Announcing its focus areas for 31 December 2018 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.
Both full-year and half-year reports at 31 December 2018 must comply with new accounting standards on revenue recognition and financial instrument values (including hedge accounting and loan loss provisioning).
The reports must also disclose the future impact of new lease accounting requirements. There are also new standards covering: accounting by insurers; and the definition and recognition criteria for assets, liabilities, income and expenses.
ASIC Commissioner John Price said, ‘We are concerned that some companies may not have adequately prepared for the impact of new accounting standards that can significantly affect results reported to the market by companies, require changes to systems and processes, and affect businesses. We will monitor these areas closely and will take action where required.’
It is important that directors and management ensure that companies are prepared for these new standards and inform investors and other financial report users of the impact on reported results.
ASIC will be reviewing more than 85 full year financial reports at 31 December 2018 and selected half-year reports.
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).
FOCUSES FOR 31 DECEMBER 2018 FINANCIAL REPORTS
New accounting standards
1. Impact of the new standards
New accounting standards that will significantly affect reported results of many companies include:
- AASB 9 Financial Instruments (applies from years commencing 1 January 2018);
- AASB 15 Revenue from Contracts with Customers (applies from years commencing 1 January 2018);
- 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: Subject to consultation in 2019, the International Accounting Standards Board has proposed to change the application date for the standard on which AASB 17 is based to years commencing 1 January 2022.]
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.
Given the extent of the changes to financial reporting, companies that have not already done so should determine the extent of any impact. 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 and timely implementation is important for investors and market confidence. Information that there will be no material impact may also be important information for the market.
Directors and preparers should consider any continuous disclosure obligations and the need to keep the market informed, as well as the impact on any fundraising and other transaction documents.
Half year reports
The new revenue and financial instrument standards apply to years commencing 1 January 2018, directly impacting on reported results of companies with half-year financial reports at 30 June 2018. The half-year financial reports must disclose the nature and effect of changes in accounting policies from applying the new standards.
ASIC will review selected half-year reports, focusing on compliance with the new standards.
New lease accounting and other requirements
Directors and auditors should ensure that notes to 31 December 2018 financial statements disclose the impact on future financial position and results of new requirements for accounting for leases, accounting for insurance businesses, and new definition and recognition criteria for assets, liabilities, income and expenses.
It is reasonable for the market to expect that companies will be able to quantify the impact of the new standards, particularly for the lease standard.
Companies with 31 December 2018 year ends will be reporting to the market part way into the 2019/20 year for which the new lease standard will first apply. Any results forecast for the 2019/20 year disclosed to the market should be consistent with the accounting basis required by the new standards for that year.
The new leases standard will bring all leases onto the balance sheet and apply a new measurement basis. Where companies choose to apply the new requirements in comparative information in their 30 June 2020 financial report, new lease balances will be needed as at 30 June 2018.
New conceptual framework
In March 2018, the International Accounting Standards Board released a new conceptual framework. Amendments were made to international standards to apply new definition and recognition criteria for assets, liabilities, income and expenses in the framework will apply for years commencing 1 January 2020 where the criteria are not inconsistent with a specific requirement of an accounting standard.
While the Australian equivalent standards have not yet been amended, companies that are required to make an explicit unreserved statement of compliance with IFRS will need to make note disclosure at 31 December 2018 of the future impact of the criteria in the new framework in order to make that statement.
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:
- cash flows and assumptions are reasonable having regard to matters such as historical cash flows, economic and market conditions, and funding costs. Where prior period cash flow projections have not been met, careful consideration should be given to whether current assumptions are reasonable and supportable;
- discounted cash flows are not used to determine fair value less costs of disposal where forecasts and assumptions are not reliable. Fair value less costs to sell should not be viewed as a means to use unreliable estimates that could not be used under a value in use model;
- value in use calculations:
- do not use increasing cash flows after five years that exceed long term average growth rates, and without taking into account offsetting impacts on discount rates, and
- do not include cash flows from restructures and improving or enhancing asset performance
- cash flows used are matched to carrying values of all assets that generate those cash flows, including inventories, receivables and tax balances;
- discount rates and other key assumptions are reasonable and supportable;
- CGUs are not identified at too high a level, including where cash inflows for individual assets are not largely independent; and
- CGUs for testing goodwill are not grouped at a higher level than the operating segments or the level at which results are monitored for internal management purposes.
Other areas of focus on asset values include:
- companies affected by market changes, digital disruption, technological change, climate change or Brexit;
- the pricing, valuation and accounting for inventories, including the net realisable value of inventories, possible technical or commercial obsolescence, and the substance of pricing and rebate arrangements; and
- 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.
Accounting policy choices
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:
- there is an asset as defined in the accounting standards;
- it is probable that future economic benefits will arise; and
- the requirements of the intangibles accounting standard are met, including
- expensing start-up, training, relocation and research costs;
- ensuring that any amounts deferred meet the requirements concerning reliable measurement; and
- 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:
- there is a proper understanding of both the tax and accounting treatments, and how differences between the two affect tax assets, liabilities and expenses;
- the impact of any recent changes in legislation are considered; and
- 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 digital disruption, new technologies, climate change, 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 OFRs.
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.