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11-312MR Improved financial information for investors and others

Wednesday 21 December 2011

ASIC today released the results of its reviews of financial reports for the year ended 30 June 2011 and announced its areas of focus for 31 December 2011 financial reports.

ASIC Deputy Chairman Belinda Gibson, said, ‘ASIC is focused on fair and efficient markets. Confidence in the quality of financial reporting is fundamental for investors, lenders and also market regulators.

‘While the overall quality of financial reporting in Australia compares favourably with other major jurisdictions, we continue to find a number of cases where material adjustments are required to financial reports. This release is intended to assist companies and auditors to finalise financial reports that best meet the requirements of the law and ultimately benefit the users of financial reports’, Ms Gibson said.

ASIC reviews a significant number of financial reports of listed and unlisted entities each year. In this next reporting season, given the current difficult economic climate that confronts all companies, ASIC will focus particularly on: ASIC recently issued its Regulatory Guide 230 Disclosing non-IFRS financial information [RG 230] following extensive consultation. In the next months, ASIC will be monitoring both the financial reports and market releases about those reports to ensure proper balanced use of non-IFRS information in the market.

More information about the findings of our review of the financial reports for the year ended 30 June 2011 and focuses for the 31 December 2011 reports are provided in the attachment to this advisory.

Attachment to 11-312MR: Improved financial information for investors and others

Financial position of entities

1. Asset values

Impairment testing of goodwill, identifiable intangibles and other assets continues to be an area requiring improvement. A number of companies have made substantial impairment write-downs following ASIC enquiries.

We are currently making further enquiries of a number of entities where there are indicators of possible asset impairments, such as reported net assets being significantly higher than the entity’s market capitalisation. We have concerns that some entities are ignoring the significance of these indicators.

Other issues identified in our reviews included:
  1. use of unrealistically optimistic discount and growth rates;
  2. failure to disclose carrying amounts allocated to each cash generating unit and the basis for determining recoverable amounts;
  3. lack of disclosure of assumptions used in discounted cash flow calculations, particularly growth rates and discount rates; and
  4. no sensitivity analysis for changes in key assumptions.

In response to ASIC enquiries, many entities are making greater disclosure of key assumptions underlying asset impairment calculations. These disclosures are important to investors and other users of financial reports given the subjectivity of any calculations.

ASIC will continue to review asset values, impairment testing and related disclosures at 31 December 2011. ASIC recognises the challenges of making subjective judgements in asset valuations. The learnings from the Centro case should encourage directors to carefully consider values in light of their knowledge of the business and its prospects in the context of the economic conditions.

Some topical events that may affect asset values include: exposures to countries with economic uncertainties; the impact of exchange rate movements; the imminent carbon tax and the proposed mineral resource rent tax. Focus should also be placed on values of financial assets and investment properties measured at fair value.

2. Going concern

There continue to be instances where companies have failed to make adequate disclosures relating to the ability to continue as a going concern.

Going concern assessments are critical. Directors need to be realistic in their assessment of the business, its’ prospects and future cash flows. Entities should also continue to focus on the ability to refinance debt at appropriate cost and compliance with lending covenants.

3. Off balance sheet arrangements

ASIC has queried a number of entities that have not consolidated entities in which they hold an ownership interest of over 50%. Many of these entities are now consolidating those interests.

While ownership interest is only an indicator of control, directors should review off-balance sheet investments in which a majority ownership is held.

Leaving arrangements off-balance sheet on the basis that risks may be remote is unlikely to be appropriate where no significant risks are borne by other parties. Where adverse economic circumstances may result in the entity bearing most losses, it is likely that arrangements should be on-balance sheet.

Where arrangements remain off balance sheet, the details of the arrangements and any exposures should be disclosed, together with the reasons why they are not on balance sheet.

4. Current vs non-current classifications

The correct classification of liabilities and assets between current and non-current is important to an understanding of the financial position of an entity. ASIC has continued to find cases where current liabilities have been incorrectly classified as non-current and adjustments have been required.

Directors should ensure that there are appropriate processes to ensure the correct classification and should review the classification having regard to their knowledge of the business and its’ funding arrangements.

5. Estimates and accounting policy judgements

Some entities did not make material disclosures of significant judgements in applying accounting policies and sources of estimation uncertainty. Other entities included ‘boiler plate’ disclosures. These disclosures should be specific to the entity and its assets, liabilities, equity, income and expenses.

Sources of estimation uncertainty are important, as is information on accounting policy judgements. Directors should ensure that meaningful disclosures are made in these areas.

Providing meaningful information to assist in understanding entity performance

6. Non-IFRS profits

ASIC released a Regulatory Guide RG 230 Disclosing non-IFRS financial information (RG 230), which provides guidance on the disclosure of non-IFRS financial information in financial reports, transaction documents, and other documents. Directors, preparers of financial reports and auditors should consider the impact of RG 230 at 31 December 2011.
Non-IFRS financial information is financial information that is presented other than in accordance with all relevant accounting standards. Australian accounting standards are consistent with the International Financial Reporting Standards (IFRS).

Non-IFRS financial information can provide useful information to investors and other users of financial reports. The information can be presented in documents such as directors’ reports, market announcements, investor briefings and transaction documents, provided it is not misleading. While the presentation of the information in financial reports is subject to particular legislative and accounting standards restrictions, these restrictions do not apply to documents attached to financial reports or other documents.

However, it is important that information is not misleading. RG 230 includes guidance to assist directors in reducing the risk that information is misleading, including:
ASIC reviewed the financial reports, market announcements, investor and analyst presentations and related media releases for 120 listed entities in relation to non-IFRS profit disclosures. Over half of these entities disclosed a non-IFRS profit number in at least one of the documents reviewed.

ASIC has contacted a number of companies to discuss their disclosures further. Some companies have already responded by removing non-IFRS profit numbers from the face of the statement of comprehensive income in their 30 June 2011 financial reports. Other companies have addressed misleading presentations in other documents.

Cases under discussion with companies include market disclosures where the non-IFRS profit measures have been changed between years, possibly to give a more favourable result. Some companies have already recently addressed inconsistent non-IFRS profit calculations between periods in response to ASIC enquiries.

Directors should ensure that disclosures at 31 December 2011 are prepared with regard to the guidance in RG 230. ASIC will contact companies where the disclosures breach accounting standards or are potentially misleading.

7. Operating and financial review

ASIC reviewed the Operating and Financial Reviews (OFRs) of 120 listed companies at 30 June 2011 for compliance with sections 299 and 299A of the Corporations Act. We are concerned with a lack of meaningful disclosure of information in many OFRs, including the extent of meaningful analysis of underlying drivers of results. We are also concerned by poor disclosure by many entities of business strategies and prospects for future financial years.

We are making enquiries of a number of companies and are planning a consultation on the proper content of these reports in the coming year. The consultation paper will also deal with the possible over-use of the exemption from disclosing information on the basis of unreasonable prejudice.

Providing a meaningful OFR should continue to be a focus for directors at 31 December 2011.

8. Segment reporting

Listed entities must disclose segment information to enable users to evaluate the nature and financial effects of their business activities and the economic environments in which they operate. They are also required to identify and report on segments having regard to components of their business for which there is regular internal reporting of operating results to the entity’s chief operating decision maker.

Following ASIC enquiries, some entities are now reporting more segments. In some cases, information disclosed in documents such as market announcements or the OFR suggest that there may be more segments that should be reported in the financial report.

Directors should ensure that segment disclosures at 31 December 2011 provide information based on internal reporting and any other segment information needed by investors.

Disclosure of other key information needed by investors and others

9. Financial instruments

A number of entities did not make adequate disclosures to enable users of financial reports to understand and evaluate the nature and extent of the specific market, credit and liquidity risks associated with their use of financial instruments. Disclosures should be meaningful to users, and specific disclosures should be made rather than boilerplate disclosures.

A number of entities failed to disclose financial asset fair value information using a three level hierarchy reflecting the extent to which observable market data is used in the measurement , or failed to disclose the methods and significant assumptions used to value assets for which there was no observable market data.

Other deficiencies related to disclosing an ageing analysis of financial assets that are past due but not impaired and an analysis of impaired financial assets.

Directors should focus on financial instrument disclosures at 31 December 2011.

10. New accounting standards

A number of new accounting standards have been issued recently that may impact materially on the financial reports in future years, including a new standard on consolidation accounting. The impacts of the new standards must be disclosed in 31 December 2011 full year financial reports.

Other focus areas for 31 December 2011

11. Minerals Resource Rent Tax (MRRT)

The MRRT legislation has passed the lower House of Parliament but is still to be considered by the Senate. When enacted or substantively enacted, entities impacted by the tax may need to re-measure their deferred tax balances. The MRRT appears to be an income tax to be accounted for under AASB 112 Income Taxes (similar to the Petroleum Resource Rent Tax). Where an entity re-measures the tax base of its depreciable mining assets under the legislation, there could be a significant impact on deferred tax balances and income tax expense. Entities should adequately plan for any valuation advice required and take care when re-measuring the tax base of their depreciable assets. Entities should assess the impact of the proposed MRRT on asset impairment and consider disclosing expected future impacts on deferred tax balances.

12. Rights to future income

ASIC is making further enquiries of some entities that have recognised a right to future income as a financial asset at fair value rather than intangible assets required to be measured at amortised cost. Recently, two companies have amended their treatments in this regard.

Directors should ensure the correct classification of rights to future income at 31 December 2011.

13. Intangible asset revaluation

Accounting standards only allow entities to revalue certain identifiable intangible assets to fair value and only then where an active market exists for the asset. ASIC is not aware of any identifiable intangible assets for which an active market exists in Australia. After ASIC enquiries, some entities have recently ceased using fair values. Recent changes in accounting standards will not change the ‘active market’ test.

Directors should ensure that the active market test is met for any revalued intangible assets at 31 December 2011.

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