
|
20
|
83%
|
38
|
88%
|
58
|
87%
|
|
|
|
|
|
|
|
|
(3)
|
Second letter sent
|
3
|
|
5
|
|
8
|
|
(4)
|
Other follow-up action
|
1
|
|
0
|
|
1
|
|
|
Further follow-up action taken
|
4
|
17%
|
5
|
12%
|
9
|
13%
|
|
|
|
|
|
|
|
|
|
Total matters raised
|
24
|
|
43
|
|
67
|
|
|
%'s
|
36%
|
|
64%
|
|
100%
|
|
Notes to the Table
(1)
Resolved: a satisfactory explanation was provided by the issuer on the
matters raised.
(2)
Point taken / change agreed: the issuer has acknowledged the point made /
agreed to make changes in the 2005 or 2006 financial statements.
(3)
Second letter sent: a second letter closed the matter but reiterated the
points made.
(4)
Other follow-up action: more action required, e.g. the need for subsequent
correspondence to seek answers to follow-up questions.
- The
significant matters that came up several times in Cycle 2 related to:
- the
format of the Statement of Movements in Equity - lack of a total recognised
revenues and expenses line (6 instances);
- failure
to date and/or sign the financial report (4 instances);
and
- inadequate
actual versus prospective financial information comparison (3
instances).
These matters are explained further below.
- Satisfactory
agreement was reached with issuers on 83% of significant matters raised. Three
of the remaining four significant matters
were reiterated in a second letter and
will be monitored on an on-going basis. One matter is still under review.
- There
was a reasonable degree of similarity between matters found in Cycle 1 and Cycle
2.
- It
is acknowledged that Cycle 2 issuers did not have the benefit of being able to
read the Cycle 1 report before preparing their financial
statements. The Cycle 1
report is expected to provide a guide for issuers with balance dates after its
publication.
Significant Findings
Financial reporting disclosures
- The
nature of many of the matters raised with issuers suggests that issuers should
pay greater attention to detail in complying with
some of the ancillary
financial reporting disclosures (e.g. disclosures in respect of financial
instruments and related party disclosures).
- In
some cases the disclosures provided raised questions which prompted the
Commission to seek further explanation. Some of the responses
explained the
situation, indicating that the questions would not have been raised if there had
been more clarity or transparency
by the issuer in the original disclosure.
- One
issuer reported large differences between actual and prospective financial
information. The Commission's interest is in:
- the
basis for the projections;
- the
basis for the prospective financial information included as a comparison in the
year end financial report; and
- inconsistencies
in labelling of prospective financial information between the prospectus and the
annual report.
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:
- 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.
- 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:
- non-disclosure
of the name of the valuer;
- misleading
disclosure regarding the transfer of revaluation deficits to retained earnings
upon disposal; and
- 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:
- the
accounting policy disclosure on financial instruments did not cover the basic
types of financial instruments;
- a
lack of interest rate sensitivity information disclosure in respect of, e.g.
short-term deposits, term deposits, bank overdraft
and convertible notes;
and
- 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:
- a
lack of detail about the identity of the related parties for which there have
been transactions
- a
total was given for related parties as a group rather than for each related
party; and
- 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:
- the
need to provide reasons for an accounting policy change (FRS-1, para.
5.11);
- disclosure
of a total operating revenue figure (FRS-9, para. 6.6);
- consideration
be given to disclosing exceptional risks of operating (FRS-9, para.
8.14);
- appropriate
inclusion and clarity of disclosure for cash flows from investing;
- further
disclosure in respect of contingent rental payments; and
- 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.
FOLLOW-UP FROM CYCLE 1
- The
Commission continues to monitor the reports of two issuers reviewed in Cycle 1
that had serious problems.
- Matters
identified in Cycle 1 relating to two other issuers are still being
investigated.
INTERNATIONAL FINANCIAL
REPORTING STANDARDS
- Issuers
have three years within which they will be able to choose to make the switch to
NZ IFRS.
- As
part of its surveillance programme the Commission will review NZ IFRS financial
statements of a selection of issuers during this
period. The first reviews will
be of NZ IFRS financial statements relating to the reporting period ended 31
December 2005.
- The
aim of these early reviews is to provide feedback to the Commission on the early
implementation of NZ IFRS and enable the Commission,
where appropriate, to be
able to provide feedback to later appliers of NZ IFRS. The Commission will seek
to maintain an appropriate
balance between education and enforcement during the
initial adoption of NZ IFRS.
- Disclosures
about the impact of adopting NZ IFRS must be made by issuers prior to adopting
NZ IFRS as required by FRS-41 Disclosing the Impact of Adopting New Zealand
Equivalents to International Financial Reporting Standards. These
disclosures will be reviewed as part of the
programme.
ONGOING REVIEW AND
ENFORCEMENT
- The
Commission will continue to review issuers' financial reporting as part of the
Financial Reporting Surveillance Programme and
to take any appropriate steps to
encourage compliance with Financial Reporting Standards and other elements of
GAAP.
* * * * *
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