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New Zealand Securities Commission |
Last Updated: 16 November 2014
FINANCIAL REPORTING SURVEILLANCE PROGRAMME
REVIEW OF FINANCIAL REPORTING BY ISSUERS
For the periods ended 30 June 2009 - 31 January 2010
CYCLE
12
Securities Commission New Zealand
Level 8, Unisys House
56 The Terrace
P O Box 1179
WELLINGTON 6011
October 2010
ISBN 978-0-478-36510-8 (print) ISBN 978-0-478-36511-5 (pdf)
CONTENTS
EXECUTIVE SUMMARY
..................................................................................................................
3
ALTERNATIVE PERFORMANCE MEASURES
...........................................................................
3
INTRODUCTION
................................................................................................................................
5
CYCLE 12 FINDINGS
........................................................................................................................
6
Scope and issuer selection
....................................................................................................
6
Overall comments on Cycle 12
.............................................................................................
6
Outcome of matters raised
....................................................................................................
7
Specific comments on Cycle 12 findings.............................................................................. 9
Financial instruments: disclosures ..............................................................................................9
Financial instruments: measurement and recognition ............................................................. 12
Impairment of non-financial assets ........................................................................................... 13
Description of non-audit services provided................................................................................ 15
Other
matters...............................................................................................................................
16
SECURITIES COMMISSION WORKSHOP
.................................................................................
17
ALTERNATIVE PERFORMANCE MEASURES
.........................................................................
19
CONCLUSION
...................................................................................................................................
20
LOOKING AHEAD
...........................................................................................................................
20
APPENDIX 1: BACKGROUND TO THE SECURITIES COMMISSION’S FINANCIAL
REPORTING SURVEILLANCE
PROGRAMME.........................................................................
21
The Commission’s Financial Reporting Surveillance
Programme..................................... 21
New Zealand Generally Accepted Accounting
Practice..................................................... 22
Selecting issuers
..................................................................................................................
23
Identifying matters and taking action ................................................................................. 23
3
EXECUTIVE SUMMARY
The Financial Reporting Surveillance Programme (FRSP) is designed to
encourage high- quality financial reporting that enhances the
credibility of
financial information provided by issuers and, therefore, strengthens investor
confidence.
Our FRSP report informs directors, chief financial officers and other
financial statement preparers, auditors and financial analysts
on what the New
Zealand Securities Commission considers could, and should, be improved. The
Commission’s Cycle 12 review of
selected issuers shows better compliance
in some areas of NZ IFRS than past reviews have.
We comment on matters arising from our Cycle 12 review and on two additional
areas of financial reporting – impairment testing
of goodwill and the
disclosure of information not prepared under New Zealand Generally
Accepted Accounting Practice
(non-GAAP measures).
Actions taken as a result of this review
We raised with issuers many matters to do with financial instrument
disclosures and measurement, which reflects the high proportion
of financial
institutions included in the Cycle 12 review.
We wrote to 17 of the 21 issuers, mainly about:
(a) financial instruments – in particular, inadequate or incorrect disclosure of concentrations of credit risk by security type and fair-value assumptions;
(b) financial instruments measurement – in particular, the incorrect classification of financial assets and accounting policies for impairment that were inconsistent with NZ IFRS;
(c) cash flow statements – inadequate explanations for certain transactions; and
(d) property, plant and equipment – in particular, inadequate
disclosure of significant assumptions underlying valuations.
No matters warranted Commission enforcement action or referrals to any other
body.
Goodwill impairment testing
Impairment testing of goodwill and its disclosure need to improve
in order for the information to be useful. Properly
accounted for and
disclosed, information on goodwill impairment can be used to assess
management’s past decisions on particular
acquisitions and as an
indication of management’s view of the future of those
acquisitions.
Alternative performance measures
The Commission supports additional non-GAAP disclosures that improve a
user’s understanding of financial statements,
provided these
are properly disclosed and
communicated, consistently applied, do not replace the statutory NZ GAAP
financial information and are not disclosed more prominently
than NZ GAAP
financial information.
Feedback from financial reporting workshop
During the Cycle 12 review, the Commission held a workshop for directors,
chief financial officers, other financial statement preparers
and auditors
focusing on matters repeatedly raised with issuers. The exchange of information
was valuable and timely, given the number
of years that NZ IFRS has been applied
by issuers and the number of years that the FRSP has been conducted.
Looking ahead
The Commission will continue to monitor compliance with NZ IFRS 8 Operating Segments
during this early stage of its application.
Also, the Commission is in the process of considering whether to include a
list of the issuers reviewed in each cycle in its future
public reports.
However, if it does so, the Commission would not identify to which issuers it
had written.
INTRODUCTION
1. This report sets out findings from Cycle 12 of the
Commission’s ongoing Financial Reporting Surveillance Programme
(FRSP). It
covers 21 issuers with balance dates ranging from 30 June 2009 to 31 January
2010.
2. Appendix 1 sets out the programme’s background, including
how the Commission selects issuers for review, and deals
with any issues it
identifies.
3. This report is intended to inform directors, chief financial
officers and other financial statement preparers, auditors
and financial
analysts on financial reporting areas the Commission considers could and should
be improved.
4. While the FRSP primarily encourages improvements in financial
reporting, it can result in enforcement actions. If a matter
warranting
enforcement is identified, it is removed from the FRSP and immediately becomes
an enforcement matter. There were no such
instances in this cycle.
CYCLE 12 FINDINGS Scope and issuer selection
5. The Commission reviewed the annual reports of 21 issuers with balance dates ranging
from 30 June 2009 to 31 January 2010. They included:
• 10 listed on the equity security market (NZSX) of NZX Limited (NZX);
• 4 with securities listed on the debt security market (NZDX) of NZX;
• 7 whose securities are not listed on any exchange.
(b) 2 registered banks;
(c) 1 unit trust;
(d) 1 building society;
(e) 1 insurance company; and
(f) 1 consumer finance company.
Overall comments on Cycle 12
8. We wrote to 17 of the 21 issuers, mainly about:
(a) financial instruments – in particular, inadequate or incorrect disclosure of concentrations of credit risk by security type and fair value assumptions;
(b) financial instruments measurement – in particular, the incorrect classification of financial assets and accounting policies for impairment that were inconsistent with NZ IFRS;
(c) cash flow statements – insufficient explanations for certain figures; and
(d) property, plant and equipment – in particular, inadequate
disclosure of significant assumptions underlying valuations.
9. These 17 letters drew issuers’ attention to a total of 39 matters
raised.
1 Matters raised are important matters or those needing
further clarification or information. (See Appendix 1, paragraph 20 for a
further explanation.)
Outcome of matters raised
Notes
|
Table 1: Outcome of matters raised
Outcome
|
Matters raised 2
|
%
|
(1)
|
Resolved
|
12
|
|
(2)
|
Point taken/change agreed
|
26
|
|
|
Agreement reached
|
38
|
97%
|
(3)
|
Second letter sent
|
1
|
|
(4)
|
Other follow-up action
|
0
|
|
|
|
1
|
3%
|
|
Total matters raised
|
39
|
100%
|
Notes to the Table
(1) Resolved: the issuer provided a satisfactory explanation.
(2) Point taken/change agreed: the issuer acknowledged the point made and/or agreed to make changes in subsequent financial statements.
(3) Second letter sent: a second letter reiterated the points made and closed the matter.
(4) Other follow-up action: more action required eg a written request
for answers to further questions; or referral to another body, such as the
National Enforcement
Unit of the Companies Office, for consideration of
enforcement action.
10. Some issuers explained and clarified the matters raised with
them. In many other cases, issuers agreed, as a result of the Commission raising
an issue, to change their next set of financial
statements. We continue to urge
issuers and their directors to correctly apply NZ IFRS and to ensure
financial statements
contain all the information necessary for users to make
informed decisions.
11. Our Cycle 11 report highlighted matters consistently raised from
Cycles 9 to 11 of the FRSP. These included errors in key
management personnel
disclosure and lack of an unreserved statement of compliance with NZ IFRS. In
Cycle 12 these matters were raised
in only three instances, indicating improved
disclosures in these areas.
2 Matters raised exclude instances where the Commission
wrote directly to audit firms and/or directors of issuers.
Comparison with previous cycles
12. Table 2 compares statistics from previous FRSP cycles with Cycle 12
results. Under NZ IFRS the Commission has written to
more issuers and raised, on
average, more issues per issuer than under previous NZ GAAP3. We
would like to see this situation improve.
Table 2: Financial Reporting Surveillance Programme statistics
Cycle
#
|
NZ GAAP
|
Number of issuers reviewed
|
Number of issuers we wrote to
|
Issuers written to
%
|
Matters raised
|
Matters per issuer written to
|
1
|
Previous NZ GAAP
|
40
|
15
|
38%
|
22
|
1.5
|
2
|
Previous NZ GAAP
|
46
|
19
|
41%
|
24
|
1.3
|
3
|
Previous NZ GAAP
|
45
|
19
|
42%
|
27
|
1.4
|
4
|
Previous NZ GAAP
|
40
|
17
|
43%
|
27
|
1.6
|
5
|
Previous NZ GAAP
|
40
|
16
|
40%
|
19
|
1.2
|
6
|
Previous NZ GAAP
|
30
|
20
|
67%
|
37
|
1.9
|
7
|
Previous NZ GAAP/NZ IFRS
|
44
|
17
|
39%
|
29
|
1.7
|
8
|
NZ IFRS
|
40
|
35
|
88%
|
97
|
2.8
|
9
|
NZ IFRS
|
24
|
17
|
71%
|
31
|
1.8
|
10
|
NZ IFRS
|
20
|
17
|
85%
|
50
|
2.5
|
11
|
NZ IFRS
|
24
|
20
|
83%
|
34
|
1.7
|
12
|
NZ IFRS
|
21
|
17
|
81%
|
39
|
2.3
|
3 Previous NZ GAAP is the financial reporting regime existing in
NZ prior to the implementation of NZ IFRS.
Specific comments on Cycle 12 findings
13. Figure 1 shows matters most frequently raised with issuers.
Matters the Commission wishes to highlight are detailed in
subsequent
paragraphs.
14. Of 39 matters raised, 15 (38%) related to financial instruments
disclosure or measurement, reflecting the large proportion
of financial
institutions included in Cycle 12.
15. It is important that financial statements clearly address matters
relating to financial instruments, given the recent history
of finance sector
failures and investors’ increasing reliance on this information.
16. In spite of a high number of matters raised in this area,
our review revealed nothing warranting further enforcement action. A significant
proportion of matters raised related to one industry group. As part of
our follow-up work, we are having further dialogue with this group with the aim
of improving
its financial reporting.
Figure 1: Top Matters Raised Cycle 12
9
8
7
6
5
4
3
2
1
0
Financial instruments disclosures
Financial instruments measurement
Nature of non audit services
Property, plant and equipment
Cash flow
statement
Financial instruments: disclosures
17. Financial instruments include financial assets and financial
liabilities. Financial assets include cash, shares in other
entities, trade
receivables and derivatives that are “in the money”. Financial
liabilities include trade payables, loans
received and derivatives that are
“out of the money”. NZ IFRS 7 Financial instruments: Disclosures
and NZ IAS 32 Financial instruments: Presentation sets out the
disclosure and presentation requirements for financial instruments.
18. Such disclosures are important because they allow users to
assess the liquidity, market risk and credit risk
of an entity’s
financial instruments.
19. Matters raised in this area seldom relate to just one aspect of financial instruments.
Our view is that the absence of, or errors in, disclosures relating to
various aspects of an entity’s financial instruments
usually mean the
disclosures, taken as a whole, are inadequate.
20. Directors and management have the responsibility for financial
statement preparation, and must review disclosures in this
area considering
whether the disclosures comply with applicable NZ IFRS, are adequate and
transparent, and provide financial report
users with coherent and meaningful
information. Auditors have the role of assessing these disclosures from an
independent perspective.
21. Assessing the adequacy of disclosures in this area includes looking
specifically at:
(a) the principles of NZ IFRS 7 has the issuer disclosed sufficient information to enable users of its financial statements to evaluate:
(i) the significance of its financial instruments and their impact on the issuer’s financial position and performance; and
(ii) the nature and extent of risks arising from its financial instruments to which the issuer is exposed at the end of the reporting period;4 and
(b) whether the issuer’s qualitative and quantitative
disclosures of credit, liquidity and market risk reflect the processes and
information provided internally to key management
personnel.5
Concentrations of credit risk by security type
22. NZ IFRS 7 requires all entities to disclose concentrations
of risk arising from financial instruments where
it is not apparent
from disclosures already provided (paragraph 34(c)).
23. A main contributor to the significant loan impairments of property
finance companies has been high levels of subordinated
lending on failed
investments in their loan portfolios. Therefore, in addition to the specific
requirement to disclose geographic,
industry and counterparty credit risk
concentrations, financial institutions should also consider information about
their credit
risk concentrations by security type. Where an issuer is a
subordinated lender for significant portions of its loans and advances,
this
information is likely to be material and should be provided.
24. We note that a number of issuers now provide this information by
way of a security dissection which shows the value of loans
by security type eg
first mortgage, second mortgage, loans secured by charge of personal property
and unsecured loans.
4 NZ IFRS 7 paragraphs 1,7 and 31.
5 NZ IFRS 7 paragraphs 33 and 34
25. In Cycle 12 we wrote to four issuers about the security held on
their loan portfolios, including instances where:
(a) the issuer had not provided a security dissection; (b) the issuer had provided a security dissection but:
(i) had not distinguished between loans secured by first or subsequent ranking mortgages;
(ii) the value of loans represented in the dissection was substantially less
than the total loan portfolio and it was unclear what
type of security, if any,
existed over the remaining loans.
26. All four issuers agreed to provide further disclosures in future
financial statements.
27. Currently, under NZ IFRS 7, issuers are required only to
provide where it is practicable an estimate of the
fair value of collateral
held by the entity as security. However, for periods beginning on or after 1
January 2011, for all financial
instruments issuers must disclose a
quantification of the extent to which collateral and other credit enhancements
mitigate credit
risk.6 We strongly encourage issuers to consider
whether providing this information prior to its effective date would enhance
their disclosures.
Other financial instrument disclosures
28. Other matters raised with issuers on financial instruments disclosures
included:
(a) 3 instances where issuers failed to disclose the methods and, where a valuation technique was used, the assumptions used to value their financial instruments.7 One issuer had used a third party to value the financial instrument in question. In such a case, the issuer should ensure the third party provides sufficient information underlying the valuation to enable the issuer to
meet the disclosure requirements of applicable NZ IFRS.
(b) 1 instance where financial instruments were recognised on the balance sheet at fair value, but a breakdown of how the instruments were valued in accordance with the hierarchy defined in NZ IFRS 7 was not provided;8
(c) 3 instances where reconciliations of individually impaired
assets and/or related impairment allowances were not
disclosed or the
disclosures were incomplete. Financial institutions should note that, in
complying with Appendix E of NZ IFRS 7,
these reconciliations must be provided
for sub- classes of impaired assets such as restructured assets, financial
assets acquired
through the enforcement of security and other individually
impaired assets.9
6 This new requirement was introduced in May 2010 as part of the IASB’s Annual Improvements Project.
7 NZ IFRS 7 paragraph 27.
8 NZ IFRS 7 paragraphs 27A - 27B.
9 NZ IFRS 7 paragraphs 16, E5, E6, 37(b), E17, E18.
Financial instruments: measurement and recognition
29. In Cycle 12 we raised six matters relating to NZ IAS 39:
Financial instruments: measurement and recognition. The Commission wishes
to highlight the following two matters.
Impairment testing methodology
30. Most entities have certain financial assets measured at amortised
cost – such as loans and accounts receivables. Under
NZ IAS 39 financial,
assets measured at amortised cost need to be tested for objective evidence of
impairment as follows:
(a) first, individually for financial assets that are individually significant; and
(b) second, individually or collectively for financial assets that are not
individually significant.
31. Where an entity has determined that no objective evidence of
impairment exists for an individually assessed financial asset
it includes the
asset in a group of financial assets with similar credit risk characteristics
and collectively assesses them for
impairment.
32. We observed that some issuers’ stated accounting
policy for determining their collective impairment allowance
was:
(a) first, determine past due financial assets and group these by how long they had been overdue; and
(b) then apply industry-based percentages to each group of assets.
33. However, as outlined above, NZ IAS 39 requires that a
collective impairment allowance is based on all financial
assets not
individually determined to be impaired, whether past due or otherwise.
34. We also emphasise that statistical or formula-based methods
for determining collective impairment allowances, such
as using industry rates,
are only permitted where these are consistent with the requirements of NZ IAS
39. This includes:
(a) ensuring that industry rates or formulas used are consistent with the historical loss experience for assets with similar credit risk characteristics adjusted for current market conditions; and
(b) making an adjustment for the time value of money.10
35. Failure to do this could result in a material misstatement in an
issuer’s impairment allowance.
10 See NZ IAS 39 paragraphs 63 – 65 and AG87 -
AG91.
Financial assets classifications
36. Under NZ IAS 39 held-to-maturity investments are measured at
amortised cost rather than fair value. To classify a financial
asset as a
held-to-maturity investment it must have fixed or determinable payments and a
fixed maturity. In addition, the entity
must have the positive intention and
ability to hold that instrument to maturity.11
37. We noted that some issuers classified their financial assets as
held-to-maturity investments notwithstanding that the
assets have no
fixed payment or maturity. Further investigation revealed that, while the
issuers intended to hold the items
indefinitely, the assets should have been
classified as available-for-sale financial assets.12 We acknowledge
that, where an issuer does intend to hold such assets indefinitely, classifying
them as available-for-sale financial
assets, as required by NZ IAS 39, may
appear to misinform. In such situations, we suggest that issuers make additional
disclosures
to clarify their long-term holding intentions.
38. The issuers written to agreed to reclassify their assets
from held-to-maturity investments to available-for-sale
financial
assets.
Impairment of non-financial assets13
39. Disclosures of goodwill impairment testing are a commonly raised issue in the FRSP.
We recently reviewed a sample of goodwill disclosures in the financial
statements of certain issuers to identify areas for improvement.
40. Under NZ IFRS 3 Business Combinations, goodwill from a
business combination is calculated as the excess of the consideration paid over
the identifiable net assets acquired.
This goodwill must be allocated to the
cash generating units (CGUs) expected to benefit from the business
combination.
41. Under NZ IAS 36 Impairment of assets, CGUs to which goodwill
is allocated must be tested for impairment at least annually, and where there is
an indicator of impairment.14 This involves calculating the
recoverable amount of the CGU, usually using discounted cash flow models based
on the future profitability
of the CGU.
42. Such testing can be subjective as it requires management judgement
about key assumptions. NZ IAS 36 therefore requires a series
of disclosures to
inform users of the methodology and assumptions used by the entity.
Disclosure of impairment testing
of goodwill provides relevant information to
users in at least two ways:
11 NZ IAS 39 paragraph 9.
12 Available-for-sale financial assets need to be measured at fair value with limited exceptions. For example, an available for sale financial asset may be measured at cost where the financial asset is an investment in an equity instrument that does not have a quoted price in an active market and whose fair value cannot be determined
reliably. See IFRS 7 paragraph 46(c).
13 See article in the December 2009 issue of the New Zealand Institute of Chartered Accountants’ Journal by
Lay Wee Ng and Liz Hickey for further discussion on this topic.
14 NZ IAS 36 paragraph 90.
(a) Confirmatory information – it indicates to users management’s ability to make good investment decisions. Goodwill is supported by the profitability of the underlying CGU to which it is allocated. Therefore, an impairment of goodwill indicates that future returns from the CGU as a result of the acquisition are not as high as initially expected. Conversely, no impairment of goodwill indicates that CGUs are operating as, or more profitably than, initially expected. This information enables users to evaluate management's past decisions through confirming or correcting past evaluations.
(b) Predictive information – disclosure of expected
growth rates, budget assumptions and discount rates
provides users with an
indication of management’s expectations for the future of that particular
CGU.
43. In general, we note that disclosures provided by issuers about
impairment testing of goodwill limited the usefulness of
the information. Issues
identified included:
(a) non-disclosure of goodwill allocated to each CGU;15
(b) non-disclosure relating to key assumptions:
(i) non-disclosure of key assumptions underlying the budgets and how these key assumptions were determined – disclosures are often too brief and too generic to be useful;16
(ii) unclear disclosure of the expected growth prospects and risks associated with a particular CGU, as, for example, where a range of assumptions is applied across several CGUs;
(c) use of conservative rather than realistic growth rates;
(d) use of the same discount rates across all CGUs when CGUs are
located in different jurisdictions, are different types of
businesses or have
different risk profiles.17
44. The above are key areas in the impairment testing of goodwill where
we consider both related accounting and disclosures
could be improved. We
emphasise that disclosures must be provided for each CGU to which
goodwill allocated is significant.
Issuers may consider using tables as a
clear and concise way of providing this information.
45. We wrote to one issuer in Cycle 12 because the issuer:
(a) had not described the key assumptions underlying the valuation of its CGU’s recoverable amount or its approach to determining those assumptions;
(b) had generally described, but did not disclose, the specific growth rate used beyond the initial forecast period; and
(c) had not disclosed the specific discount rate(s) applied to
the cash flow projections.
15 NZ IAS 36 paragraph 134(a)
16 NZ IAS 36 paragraph 134(d)
17 Discount rates should take into account current market
assessments of the time value of money and risks specific to each CGU –
see NZ IAS 36 paragraph 30 and 55.
46. The issuer has agreed to include additional information on its
valuation and specific disclosures of the discount and growth
rates used in its
future disclosures.
Description of non-audit services provided
47. We wrote to four entities about their disclosure of the nature of
non-audit services received from their auditors. We note
that, while entities
usually disclose fees paid by the required categories, some do not describe the
nature of those services as
required by NZ IAS 1 (paragraph NZ105.1).
48. The requirement is designed to increase the transparency of the
auditor-issuer relationship, enabling annual report readers
to make their own
judgement over the level of independence between auditor and issuer.
Property, plant and equipment
Disclosure of significant valuation assumptions
49. The Commission wrote to two issuers about valuation of their
property, plant and equipment. NZ IAS 16 Property, plant and equipment
(paragraph 77(c)) requires that, where items of property, plant and
equipment are stated at revalued amounts, entities must disclose
“the
methods and significant assumptions applied in estimating the items’ fair
values”.
50. These entities provided only a general description of the methods
and significant assumptions applied. We question
whether this
complies with NZ IAS 16 (paragraph 77(c)).
51. The types of assumptions to disclose will depend on the type of
property, plant and equipment.
52. Issuers have cited commercial confidentiality and sensitivity in
relation to certain assumptions and information. However,
the Commission’s
view is that commercial sensitivity is no reason for non-disclosure.
53. In this area, issuers must assess the extent of their disclosures
against the objective of ensuring they provide a fair
presentation. We consider
disclosure of significant assumptions can usually be achieved by providing a
range rather than point data.
Disclosure of extent of security provided
54. We wrote to one issuer because it indicated that the group’s
property, plant and equipment are used as partial security
for bank facilities.
However, it did not provide details of the extent of assets pledged as
security.
55. NZ IAS 16 Property, Plant and Equipment (paragraph 74(a)) requires
that:
The financial statements shall also disclose: (a) the existence and
amounts of restrictions on title, and property, plant and equipment
pledged as
security for liabilities;
Other matters
Operating segments
56. NZ IFRS 8 Operating Segments is a new standard that became
mandatory for annual reporting periods beginning on or after 1 January 2009. It
requires certain entities
to publish segment information consistent with that
reported to their management, so the market has the same perspective.
57. The core principle in NZ IFRS 8 (paragraph 1) is that:
An entity shall disclose information to enable users of its financial
statements to evaluate the nature and financial effects of the
business
activities in which it engages and the economic environments in which it
operates.
58. We wrote to one issuer asking how their operating segment reporting aligned with
NZ IFRS 8 Operating segments, particularly the core principle in NZ
IFRS 8.
59. The matter was resolved with the issuer, but the Commission
encourages issuers to provide a level of disclosure consistent
with the
standard’s core principle. The Commission will continue to monitor
disclosures in this area.
Statement of cash flows
60. The Commission wrote to three issuers about their disclosures in
the Statement of Cash Flows. All three issues were
resolved but the
Commission would like to highlight the following point.
61. We queried with one issuer why a certain cash transaction was
classified as a cash flow from operating activities rather
than as a cash flow
from financing activities in the Statement of Cash Flows.
62. The issue was resolved by further clarification from the issuer.
However, it would have been useful if the financial statements
had included a
clearer explanation of the nature of the transaction to enable users to
understand the basis of its classification.
63. The Commission reminds issuers they should ensure that the
necessary disclosures are made to explain material items presented
in financial
statements.
SECURITIES COMMISSION WORKSHOP
64. As part of a programme to encourage further improvement in
financial reporting and also to initiate dialogue on recurring
issues,
the Commission held a financial reporting preparer and auditor workshop in
Auckland on 1 July 2010. Feedback from participants
was that the workshop was
useful. We highlight the following points discussed at the workshop.
65. The Commission believes that reviewing disclosures against the
principle of “telling the story to users” should
help preparers
decide the level of detail to include in or exclude from financial
statements.
66. We encourage issuers to carefully consider matters raised with them
and to challenge these if they believe they have good
NZ GAAP reasons for a
particular accounting treatment.
67. Participants agreed that, for improved financial reporting, greater
transparency and more readable financial statements,
preparers need to focus on
materiality when making relevant NZ GAAP judgements during the preparation and
audit of their financial
statements. The Commission considers that issuers
should:
(a) Develop and apply materiality guidelines18 for their business.
(b) Document key judgments, and have them approved by the directors and/or the audit committee. These can then be provided to auditors and/or regulators on request.
(c) Remove accounting policies that have no underlying or significant economic activity.
(d) Customise accounting policies and cross-reference the policies to the entity’s underlying economic activity. Entities should not regurgitate the whole standard but should explain NZ IFRS in plain English.
(e) Prioritise notes in financial statements and emphasise key areas of judgement and disclosures that reflect how the entity is actually managed (eg it is useful to link qualitative and quantitative disclosures).
(f) Align information in any entity news releases to better reflect
the information in financial statements and vice
versa.
18 The Commission has not developed its own set of guidelines but through its membership of IOSCO is aware that a number of overseas regulators have released papers on the issue of assessing materiality in the context of financial reporting under IFRS that issuers may find useful. The Danish Securities Council has issued a paper entitled The Danish Securities Council’s general considerations and deliberations on the assessment of materiality in relation to its financial reporting enforcement activities
(available at http://www.fondsraadet.dk/graphics/Finanstilsynet/Mediafiles/newdoc/FR/FR_Materiality2009.pdf ).
The Irish Auditing & Accounting Supervisory Authority has released a document Observations on Materiality in Financial
Reporting (available at http://www.iaasa.ie/publications/Obs_materiality2010.pdf
).
68. Support for this approach can also be found in the work
of the UK Financial Reporting Review Panel19. It believes the
following characteristics make for a good annual report:
(a) a single story – material throughout the report is consistent and the narrative properly explains the numbers;
(b) how the money is made – the report includes an explanation of the company’s business model and the salient features of the company’s performance;
(c) what worries the board – the risks and uncertainties facing the board are appropriately described and the links to accounting estimates and judgements are clear;
(d) consistency – highlighted or adjusted figures, key performance indicators and non-GAAP measures are clearly reconciled to main heading figures in the financial statements and any adjustments are clearly explained;
(e) cutting the clutter; (f) clarity;
(g) summarise – there is an appropriate level of aggregation; (h) explain change;
(i) true and fair – the spirit, as well as the letter, of the
financial reporting standards is
followed.
19 Pages 2-3 of the FRRP annual report 2010
(available at http://www.frc.org.uk/images/uploaded/documents/ANNUAL%20REPORT%202010%20-%20FINAL1.pdf
).
ALTERNATIVE PERFORMANCE MEASURES
69. Non-GAAP measures or alternative performance measures can provide
investors with appropriate additional information if properly
used and
interpreted.
70. Some issuers provide alternative non-GAAP performance
measures such as underlying profit to supplement statutory earnings
information when communicating with the market.
71. The Commission supports additional disclosures that improve
investors' understanding of financial statements, as long
as they are properly
disclosed and communicated, consistently applied year on year and are not
attempting in any way to substitute
for the statutory financial information
required by NZ GAAP. Neither should such non-GAAP measures be disclosed more
prominently
than financial information required by NZ GAAP.
72. The Commission intends to closely review any non-GAAP measures
disclosed and take action if required.
73. The Committee of European Securities Regulators (CESR) has
addressed this concern about non-GAAP measures by publishing
guidelines for
issuers in Europe using alternative non-GAAP performance
measures.20
74. The CESR recommendation:
(a) defines alternative performance measures;
(b) provides guidance on the presentation of alternative performance measures;
and
(c) suggests disclosure of any audit review of those alternative
performance measures.
75. This CESR recommendation is available on the CESR website www.cesr-eu.org
20 CESR Recommendation on Alternative Performance Measures issued
October 2005 (available at
http://www.cesr-eu.org/popup2.php?id=3601).
CONCLUSION
76. The Commission’s review of selected issuers in Cycle
12 indicates improved compliance in some areas of NZ
IFRS raised in past
reviews. However, we consider there is still room for issuers to improve
compliance with NZ IFRS in many other
areas, including those for financial
instruments and impairment testing of goodwill. Moreover, while the Commission
supports additional
non-GAAP disclosures that improve a user’s
understanding of financial statements, it cautions that such information should
not be substituted for the statutory financial information required by NZ
GAAP.
77. The Commission’s workshop attended by directors, chief
financial officers, other financial statement preparers and
auditors resulted in
valuable and timely exchange of information.
78. In order for financial statements to remain transparent and
coherent, issuers and their directors must comply with the
principles
underlying NZ IFRS. This requires assessing the materiality of information in
terms of whether its inclusion or omission
could influence economic decisions
made by users of financial statements.
LOOKING AHEAD
79. The Commission will continue to monitor compliance with NZ IFRS 8 Operating
Segments during this early stage of its application.
80. Also, the Commission is in the process of considering whether to
include a list of the issuers reviewed in each cycle in
its future public
reports. However, if it does so, the Commission would not identify to which
issuers it had written.
APPENDIX 1: BACKGROUND TO THE SECURITIES COMMISSION’S FINANCIAL
REPORTING SURVEILLANCE PROGRAMME
1. The Securities Commission is the main regulator of the
New Zealand securities market. Our purpose is
to strengthen investor
confidence and foster capital investment in New Zealand by promoting the
efficiency, integrity and cost-effective
regulation of our securities
markets.
2. The Commission regards quality financial reporting by
issuers21 to be fundamental to the fairness, efficiency and
transparency of New Zealand’s securities markets.
The Commission’s Financial Reporting Surveillance
Programme
3. Section 10(c) of the Securities Act 1978 requires the Securities
Commission “to keep under review practices relating
to securities, and to
comment thereon to any appropriate body”.
4. As part of carrying out this function the Commission
established an ongoing Financial Reporting Surveillance
Programme (FRSP) in
2004, with its first cycle review taking place in 2005. The FRSP is an ongoing
surveillance programme.
5. The aim of the Commission’s FRSP is to encourage New Zealand
issuers to improve the quality of their financial reporting
so that:
(a) issuers’ financial statement disclosures are clear and comprehensive;
(b) investors can have confidence in the credibility of financial information provided by issuers; and
(c) high-quality financial reporting contributes to the integrity of New
Zealand’s securities markets.
6. The FRSP involves reviewing selected issuers’ financial
statements. At the end of each cycle the Commission publicly
reports on this
surveillance work by providing market participants with a summary of its
findings. Copies of reports for all cycles
are available on the
Commission’s website www.seccom.govt.nz
21 An issuer is defined by the Securities Act 1978 (section 2) to mean:
(a) In relation to an equity security or debt security, or to an advertisement, investment statement, prospectus, or registered prospectus that relates to an equity security or a debt security, or to a trust deed that relates to a
debt security, the person on whose behalf any money paid in consideration of the allotment of the security is
received:
(b) In relation to a participatory security, or to an advertisement, investment statement, prospectus, or registered prospectus, or to a deed of participation that relates to a participatory security, the manager:
(c) In relation to an interest in a contributory mortgage offered by a contributory mortgage broker, or to an
advertisement that relates to such an interest, the contributory mortgage broker:
(d) In relation to a unit in a unit trust, or to an advertisement, investment statement, prospectus or registered prospectus that relates to such a unit, the manager:
(e) In relation to a life insurance policy, or to an advertisement, investment statement, prospectus, or registered
prospectus that relates to a life insurance policy, the life insurance company that is liable under the policy:
(f) In relation to an interest in a superannuation scheme, or to
an advertisement, investment statement, prospectus,
or registered prospectus
that relates to such an interest, the superannuation trustee of the
scheme.
New Zealand Generally Accepted Accounting Practice
7. The Financial Reporting Act 1993 requires issuers to prepare
financial statements that comply with New Zealand Generally
Accepted Accounting
Practice (NZ GAAP) and provide a true and fair view of the matters to which they
relate22.
8. The Commission reviews issuers’ financial statements against
NZ GAAP. For the purpose of the Financial Reporting
Act, financial statements
and group financial statements comply with NZ GAAP only if those statements
comply with:
(a) applicable financial reporting standards; and
(b) in relation to matters for which no provision is made in applicable financial reporting standards and that are not subject to any applicable rule of law, accounting policies that:
(i) are appropriate to the circumstances of the reporting entity; and
(ii) have authoritative support within the accounting profession in New
Zealand.
9. The Financial Reporting Act defines “applicable
financial reporting standard” to mean an approved
financial reporting
standard that applies to a reporting entity (or group) and to an accounting
period (or interim accounting period)
in accordance with a determination of the
Accounting Standards Review Board (ASRB) for the time being in force or any
election made
under section 27 of the Financial Reporting Act. All issuers are
required to apply NZ IFRS in the preparation of their financial
statements for
annual accounting periods commencing on or after 1 January 2007.
10. The purpose of the Commission’s cycle reviews is to form a
view on:
(a) the level of issuer compliance with NZ GAAP in financial statements prepared under the Financial Reporting Act;
(b) whether any breach of NZ GAAP identified in those financial statements is likely to cause the financial statements to not show a true and fair view, or be materially misleading to users in the context of information disclosed for investment decision-making under the Securities Act, and therefore require enforcement action; and
(c) the overall quality of financial reporting practices by
issuers.
22 Part II of the Financial Reporting Act 1993 (section 11)
requires every ‘reporting entity’ to prepare financial statements
that comply with generally accepted accounting practice and to provide any
additional information required to ensure those statements
are a true and fair
view of the matters to which they relate.
Part I, Section 2 of the Financial Reporting Act 1993 defines a reporting entity as : (a) An issuer; or
(b) A company, other than an exempt company; or
(c) A person that is required by any Act, other than this Act, to comply
with this Act as if it were a reporting entity.
Selecting issuers
11. The FRSP aims to review all issuers listed on NZX Limited (NZX) at
least once over a three to four year period.
12. In reviewing all listed issuers, dual and overseas listed issuers may also be selected.
Overseas listed issuers are issuers domiciled or incorporated outside New
Zealand that have a recognised stock exchange as the home
exchange and are also
listed on NZX.
13. Dual listed issuers are issuers incorporated in Australia that are on the Australian
Stock Exchange’s (ASX) Official List and also listed on the
NZX.
14. Where dual and overseas listed issuers are selected, the Commission
first writes to the regulator in the overseas jurisdiction
to determine whether
a review of the financial reporting of the issuer has already been undertaken
locally. If it has, the Commission
does not review them. Where the issuer has
not been reviewed by the overseas regulator, the Commission reviews the annual
report,
NZX announcements and, if applicable, the current prospectus. Where
appropriate, findings are communicated to the overseas regulator.
If the
Commission communicates what it considers to be a significant matter about an
issuer to an appropriate overseas regulator
and the overseas regulator
proposes to take no action, the Commission will write directly to the overseas
or dual listed issuer
on the matter.
15. Issuers trading on the Unlisted23 exchange and issuers
not listed on any exchange may be also included in cycle reviews.
16. Issuers may be selected on the basis of criteria determined by the
Commission: on areas of particular risk affecting the
issuer; the sector the
issuer is in at the time of selection; and/or their balance dates. Issuers can
also be reselected for a later
review where the nature of issues identified in
an earlier cycle raised concerns.
Identifying matters and taking action
17. The Commission reviews an issuer’s annual report when reviewing
its financial statements and, in the case of listed
issuers, this includes a
review of any NZX announcements for the period and any relevant prospectuses.
While NZX announcements are
not comprehensively reviewed, any market matters
relating to continuous disclosure, disclosure of relevant interests by directors
and officers, and substantial security holder disclosure are followed up where
necessary.
18. Matters identified in the review are referred to as matters raised24 or other matters.
Matters raised include market matters.
23 Unlisted is an unregistered securities trading facility; it is not a registered stock exchange or authorised securities exchange under the Securities Markets Act 1988. Unlisted provides a facility for trading previously allotted securities.
24 Prior to Cycle 6, the Commission referred to matters raised
as significant matters.
19. Matters raised are those that are important or where
further clarification or information is needed. The Commission is likely, for
example,
to write to an issuer where a matter:
(a) appears to be wrong;
(b) appears not to make sense;
(c) is not clear and lacks transparency; (d) seems unusual or irregular;
(e) raises questions about its validity; or
(f) is insufficiently explained.
20. Financial reporting requires the exercise of professional
judgement. The Commission takes this into account when reviewing
financial
statements and determining which matters to follow up.
21. The Commission writes to an issuer requesting additional
information and in some cases asks the issuer to revise or enhance
disclosures
in future financial statements.
22. When writing to an issuer about matters raised, the
Commission includes other matters found in the review in relation to
that issuer. Other matters are miscellaneous matters the Commission
considers could be better disclosed.
23. The Commission’s policy is not to write to an issuer whose
financial statements raise only other matters, unless these are so
numerous that it is useful to provide the issuer with feedback. In this
respect, the Commission is mindful
of its educative role in the FRSP.
24. In each case where the Commission writes to an issuer, a copy of
the letter is also sent to the issuer’s auditor.
This practice
acknowledges the role of auditors in helping maintain and improve the standard
of financial reporting. It also alerts
an auditor to the particular aspects of
its client’s financial statements that may concern the Commission.
25. 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 the integrity of
financial reporting and to the efficiency and integrity of the securities
markets.
26. Where a matter may have significant market impact it is removed
from the FRSP and considered separately as an enforcement
matter.
27. Referrals are also made to appropriate bodies where matters identified in the FRSP
are considered likely to be a breach of:
(a) the Financial Reporting Act;
(b) the Rules or the Code of Ethics of the New Zealand Institute of Chartered
Accountants; or
(c) the NZX Listing Rules.
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