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New Zealand Securities Commission |
Last Updated: 11 November 2014
Financial Reporting Surveillance Programme
REVIEW OF FINANCIAL REPORTING BY ISSUERS CYCLE 3
CONTENTS
EXECUTIVE SUMMARY
INTRODUCTION
Financial Reporting
Surveillance Programme
Cycle 3 Review of Financial Reporting by
Issuers
Background and Work Undertaken
Purpose of this Report
RESULTS
OF THE REVIEW
Follow-up Action
Outcome of Matters Raised
Significant
Matters
Omission of disclosures required by FRS-41
Parent financial
statements materially incorrect
Retention of a provision where no present
obligation existed
Classification of convertible instruments insufficiently
clear
Non-disclosure of an actual versus prospective financial information
comparison
Lack of a total recognised revenues and expenses line in the
Statement of Movements in Equity
Failure to date the financial
statements
Non-disclosure of a significant future commitment
Accounting
for an unconditional sale of properties
Accounting treatment for recognition
of reclaimed lands
Minor Matters
Recurring minor matters
Miscellaneous
matters
Market Matters: NZX Referrals
FOLLOW-UP FROM CYCLE 1
FOLLOW-UP
FROM CYCLE 2
INTERNATIONAL FINANCIAL REPORTING STANDARDS
ONGOING REVIEW
AND ENFORCEMENT
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 3 the Commission reviewed the financial reports of 45 issuers with balance dates from 31 March 2005 to 30 September 2005. The purpose of the Cycle 3 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 3 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 3 findings were similar to Cycle 1 & 2 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 45 reviewed had matters that needed to be addressed. The Commission wrote to these issuers.
The key issues amongst the significant matters found were:
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 issues relating to continuous disclosure notices that have been referred to NZX for their consideration.
The Commission will continue its Financial Reporting Surveillance Programme. The financial reports of early adopters of New Zealand Equivalents to International Financial Reporting Standards with a 31 December 2005 balance date are currently being reviewed. This is part of the Commission's plan to review disclosures and adjustments made by issuers as they move to NZ IFRS.
Financial Reporting Surveillance Programme
1.
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".
2.
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.
3.
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.
4.
The aim of the Commission's programme is to encourage New Zealand issuers to improve the quality of their financial reporting so that:
Cycle 3 Review of
Financial Reporting by Issuers
5.
In the third cycle of the programme the Commission reviewed the financial
reports of 45 issuers with balance dates from 31 March 2005
to 30 September
2005.
6.
The reports were reviewed against NZ GAAP. Financial statements comply with NZ GAAP only if they comply with:
7.
The purpose of the review was to form a view on:
8.
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.
9.
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
10.
The Commission reviewed the audited full-year financial reports of 45 companies with balance dates from 31 March 2005 to 30 September 2005. To gain a complete view of financial reporting practices the following were also reviewed:
11.
The review of the wider information was to identify any inconsistencies
between the various documents, which in turn helped assess
the adequacy of NZ
GAAP compliance.
12.
The selection of 45 issuers was made up of:
13.
Further enquiries were made 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.
This report on Cycle 3 of the Commission's Financial Reporting Surveillance Programme provides market participants with the Commission's findings from this review. It also provides guidance on the Commission's expectations of disclosure by issuers.
RESULTS OF THE REVIEW
15.
As with Cycles 1 and 2 few serious problems were identified in the Cycle 3
review. However, also similar to the earlier reviews, Cycle
3 found that some
issuers need to raise the standard of their financial reporting.
16.
Most of the identified shortcomings can be remedied by greater attention to detail in respect of the requirements of NZ GAAP.
Follow-up Action
17.
As with Cycle 2, reports of 19 issuers had matters that the Commission
considered 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.
18.
The Commission's approach is to write to issuers whose reporting raises matters of significance. A matter is considered "significant" if further clarification or information is needed. For example, where a matter:
19.
In some cases the disclosures raised questions which prompted the Commission
to seek further explanation. Some responses from issuers
explained the
situation, indicating that the questions would not have been raised if the
issuer's original disclosure had been clearer
or more transparent.
20.
In the letters on significant matters any minor matters were also drawn to
the attention of the issuer. We did not write to issuers
whose reports raised
only minor matters.
21.
A copy of the letter was sent to the issuer's auditor in most cases. 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.
22.
For the first time as part of the on-going surveillance programme a matter relating to an auditor was referred to NZICA for consideration for follow-up action.
Outcome of Matters Raised
23.
Thirty-nine 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 and twenty-nine percent for Cycle 2.
24.
Table 1 on page 8 shows the outcome of matters raised with issuers.
Table 1: Outcome of matters raised in letters to issuers
Notes
|
Outcome
|
Significant
|
%
|
Minor
|
%
|
Total
|
%
|
|
|
|
|
|
|
|
|
(1)
|
Resolved
|
10
|
|
18
|
|
28
|
|
(2)
|
Point taken/change agreed
|
12
|
|
12
|
|
24
|
|
|
Agreement reached
|
22
|
81%
|
30
|
71%
|
52
|
75%
|
|
|
|
|
|
|
|
|
(3)
|
Second letter sent
|
3
|
|
7
|
|
10
|
|
(4)
|
Other follow-up action
|
2
|
|
5
|
|
7
|
|
|
Further follow-up action taken
|
5
|
19%
|
12
|
29%
|
17
|
25%
|
|
|
|
|
|
|
|
|
|
Total matters raised
|
27
|
|
42
|
|
69
|
|
|
%'s
|
39%
|
|
61%
|
|
100%
|
|
|
Notes to the Table
25.
The significant matters that came up several times in Cycle 3 related to:
These
matters are explained further below.
26.
Satisfactory agreement was reached with issuers on 81% of significant matters
raised. Three of the remaining five significant matters
were reiterated in a
second letter and will be monitored on an on-going basis. Two are being followed
up separately.
27.
On a more positive note, the number of instances of failure to date and/sign
the financial report had decreased. The Cycle 3 review
found only one instance
of such non-compliance compared with four in Cycle 2 and three in Cycle 1.
28.
No improvement was found regarding the disclosure of total recognised
revenues and expenses lines in the Statement of Movement in
Equity. Cycle 3
review found six instances of this non-compliance, the same number as in Cycle
2.
29.Apart from the matters noted in paragraph 23 above, other significant
matters noted are generally of a different nature from those
in Cycles 1 and 2.
Significant Matters
30.
The significant matters found were:
31.
The following matters were also raised with issuers:
Issuers provided
adequate explanations about these.
32.
The nature of many of the matters raised with issuers indicates that issuers should pay greater attention to detail in complying with some of the financial reporting disclosures (e.g. disclosures in respect of financial instruments and related party disclosures).
Omission of disclosures required by FRS-41
33.
Entities have to adopt New Zealand Equivalents to International Financial
Reporting Standards (NZ IFRS) for reporting periods beginning
on or after 1
January 2007 or choose to early adopt for reporting periods beginning on or
after 1 January 2005.
34.
Important information on the transition to adoption is required by FRS-41:
Disclosing the Impact of Adopting New Zealand Equivalents
to International
Financial Reporting Standards. FRS-41 applies to annual, half yearly and
quarterly reporting periods of issuers
that end on or after 30 June 2005.
35.
The Commission has analysed the FRS-41 disclosures for Cycle 3 issuers that
were required to make these disclosures.
36.
The Commission acknowledges that a great deal of effort is going into NZ IFRS
transition but is disappointed with the level of response
to these disclosures
in the financial statements examined in Cycle 3.
37.
These disclosures are very important as they provide an opportunity for
issuers to signal to the market as to the likely impact of
adoption of NZ IFRS.
38.
The annual reports of the 45 Cycle 3 issuers indicate that:
The
remaining 7% were issuers to which FRS-41 did not apply because of the timing of
their balance dates.
39.
The Commission has written to issuers that did not include this information
in this report seeking details about the issuers NZ IFRS
conversion
process.
40.
Many did not include a cautionary statement that the actual impact of
adopting NZ IFRS may vary from the information presented and
that the variation
may be material. Others did not include explanations of the expected key
differences or estimated impacts or,
where these were not known, statements to
that effect.
41.
Overall, the level of detail of the disclosures was varied:
The remaining 7% were not
required to disclose information about the transition to NZ IFRS.
42.
Many provided detailed information on the background to adoption of NZ IFRS.
Some disclosed the effects of first time adoption, including
the exemptions
available on first time adoption of NZ IFRS. Some made no disclosure on this.
Issuers who did provide disclosure on
adoption of NZ IFRS devoted space to it
ranging from three sentences to four A4 pages of information.
43.
There is an expectation that if an issuer has some IFRS numbers, the issuer
should disclose them. Also plain English explanations
of what the transition to
IFRS means to readers is always preferred.
44.
Comments on the various specific FRS-41 requirements:
About half the issuers made minimal or no disclosure of their transition management. They either had not started the process or were in the early stages of considering the impact. Many had not determined the adoption date, considered the timing of adoption or identified the expected key areas of difference in accounting policies that were likely to arise.
Issuers identified between one and 12 key areas of difference that were considered most likely to impact on their accounting policies based on the NZ IFRS issued to date. The three most commonly identified areas were NZ IAS 39 Financial Instruments - Recognition and Measurement (cited in 31 instances), NZ IAS 12 Income Taxes (cited in 27 instances) and NZ IAS 38 Intangible Assets (cited in 18 instances). Other areas included accounting for business combinations, share-based payments, revenue, first time adoption of NZ IFRS, property, plant and equipment, investment properties, presentation of financial statements, employee benefits, financial instruments presentation, and impairment.
Parent financial
statements materially incorrect
45.
An issuer in its parent financial statements incorrectly included dividends
received from a subsidiary through the Statement of Movements
in Equity rather
than through the Statement of Financial Performance as required by NZ GAAP.
46.
The effect was to materially understate parent revenue. Although the
transaction eliminates at the group financial statement level
the Financial
Reporting Act does require parent financial statements to fully comply with NZ
GAAP.
47.
The Commission indicated to the issuer that it expects this error to be corrected in their 2006 financial statements.
Retention of a provision where no present obligation
existed
48.
One issuer set up a fund for the purpose of defending certain legal issues
but no significant issues relating to the defence were
noted at year end. The
issuer was asked to provide explanations for the significant provision when
there appeared to be no present
obligation.
49.
FRS-15: Provisions, Contingent Liabilities and Contingent Assets says:
5.1
A provision must be recognised when:
If
these conditions are not met, a provision must not be recognised.
50.
The Commission reminds issuers to ensure that all the conditions of FRS-15 paragraph 5.1 are met before any provision is recognised in the financial statements.
Classification of convertible instruments insufficiently
clear
51.
One issuer was asked about the classification of convertible instruments in
their financial statements. It was not clear whether the
instruments were debt
or not as they had not classified them as either current or non-current
liabilities.
52.
Although companies in the past have sometimes relied on a "mezzanine type"
presentation, more recently companies have moved to classify,
and in many cases
correctly classify, such instruments.
53.
Moreover, being uncommitted in the classification of such financial
instruments does not help readers of financial statements to assess:
"the nature
amounts and liquidity of available resources as required under FRS-2
Presentation of Financial Reports.
54.
FRS-2 (para 8.5) requires all items in the Balance Sheet to be classified as
either equity, asset (current or non-current), or liability
(current or
non-current).
55.
The Commission acknowledge that there are debates 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.
56.
The Commission expects issuers to be guided by NZ GAAP, including relevant overseas guidance, 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 guidance.
Non-disclosure of an actual versus prospective financial information
comparison
57.
The Commission considers that the actual versus prospective financial
information 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.
58.
In one instance the financial statements did not include a comparison of
actual or prospective financial information when this was
required. A comparison
and explanations is required to be included by FRS-9 Information to be Disclosed
in Financial Statements paragraph
5.4.
59.
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.
Lack of a total recognised revenues and expenses line in the Statement
of Movements in Equity
60.
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 line.
61.
The Statement of Movements in Equity is a primary financial statement. FRS-2
Presentation of Financial Reports paragraph 7.1 indicates
that one of the
objectives of the Statement of Movements in Equity is as a measure of
comprehensive income. To this end FRS-2 paragraph
7.3(a) requires disclosure of
a total recognised revenues and expenses line in the Statement of Movements in
Equity. Therefore this
line should be disclosed in a Statement of Movements in
Equity.
62.
Although all of the components making up total recognised revenues and
expenses are disclosed in the Statement of Movements in Equity,
meaning that a
knowledgeable reader could calculate the figure, the Commission believes that it
is important that the total recognised
revenues and expenses figure is also
disclosed.
63.
Six issuers had multiple figures making up total recognised revenues and
expenses. However, even for other issuers where total recognised
revenues and
expenses only comprises Net Surplus, best practice is to disclose a total
recognised revenues and expenses line in the
Statement of Movements in
Equity.
64.
Cycle 3 review found six instances where the Statement of Movements in Equity
did not show the total recognised revenues and expenses
line. The instances of
non-compliance have not declined compared with Cycle 2.
65.
This issue is easy to remedy and the Commission expects issuers to adjust the format of the Statement of Movements in Equity to include the total recognised revenues and expenses line in future financial reports where this is necessary.
Failure to date the financial statements
66.
In Cycle 3 the instances of failure to date the financial statements as required by the Financial Reporting Act 1993 and Companies Act 1993 have decreased. One instance of non-compliance was found compared to 4 and 3 for Cycles 2 and 1 respectively. The Commission views the decrease in instances of non-compliance as a positive development.
Non-disclosure of a significant future commitment
67.
One issuer disclosed what appeared to be a significant commitment in their
Chairman's report but not in their financial statements.
Although the particular
commitment may not be viewed as a capital commitment (which would require
disclosure under FRS-9) for the
financial statements to give a fair
presentation, the issuer should have disclosed this commitment, given the
significant amount
involved.
68.
The Commission encourages issuers to consider whether significant commitments, other than those traditionally viewed as capital, need to be disclosed in their financial statements.
Accounting for an unconditional sale of properties
69.
Two issuers were asked whether there had been inappropriate early recognition
of a purchase/sale of properties. The issuers had accounted
for a purchase/sale
of properties at the point when the unconditional contracts were signed but
before the legal ownership had transferred.
70.
The Commission acknowledges that some parts of the accounting profession may
view that accounting for a purchase when a contract is
unconditional is
acceptable. However, the Commission's view is that recognition should only occur
when the risks and rewards of ownership
have transferred, and this needs to be
fully considered by issuers and their auditors. Prima facie this occurs when
legal ownership
transfers.
71.
IAS 18 Revenue (Appendix A, paragraph 9) deals with accounting for real estate sales. It states that:
Revenue is normally recognised when legal title passes to the buyer. However,
in some jurisdictions the equitable interest in a property
may vest in the buyer
before legal title passes and therefore the risks and rewards of ownership have
been transfrred at that stage.
72.
The Commission expects issuers to ensure that risks and rewards of ownership have transferred before recognising a purchase of properties.
Accounting treatment for recognition of reclaimed lands
73.
The Commission sought explanations from two issuers about their accounting
for reclaimed land and whether or not such land should
be classified as an
asset.
74.
Satisfactory answers have been received from these issuers.
Various minor 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 and 2. Details on these matters are available in the Cycle 1 and 2 reports.
Recurring minor matters
76.
The following matters have been recurring during the three cycle reviews.
Issue
|
Details of FRS/SSAP requirement
|
Details of findings
|
Disclosures relating to property, plant and equipment
|
FRS-3: Property, Plant and Equipment
|
A range of matters relating to revalued property, plant and equipment were
identified. Examples are:
|
General disclosures
|
FRS-9: Information to be Disclosed in Financial Statements
|
A number of instances of non-compliance with FRS-9: Information to be
Disclosed in Financial Statements were noted.Examples are:
The issuers need to comply fully with the requirements of FRS-9
so that readers of financial statements will have sufficient and appropriate
information for decision making.
|
Foreign currency transactions
|
FRS-21: Accounting for the Effects of Changes in Foreign Currency
Exchange Rates
SSAP-21: Accounting for the Effects of Changes in Foreign Currency
Exchange Rates requires disclosures to be made in respect of foreign currency
transactions.
|
Cycle 3 found two instances related to non-disclosure. They were:
|
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 & 2 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:
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). |
Employee share ownership plan (ESOP) disclosures
|
Issuers should include all matters required by FRS-30: Reporting Share
Ownership Arrangements Including Employee Share Ownership Plans.
|
As in the Cycle 1 & 2 review, areas where disclosure of ESOP did not
fully comply with the requirements of FRS-30 were identified
in this review.
|
Financial instrument disclosures
|
FRS-31: Disclosure of Information about Financial Instruments
requires disclosures to be made in respect of financial instruments
|
Findings similar to Cycle 1 & 2.
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:
|
|
77.
Financial instruments are not well addressed by a lot of issuers, possibly because most of the requirements of the FRS-31 are disclosure-related. The present requirements should be met by issuers, but the obligations in respect of financial instruments under NZ IFRS will require issuers to know what is required, particularly as recognition and measurement issues will be involved.
Miscellaneous matters
78.
Other comments raised for issuers to consider as part of the preparation of future financial statements. They were the need to:
Market Matters: NZX
Referrals
79.
Three continuous disclosure regime matters in respect of three issuers were referred to NZX for consideration. The matters were:
80.
Timely and accurate announcements must be made for the continuous disclosure regime to be effective.
FOLLOW-UP FROM CYCLE 1
81.
Cycle 1 reported that the Commission was monitoring the reports of two
issuers that had serious problems.
82.
In one of these matters no further action was taken because any action for
breach of the Securities Act 1978 that may have been available
would have been
outside the limitation period for laying charges.
83.
On the second matter the Commission referred the auditor of the issuer to the New Zealand Institute of Chartered Accountants in the form of a complaint under the Rules of the Institute.
FOLLOW-UP FROM CYCLE 2
84.
At the end of the Cycle 2 Review three matters related to an issuer's
prospectus required further investigation. The Commission has
worked through
these matters with the issuer and concluded that no further action is
warranted.
85.
The matters investigated did highlight the need for issuers to exercise greater care in preparing a prospectus. The reasons for the further investigation were:
INTERNATIONAL FINANCIAL REPORTING
STANDARDS
86.
Issuers have three years within which they can to choose to switch to NZ
IFRS. Issuers have until periods beginning on or after 1
January 2007 to make
this change.
87.
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 are underway and are of NZ IFRS financial statements relating to the
reporting period ended 31 December
2005.
88.
The aim of these early reviews is to gather information on the early
implementation of NZ IFRS and enable the Commission, where appropriate,
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.
89.
Issuers are reminded of the two Practice Notes that the Commission has published dealing with IFRS policy expectations in respect of prospectuses. These are available on the Commission's website www.seccom.govt.nz:
90.
The Commission adopted NZ IFRS for the year ended 30 June 2006. A key lesson from this experience is not to underestimate the work required to assess the NZ IFRS disclosure requirements, including the consequential information requirements to support additional disclosures.
ONGOING REVIEW AND ENFORCEMENT
91.
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 NZ GAAP.
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