ASIC has signalled a comprehensive move on company reporting in 2010, ranging from the fine detail in the financial accounts to a possible imposition of prospectus content requirements on annual reports.
An ASIC release last week details a long list of potential trouble spots that the Commission has identified in financial reports. Simultaneously, it is reviewing the role of annual reports, with a view to improving their utility for investors.
ASIC reviews a sample range of financial reports each year and issues a list of what it calls "key areas for continued focus". The review of June 2009 reports has just been published. Unsurprisingly, GFC-related issues figure large. For example, in FY accounts to 30 June 2009, writedowns were 11 per cent of the total value of indefinite life intangible assets (including goodwill). This compares with six percent in the six months to 31 December 2008, and less than one per cent for the 12 months to 30 June 2008.
Although this indicates that companies are taking account of economic reality, ASIC still has a number of concerns. In addition to the issues noted below, ASIC says that its upcoming review of 31 December 2009 financial reports will focus on compliance with revised accounting standards, including segment reporting, business combinations, consolidated financial statements and presentation.
It is important to note that ASIC's review of financial statements is not an academic exercise. Where it has concerns about a particular report, the Commission will go back to the reporting entity for an explanation/justification. That process may include follow-up reviews to ensure that ASIC's concerns have been properly addressed. We have considerable expertise advising companies in relation to these issues.
The ASIC review uncovered a number of practices (by no means all necessarily new) which impact on the reporting of asset impairment:
unrealistically optimistic discount and growth rates;
cash flows projected for more than five years in value in use calculations without any explanation justifying the longer period. ASIC says that periods of more than five years should only be used if the forecasts are detailed and explicit, management is confident that the projections are reliable, and there is past evidence supporting the ability of management to forecast accurately over the longer period;
when testing goodwill impairment, cash-generating units (CGUs) are not chosen at a sufficiently low level. CGUs have to be chosen at a level which ensures that cash flows from assets in one unit do not support asset values in other units;
failure to disclose carrying amounts allocated to each CGU and the basis for determining recoverable amount;
flawed discounted cash flow (DCF) calculations, including pre-tax discount rates being applied to post-tax cash flows or vice versa;
no sensitivity analysis disclosed for changes in key assumptions; and
a lack of disclosure of assumptions used in DCF calculations, particularly growth rates and discount rates. Disclosure of these assumptions has always been required for "value in use" and is also required for fair values based on DCF projections from 31 December 2009 year ends.
Fair value of assets
The fair value treatment of assets has also attracted ASIC's attention.
While writedowns of investment properties rose from six per cent to 12 per cent between December 2008 and June 2009, ASIC still has some concerns about the treatment of this class of asset. It notes that some entities carrying investment properties at fair value failed to appropriately disclose the methods and significant assumptions applied in determining those fair values.
Two concerns about financial assets are raised:
where there is an inactive market for a financial asset, fair value should be determined with the maximum use of market inputs, and key assumptions should be disclosed;
the quantitative criteria for the significant or prolonged test used by some entities in relation to available for sale (AFS) assets may not comply with accounting standards.
The carrying of intangible assets at fair value has also caught ASIC's attention. It advises entities that are carrying intangibles at fair value to review the basis for that treatment. (It says that it has not yet seen intangible assets in Australia that would meet the criteria under which the accounting standards allow certain identifiable intangible assets to be revalued where there is an active market for the intangible asset.)
Off balance sheet exposures
ASIC reveals that it has recently identified two cases where entities should have consolidated other entities.
It advises directors to carefully review any off-balance sheet arrangements to ensure that they are correctly treated. Where arrangements remain off balance sheet, the nature and scale of the arrangements should be disclosed, together with the reasons why they are not on balance sheet.
Other issues for financial reports
Other issues on ASIC's radar for financial reports include:
full disclosure of financial instruments, no matter how complex they may be;
disclosure of significant judgements used in applying accounting policies;
disclosure of key assumptions and sources of estimation uncertainty;
incorrect classification of current debt.
The bigger picture
Concurrently with the micro-detail of financials, ASIC is looking at whether there needs to be a new approach to annual reports as a whole.
This was foreshadowed by ASIC Commissioner Belinda Gibson in a speech in December. There, she wondered whether annual reports have declined into tick-a-box promotional publications for companies, rather than documents which perform an essential role in providing real information to the investment community. She also noted that continuous disclosure notices can be a bit of a jigsaw:
"It can be very difficult for investors to form a complete view of an entity on the basis of continuous disclosure releases of varying importance. Our regime can only work effectively if ... the annual report [provides] an opportunity for investors to take stock of the company as a whole."
Shortly after that speech, ASIC released its proposals paper for the retail corporate bond market (see ASIC jump-starts corporate retail bond market and eases disclosure for convertible notes). Tucked into the back of that paper was a request for submissions on the annual report regime. As well as an expanded version of the concerns expressed by Commissioner Gibson, the paper indicated that ASIC is reviewing the current regime, with a view to improving the annual report as a source of information to investors.
Apart from general input on how annual reports might be improved, the Commission is seeking comment on whether the their contents should be more closely aligned with fundraising documents:
"Would there be benefits for investors in expanding the role of annual reports so that they provided a more detailed update of key information about a company and its securities? Are there any matters not currently included in the annual report that would be particularly useful to investors and that are required to be included in a prospectus under s710?"
This is an issue which would require careful consideration, rather than ad hoc changes. If enacted, it would require a clarification of the interaction between the three principal arms of investor information (continuous disclosure, prospectuses and annual reports), with particular reference to the liability regime which attaches to each of them.