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The Westworth Kemp Review - December 2012

Posted by Chris Westworth on 18 December 2012
2012 has been a year of subtle but significant change.

 

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.”[1] 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[2].

 

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[3]

 

Hovering as a continuing threat are proposed significant changes to the way in which leases[4] are accounted for, which would bring almost all leasing arrangements on balance sheet and the modernisation of the revenue recognition standard[5] 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[6] 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[7] 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[8], 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”[9]  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!

 

 


[1] The speech: http://www.ifrs.org/Alerts/PressRelease/Pages/AICPA-Dec-12.aspx

[2] Media coverage of the PCAOB vs China saga: http://retheauditors.com/2012/12/04/auditors-diss-us-regulators-regarding-china/

[3] The new group accounting standards: http://www.charteredaccountants.com.au/Industry-Topics/Reporting/Current-issues/Convergence/News-and-updates/AASB-releases-consolidation-standards

[4] 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

[5] 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

[6] 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

[7] Our commentary on IAASB’s proposal for auditor’s reports:

http://westworthk.staging.thewebconsole.com/blog/improving-the-auditor-s-report?preview=1

[8] John Price’s speech on continuous disclosure: http://www.asic.gov.au/asic/asic.nsf/byheadline/Continuous+disclosure+speech+December+2012?openDocument

[9]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

Author:Chris Westworth
Tags:NewsAssuranceComplianceLitigation SupportReporting

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