Judgement has just been handed down
by Justice Peter Vickery of the Victorian Supreme Court in a case that we were involved in, ICM Investments Pty Ltd v San Miguel Corporation and another. It pulls together the law in a number of useful areas, including commercial contracts and the payment of dividends.
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SBR could completely change the face of financial reporting.
It is based on an international taxonomy, XBRL, or eXtensible Business Reporting Language, and is already used in many countries for financial and statistical returns to government. A more elaborate version, iXBRL also has the facility for producing human-readable reports as well as just coded data.
In its options paper, Treasury is canvassing making SBR mandatory in Australia for the lodgement of financial reports. It is currently optional and few organisations have chosen to do it and the potential benefits are untested in Australia. With the increasing complexity of financial information, a core of audited tagged data that can then be used by regulators, analysts and other users, is the way of the future and so our submission and detailed answers to the Treasury's questions support mandating SBR for listed entities.
Current practice has demonstrated that SBR does not provide preparers of financial information with sufficient benefits to cause them to voluntarily adopt its use and so far analysts have not provided sufficient demand to cause preparers to adopt SBR. Presently the only likely pressure for the adoption of SBR will come from analysts (principally those with experience of its use in the UK and USA). If compulsion is seen as good policy, providing the means by which Australian companies maintain their access to global capital markets, then SBR should be mandated for listed companies or companies seeking listing. There is presently no commercial rationale for the compulsory use of SBR by unlisted companies.
If the real drivers for the use of SBR are the efficient operation of government bodies, the only way to achieve adoption at present will be through compulsion. That compulsion needs to be aligned with the creation of software accessible and affordable to the range of businesses that will be affected by SBR based lodgement.
The IAASB's proposals to revise ISA 720
"The Auditor's Responsibilities Relating to Other Information in Documents Containing or Accompanying Audited Financial Statements and the Auditor's Report Thereon" will extend the auditor's responsibilities to consider other accompanying information and presents challenges to the profession, in terms of balancing risk against the need to provide a useful assurance service.
The time is right to consider this accompanying information, because of the increased use of the internet as a tool for publishing financial information and reliance by investors on reports from analysts. The number of shareholders who rely directly and exclusively on the statutory financial report for their information about their investment would be very small.
Westworth Kemp's submission on the proposals suggests that whilst the proposed ISA seeks to define a process that does not, in audit parlance, give assurance, or at least assurance comparable to an audit or review, the general reader is likely to see any form of report as giving them comfort that the matter upon which the auditor is commenting is suitable for their (the general reader’s) use. This is the essence of the expectation gap. Care must be taken not to widen that expectation gap, especially when a discrepancy between other information and the audited financial statements may be a matter of tone rather than hard facts.
This is not, however, a reason for not providing the proposed forms of report.
Effective management of the risk implicit in the giving of the proposed report requires careful consideration by the auditor. Whilst the provision in the standard of steps that can be taken when dealing with the other information may provide the auditor with some protection, ultimately the review of other information under the proposed ISA 720 would have to be undertaken by senior audit executives. Inherent in the work is the exercise of judgement and understanding of the client, which cannot be delegated to junior staff.
The AASB's controversial ED Australian Additional Disclosures - Investment Entities
is worth a read. Not many exposure drafts are issued including two Alternative Views. Because it imposes on Australian investment entities significant disclosure requirements over and above what is required by the IASB, it is worthy of attention.
Westworth Kemp have lodged a submission that is highly critical of the AASB's proposals.
Our submission together with detailed answers to the AASB's questions expresses our grave concern with the tenor of the exposure draft. In 2002, the FRC decided that Australia should adopt IFRS, a decision that was implemented by the AASB issuing a “stable platform” of converged Australian standards in 2004, the application of which resulted in compliance with IFRS. At that point, Australia ceded its sovereignty in terms of standard-setting for publicly accountable private sector entities and the role of the AASB became the role of a commentator and lobbyist in an international forum. Shortly after the changeover to AIFRS took place, the few optional treatments permitted under IFRS were reinserted into the standards and many of the remaining Aus paragraphs were removed to ensure, as far as possible, complete convergence. Australian entities then had access to all the accounting treatments permitted under IFRS overseas. To insert significant new Australian disclosure requirements now and to delay the adoption of a standard that was passed by the IASB in October 2012 is in our view a retrograde step. Furthermore Australian investment entities are being prejudiced in an international context by being prevented from early-adopting the October 2012 amendments.
Because the proposals are so at odds with IFRS, they do not fall within the provisions of IAS 1 (AASB 101) paragraph 15 which allows the inclusion of additional information to allow fair presentation. To run that argument would be to argue that the standards set by the IASB, which specifically exempt investment entities from consolidating, do not give a fair presentation. Such a view undermines the whole principle of international harmonization, achieved by using IFRS as the basis for Australian financial reporting and is at odds with the powers of AASB set out in s227 of the ASIC Act. Consequently, if ED 233 is issued as a standard, Australian companies complying with the standard would therefore not be able to make the unequivocal statement of compliance with IFRS required by AASB 101 (IAS 1) paragraph 16.
We understand that control based consolidation has been a key feature of Australian financial reporting for a long time and has stood Australia in good stead, but in our view there are circumstances where the nature of the investor relationship is better portrayed by accounting for the investment at fair value.
The life and times of the Financial Reporting Panel
Stephanie and UNSW academic Jeffrey Knapp have had their article The Life and Times of the Financial Reporting Panel published in the Company and Securities Law Journal, Vol 30/8 November 2012. We can't post the article here, but it is available through academic libraries.
The abstract reads: "On 1 January 2005, the Financial Reporting Panel was established at law amid high expectations that, as an alternative to the courts, it would prove to be a useful accounting dispute resolution body. On 23 August 2012, the Panel was effectively closed with the passage through both Houses of Parliament of the Corporations Legislation Amendment (Financial Reporting Panel) Bill 2012 (Cth). The reason proffered for the Panel's closure is that its ongoing existence could not be justified on the ground of cost-benefit, given a history of few referrals and rare use. This article is the first to consider how the Panel has operated and to narrate its history from origination to closure. The article also analyses why the Panel was underused and failed to meet its original expectations."
The year opened with the second of the two Centro cases, the shareholder class action against PwC, ASIC’s case against the directors having concluded in 2011. Whilst ostensibly about accounting standards, Centro and other corporate implosions raise important questions about internal corporate communications and the rights of creditors versus the rights of shareholders, who include the superannuation fund investments of the mums and dads of Australia. It also raises questions about governance generally and the ability of directors and auditors to determine a company’s capacity to continue as a going concern when much of the information about funding lies with the company’s bankers.
Accounting standards setting is facing important changes. Internationally, Sir David Tweedie has been replaced as Chairman of the IASB by Hans Hoogevoorst, a former minister in the Dutch government and supervisor of the Dutch financial markets regulator, with a background in finance and international relations. We anticipate changes in emphasis and direction from this move.
The role of the US in international standard setting may be at a crossroads as the US continues to debate whether or not to adopt IFRS while other nations, particularly those in the developing world, progress with adoption. Hoogevoorst in his recent speech to the AICPA challenged the US: “We really need a tangible sign of continued US commitment to a single set of global standards. Merely striving for greater comparability between standards will not do. … In the absence of a credible, tangible step on the part of the United States, international concern could turn into international scepticism. The G20 calls for global accounting standards would start to ring increasingly hollow. We cannot allow that to happen.” With the extension and regionalising of the group of IASB trustees, we may see over time a shift to significant influence from non-traditional players in standard setting space as Asian economies and in particular India and China flex their muscles. The US’s predominant role in financial regulation is also being contested with China’s challenges to the PCAOB as they attempt to conduct audit inspections of Chinese firms.
As far as the nuts and bolts of accounting standards are concerned, accounting for groups and investments is set to change. The new suite of standards will take effect from 1 January 2013, redefining the concept of control within a group and, as a result, which entities should be consolidated and how other significant interests in investees should be accounted for.
Hovering as a continuing threat are proposed significant changes to the way in which leases are accounted for, which would bring almost all leasing arrangements on balance sheet and the modernisation of the revenue recognition standard focussing more on performance obligations. Both of these moves are presenting a challenge to standard setters endeavouring to write principles based standards that can be applied to a wide variety of circumstances while constituents call for requirements and exceptions to fit specifics. When these standards are finalised, they could have material consequential implications for commercial arrangements and covenants.
Another recurring theme in 2012 was “cutting the clutter” – discussion of how to stop financial reports becoming longer and longer to the detriment of meaningful communication with the reader. Overseas papers consider various ways in which the volume of note disclosures in financial statements may be limited and discuss ways in which standards drafting could be improved. Driven by a view that clarity in information is more important than compliance with rules, these proposals, if pursued, will necessarily increase the responsibility of all those involved in financial reporting to make difficult decisions about what should be in financial statements and what should be excluded. The intent is that compliance with voluminous disclosure requirements will not cut it.
We see an uncoordinated cacophony of developments in which a variety of authorities are seeking to resolve perceived problems in financial reporting and auditing, the product of which is requirements for more explanation and a greater obligation on all involved in the financial reporting process to provide information that is often subjective and requires an increased obligation to exercise judgement, rather than rely on process or compliance.
The UK’s FRC has developed requirements for audit committees to provide more information about their processes and the global auditing standard-setter the IAASB is proposing a longer form of audit report, incorporating the auditor’s commentary on judgemental aspects of the financial report. In their submission to the IAASB, Westworth Kemp strenuously argued against lengthening the audit report. Previous expansions of the audit report to include more detail on the audit process and reduce the so-called “expectation gap” have done little to dampen the enthusiasm of aggrieved parties for suing the auditors.
At the same time ASIC has issued its draft statement on the information to be the operating and financial review. And ASX has issued a guidance paper to assist companies in navigating a course through the minefield of continuous disclosure. John Price of ASIC has, in a speech dated 3 December, reflected ASIC’s support of the proposals. In our view this remains an area where it is easy to say what should be done but the reality will remain difficult.
Beating up the auditors continues to be a popular pastime with regulators, most recently with the publication of ASIC’s audit surveillance report, asserting that “18% of the 602 audit areas reviewed did not perform all of the procedures necessary to obtain reasonable assurance that the audited financial report was not materially misstated” Such regulatory comment is in our view is ill considered and runs counter to good market regulation. Audit firm rotation is currently being advocated by overseas regulators as a panacea but there is no evidence that the longevity with one firm (rather than one partner) decreases objectivity. Conversations with practitioners reinforce the view that the auditor on the first year of an audit faces a steep learning curve coming to grips with the business operations of the new client. Further ASIC has done little to improve audit quality or market understanding by its assertions that audit quality is declining in a report that is opaque to those it is critiquing and fails to take the next regulatory step of requiring remediation of deficient audits to ensure there were no underlying failures in the information audited.
Our wish list for Christmas and going forward into a new year that could be a period of increasing uncertainty, confusion and, ultimately, for directors, auditors and their advisers, risk, is:
Let’s understand what is really needed in financial statements and strive for clear communication with stakeholders;
Let’s understand how continuous disclosure interacts with reporting generally;
Let’s continue to evolve practical working guides to cover the whole plethora of information released by companies to the markets
Let’s co-ordinate the wide variety of regulatory developments currently in train many of which have merit to ensure that we don’t just overregulate; and
Let’s get a clear idea of the roles of the several gatekeepers responsible for corporate governance and reporting.
We wish you all the best for the festive season – and the web links in our footnotes will keep you provided with holiday reading if you run out of novels!
 Media coverage of the PCAOB vs China saga: http://retheauditors.com/2012/12/04/auditors-diss-us-regulators-regarding-china/ The new group accounting standards: http://www.charteredaccountants.com.au/Industry-Topics/Reporting/Current-issues/Convergence/News-and-updates/AASB-releases-consolidation-standards
 IASB project page http://www.ifrs.org/current-projects/iasb-projects/leases/Pages/leases.aspx, including a Snapshot of the initial proposals and reports on the progress of the project IASB project page at http://www.ifrs.org/current-projects/iasb-projects/revenue-recognition/Pages/revenue-recognition.aspx, including a Snapshot of the proposals and reports of the project’s progress
 FRC paper on reducing irrelevant information http://www.frc.org.uk/Our-Work/Codes-Standards/Accounting-and-Reporting-Policy/Cutting-Clutter.aspx , EFRAG paper on a framework for note disclosures: http://www.efrag.org/front/p169-1-272/proactive---a-disclosure-framework-for-the-notes-to-the-financial-statements.aspx etc Our commentary on IAASB’s proposal for auditor’s reports:  John Price’s speech on continuous disclosure: http://www.asic.gov.au/asic/asic.nsf/byheadline/Continuous+disclosure+speech+December+2012?openDocument
ASIC’s news item on audit inspections: http://www.asic.gov.au/asic/asic.nsf/byheadline/12-301MR+ASICs+audit+inspection+findings+for+2011-12?openDocument
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continuous disclosure requirements, analysts’ presentations, regular financial reporting and even social media commentary. The European Financial Reporting Reporting Advisory Group’s (EFRAG) consultative document, “Towards a Disclosure Framework for the Notes” addresses the volume of note disclosures in financial statements that prevent the reader from “seeing the wood for the trees” by setting out some principles for a decision framework, to change how disclosure requirements are set and applied.
Westworth Kemp’s submission (see PDFs below) supports these moves and also encourages standard setters with related projects to work together to reduce the volume of disclosures and improve the quality of financial communications.
Disclosure Framework specific responses.pdf
ASIC’s proposals to regulate the contents of the OFR in Consultation Paper 187 Effective disclosure in an operating and financial review may represent a missed opportunity to explore the optimal ways in which the information already available to the market can be collated and presented without unnecessary and possibly confusing duplication.
CP 187 recognizes that important information about a company already exists in many places, but it does not explore options that might be available to deliver this information in any manner other than as a précis of matters available elsewhere.
Whilst this paper is predicated on the requirements of legislation, it represents a lost opportunity to explore more fully who the users of this information might be and how their needs could be best addressed. The Paper seems to consider the needs of a wider spectrum of users than those envisaged by the Corporations Act, by referring to “investors” rather than using the term “members” used in the Act.
In view of that implied extended brief for the Paper to cover potential as well as actual members, we neither believe that that the term “investors” is sufficiently precise when many investors get their information through intermediaries (such as brokers and financial advisers) nor do we think that is appropriate to limit the users to present and future investors. We therefore pose the following questions in respect of the OFR:
In our view if these questions were addressed, the answers to a number of the questions express or implicit in this paper would be answered including:
To see the full details of our submission, click on the PDFs below:ASIC Response to Questions.pdf
The article surveys recent international papers that discuss the nature of audit scepticism by the UK Financial Reporting Council and the International Auditing and Assurance Standards Board
Chris and Stephanie act as consultants and experts (“clean” and “dirty” experts) in the context of dispute resolution on a variety of financial reporting and audit issues.
Westworth Kemp Consultants can provide support to businesses, professional practices and regulators seeking to implement systems designed to foster compliance
Independent advice on the interpretation of auditing (or assurance) and accounting (or financial reporting) standards can be hard to find.