1. Asset values and impairment testing

ASIC continues to identify concerns regarding assessments of the recoverability of the carrying values of assets, including goodwill, other intangibles, exploration and evaluation expenditure, and property, plant and equipment. The largest number of ASIC’s enquiries at 30 June 2014 relate to asset values and impairment, and include companies in mining and mining services.

Findings include:

(a)        Determining the carrying amount of cash generating units: There are cases where entities:

(i)        appear to have identified cash generating units (CGUs) at too high a level despite cash flows being largely independent, resulting in cash flows from one asset or part of the business being incorrectly used to support the carrying values of other assets

(ii)       did not include all assets that generate the cash inflows in the carrying amount of a CGU, such as inventories and trade receivables

(iii)      incorrectly included the benefit of tax losses in determining the recoverable amount of a CGU, and

(iv)      incorrectly deducted liabilities from the carrying amount of a CGU.

(b)        Reasonableness of cash flows and assumptions: There continue to be cases where the cash flows and assumptions used by entities in determining recoverable amounts are not reasonable or supportable having regard to matters such as historical cash flows, the manner in which an entity is funded and market conditions.

In particular, we found cases where:

(i)        cash flows for value in use calculations incorrectly included estimated future cash inflows or outflows expected to arise from future restructuring or development plans

(ii)       assumptions derived from external sources were not assessed for consistency and relevance, and

(iii)           the entity’s forecast cash flows did not appear reasonable and had exceeded actual cash flows for a number of reporting periods.

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

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

(e)        Disclosures: A number of entities are not making necessary disclosure of:

(i)        sensitivity analysis where there is limited excess of an asset’s recoverable amount over the carrying amount and where a reasonably possible change in one or more assumptions could lead to impairment

(ii)       key assumptions including discount rates and growth rates together with reasons justifying any changes from previous periods,  and

(iii)      where the recoverable amount is based on fair value less costs to sell without a quoted market price:

• the valuation techniques used
• management’s approach to determining key assumptions, and
• whether assumptions reflect past experience or are consistent with external sources, and if not, how they differ and why.

These disclosures are important to investors and other users of financial reports given the subjectivity of these calculations/assessments. They enable users to make their own assessments about the carrying values of the entity’s assets and risk of impairment given the estimation uncertainty associated with many asset valuations.

This item includes matters arising from the finalisation of impairment matters identified in our reviews of 31 December 2013 financial reports.

2. Revenue recognition

ASIC is following up nine matters concerning the recognition of revenue, including the treatment of deferred income and the timing of bringing the revenue to account.

We continue to see instances where the disclosure of revenue recognition policies by some entities was not sufficiently specific to the entity, its business and sources of revenue. 

Boilerplate accounting policies do not assist users of a financial report to understand the basis of revenue recognition, particularly where business models are more complex and there are multiple sources of revenues.

3. Tax accounting

ASIC is making inquiries of four entities concerning their accounting for income tax and in particular, the substantiation of their tax expense positions.  This includes where:

(a)        there is no apparent reason why the tax expense is low having regard to reported profit, and necessary disclosures have not been made

(b)       where movements in temporary differences appear to be inconsistent with the movements in the the related accounting item, and

(c)        there are unusual reconciling items between accounting profit and tax expense/benefit that result in either significant tax benefits or tax expenses.

We are also making enquiries of three entities as to whether it is probable that future taxable income will be sufficient to enable the recovery of deferred tax assets relating to tax losses.

4. Off-balance sheet arrangements and business combinations

ASIC is making enquiries of three companies on the non-consolidation of entities, including where the ownership interest is near 100% but the direction of the relevant activities of the investee is said to be delegated to a separate decision-making body within the investee.

We have made enquiries of four entities with respect to their accounting for business combinations. Three enquiries related to reverse acquisition accounting and in particular, the determination of the fair value of the consideration.

5. Expense deferral

Expenses should only be deferred where there is an asset as defined in the accounting standards and it is probable that future economic benefits will arise. We are making enquiries of five entities in relation to the deferral of expenditure as assets. Particular concerns include recognition of intangible assets arising from the development phase where the nature of the costs are unclear and/or the strict criteria for deferral do not appear to be met.

6. Current classification of assets

ASIC is enquiring of three entities in relation to assets classified as current that would appear to be non-current.

7. Amortisation of intangible assets

ASIC is making inquiries of two entities concerning the appropriateness of their assessment of the amortisation periods attributed to intangibles.

Amortisation should take place as the benefits of an intangible asset are consumed by the entity, which may differ from the periods over which revenue is expected to be generated by the asset.  Where the useful life of an intangible asset arises from contractual or legal rights the amortisation period must not exceed the period of the contractual or legal rights. Useful life extends to the contract term, including renewal periods where renewal is expected to occur and renewal costs are not significant.

8. Estimates and accounting policy judgements

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

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

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