Announcing its focus areas for 31 December 2019 financial reports of listed entities and other entities of public interest with many stakeholders, ASIC has called on companies to focus on new requirements that can materially affect reported assets, liabilities and profits.
New accounting standards
Major new accounting standards will have the greatest impact on financial reporting for many companies since the adoption of International Financial Reporting Standards (IFRS) in 2005.
Full-year reports at 31 December 2019 must comply with a new accounting standard on lease accounting that requires lessees to recognise lease liabilities and a right-of-use asset for all leases, not just leases formerly classified as finance leases. Some leases and similar arrangements are covered by other accounting standards such as mining leases and leases of biological assets.
This is also the second full year that new accounting standards on revenue recognition and financial instrument values (including hedge accounting and loan loss provisioning) have applied.
The reports must also disclose the future impact of a new standard on accounting by insurers, and new definition and recognition criteria for assets, liabilities, income and expenses.
ASIC Commissioner John Price said, ‘The new lease accounting standard can significantly affect reported assets, liabilities and results reported to the market by companies that are lessees, require changes to systems and processes, and affect businesses.’
It is important that directors and management ensure that companies inform investors and other financial report users of the impact on reported results. Required disclosure on the effect of the new standards is more extensive than that made by many companies for the 30 June 2019 half year.
Many Australian Financial Services (AFS) Licensees are subject to financial condition requirements that may be affected by the new standards. For example, a net tangible assets requirement would include lease liabilities but intangible assets such as a lease right-of-use asset would not be counted in meeting that requirement.
Directors and auditors of AFS licensees should report any breaches of financial condition requirements to ASIC as required by the Corporations Act 2001. Because the financial condition requirements are on an ‘at all time’ basis, compliance needs to be considered from the commencement of the financial year to which the standard first applied. This is the case even if ASIC were to subsequently change a licensee’s conditions to allow right-of-use assets to be counted. Similar issues may arise with contract assets recognised in accordance with the revenue standard.
ASIC will be reviewing more than 80 full year financial reports at 31 December 2019 to promote quality financial reporting, and useful and meaningful information for investors.
The role of directors
Directors are primarily responsible for the quality of the financial report. This includes ensuring that management produces quality financial information on a timely basis. Companies must have appropriate processes, records and analysis to support information in the financial report.
Companies should apply appropriate experience and expertise, particularly in more difficult and complex areas such as accounting estimates (including impairment of non-financial assets), accounting policies (such as revenue recognition) and taxation.
Further information can be found in ASIC Information Sheet 183 Directors and financial reporting (INFO 183) and ASIC Information Sheet 203 Impairment of non-financial assets: Materials for directors (INFO 203).
We will review the governance processes over financial reporting of several companies, generally where reported net assets and profits were materially changed following our inquiries on financial reports for recent reporting periods. Our work will cover how audit committees and directors fulfilled their role in ensuring the quality of the financial reporting and supporting the audit. We will also review the identification and effectiveness of actions by firms to address root causes from an audit perspective. We will consider whether the results of this review indicate a need to improve governance at the company and/or audit firm. We anticipate completing this work by 30 June 2020.
More detailed information on focus areas for 31 December 2019 is provided in the following attachment to this media release.
FOCUSES FOR 31 DECEMBER 2018 FINANCIAL REPORTS
New accounting standards
1. Impact of the new lease and other standards
New accounting standards that will significantly affect reported results of many companies include:
- AASB 16 Leases (applies from years commencing 1 January 2019);
- AASB 17 Insurance Contracts (applies from years commencing 1 January 2021); and
- Amendments to standards to apply the new definition and recognition criteria in the Conceptual Framework for Financial Reporting (applies from years commencing 1 January 2020).
[Note: The International Accounting Standards Board will consider whether to defer the application date for the standard on which AASB 17 is based to years commencing 1 January 2022.]
The new lease accounting standard can significantly change the financial position and performance of lessees by bring leases formerly classified as operating leases on balance sheet. The standard also introduces a new measurement basis.
This is also the second year of application of the following standards that applied from years commencing 1 January 2018:
- AASB 9 Financial Instruments; and
- AASB 15 Revenue from Contracts with Customers.
These new accounting standards may significantly affect how and when revenue can be recognised, the values of financial instruments (including loan provisioning and hedge accounting), reported assets and liabilities relating to leases, accounting by insurance companies, and the general identification and recognition of assets, liabilities, income and expenses. The standards also introduce new disclosure requirements.
The new standards can have real business impacts (e.g, compliance with debt covenants or regulatory financial condition requirements, tax liabilities, dividend paying capacity, and remuneration schemes) as well as the need to implement new systems and processes.
Public disclosure on the impact of the standards is important for investors and market confidence. Information that there has been (or will be) no material impact may also be important information for the market.
Companies affected by the new insurance standard and changes to the conceptual framework need to ensure appropriate disclosures on the future impact of those new requirements in the notes to 31 December 2019 financial reports. For example, the new conceptual framework contains new definition and recognition criteria for assets, liabilities, income and expenses that apply where they are not inconsistent with a specific requirement of an accounting standard.
Further information can be found in ASIC media release Companies need to respond to major new accounting standards (refer: 16-442MR).
2. Impairment testing and asset values
The recoverability of the carrying amounts of assets such as goodwill, other intangibles and property, plant and equipment continues to be an important area of focus.
It is important for directors and auditors to ensure:
(a) cash flows and assumptions are reasonable having regard to matters such as historical cash flows, economic and market conditions, and funding costs. Particularly where prior period cash flow projections have not been met, careful consideration should be given to whether current assumptions are reasonable and supportable;
(b) discounted cash flows are not used to determine fair value less costs of disposal where forecasts and assumptions are not reasonable and supportable;
(c) cash flows used are matched to carrying values of all assets that generate those cash flows, including inventories, receivables and tax balances;
(e) discount rates and other key assumptions are reasonable and supportable;
(f) cash generating units (CGUs) are not identified at too high a level, including where cash inflows for individual assets are not largely independent; and
(g) for testing goodwill, CGUs are not grouped at a higher level than the operating segments or the level at which results are monitored for internal management purposes.
A company’s weighted average cost of capital may be relevant in determining recoverable amount using discounted cash flows. Where borrowing rates change or the split of debt and equity changes, care needs to be taken as to whether the recoverable amount has changed. In particular, a change in the split of debt and equity from recognising more liabilities under the new lease accounting standard is unlikely to affect asset values.
Further information can be found in ASIC Information Sheet 203 Impairment of non-financial assets: Materials for directors (INFO 203).
Other areas of focus on asset values include:
(i) companies affected by climate change, market changes, digital disruption, technological change or Brexit; and
(iii) the valuation of financial instruments, particularly where values are not based on quoted prices or observable market data. Fair values should be based on appropriate models, assumptions and inputs.
3. Revenue recognition
In applying the new revenue accounting standard, directors and auditors should review an entity’s revenue recognition policies to ensure that revenue is recognised in accordance with the substance of the underlying transactions.
The new revenue standard is considerably more detailed than the previous standard and focuses on performance obligations.
4. Expense deferral
Directors and auditors should ensure that expenses are only deferred where:
(a) there is an asset as defined in the accounting standards;
(b) it is probable that future economic benefits will arise; and
(c) the requirements of the intangibles accounting standard are met, including
(i) expensing start-up, training, relocation and research costs;
(ii) ensuring that any amounts deferred meet the requirements concerning reliable measurement; and
(iii) development costs meet the six strict tests for deferral.
5. Off-balance sheet arrangements
Directors and auditors should carefully review the treatment of off-balance sheet arrangements, whether other entities are controlled and should be consolidated, the accounting for joint arrangements and disclosures relating to structured entities.
6. Tax accounting
Preparers of financial reports should ensure that:
(a) there is a proper understanding of both the tax and accounting treatments, and how differences between the two affect tax assets, liabilities and expenses;
(b) the impact of any recent changes in legislation are considered; and
(c) the recoverability of any deferred tax asset is appropriately reviewed.
7. Operating and financial review (OFR)
Listed companies should provide useful and meaningful information in the OFR about underlying drivers of the results and financial position, as well as business strategies and prospects for future financial years.
Risks and other matters that may have a material impact on the future financial position or performance of the entity should be disclosed. This could include, for example, matters relating to climate change, market changes, digital disruption, new technologies, Brexit or cyber-security. For more information see ASIC Regulatory Guide 247 Effective disclosure in an operating and financial review (RG 247).
Directors may also consider whether it would be worthwhile to disclose additional information that would be relevant under integrated reporting, sustainability reporting or the recommendations of the Task Force on Climate-related Financial Disclosures where that information is not already required for the OFR.
8. Non-IFRS financial information
Directors should also consider whether any non-IFRS financial information in the OFR or other documents outside the financial report is potentially misleading and is presented in accordance with ASIC Regulatory Guide RG 230 Disclosing non-IFRS financial information. RG 230 also covers limitations on the use of non-IFRS measures in the financial report (RG 230).
9. Estimates and accounting policy judgements
Disclosures regarding sources of estimation uncertainty and significant judgements in applying accounting policies are important to allow users of the financial report to assess the reported financial position and performance of an entity. Directors and auditors should ensure disclosures are made and are specific to the assets, liabilities, income and expenses of the entity.
Disclosure of key assumptions and a sensitivity analysis are important. These enable users of the financial report to make their own assessments about the carrying values of the entity’s assets and risk of impairment given the estimation uncertainty associated with many asset valuations.