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Review of financial reporting by issuers cycle 5 [2007] NZSecCom 9 (29 October 2007)

Last Updated: 12 November 2014

REVIEW OF FINANCIAL REPORTING BY ISSUERS
CYCLE 5
Financial Reporting Surveillance Programme

29 October 2007

CONTENTS

EXECUTIVE SUMMARY
INTRODUCTION

The Commission's Financial Reporting Surveillance Programme New Zealand Generally Accepted Accounting Practice (NZ GAAP) Identifying issues
CYCLE 5: AN OVERVIEW

Scope Overall Comments Outcome of Matters Raised Follow-up action
FUTURE ADOPTION OF NZ IFRS CYCLE 5 FINDINGS ON THE APPLICATION OF NZ IFRS

Significant matters Other matters Improvements in disclosures
CYCLE 5 FINDINGS ON THE APPLICATION OF PREVIOUS NZ GAAP

Significant matters Other matters Improvements in disclosures
QUALITY OF FINANCIAL REPORTING ALTERNATIVE NON-GAAP MEASURES REFERRALS TO THE NEW ZEALAND INSTITUTE OF CHARTERED ACCOUNTANTS (NZICA)

ADOPTION OF IFRS GLOBALLY International observations
IOSCO ONGOING REVIEW AND ENFORCEMENT

EXECUTIVE SUMMARY

Financial Reporting Surveillance Programme

The Securities Commission of New Zealand has established a Financial Reporting Surveillance Programme to review financial reporting practices of issuers. The aim of this programme is to encourage New Zealand issuers to improve the quality of their financial reporting. The Commission believes the quality of financial reporting is inextricably linked to the fairness, efficiency and transparency of securities markets.

Findings from Cycle 5

In Cycle 5 the Securities Commission reviewed the financial reports of 40 issuers with balance dates from 31 March 2006 to 30 September 2006. This review comprised 12 financial statements prepared in accordance with NZ IFRS and 28 prepared under previous NZ GAAP.

The Commission's review covers compliance with Financial Reporting Standards and other sources of NZ GAAP with the purpose of assessing the overall quality of financial reporting.

The reports of 16 of the 40 issuers reviewed had matters that prompted the Commission to write to the issuer requesting additional information. In some cases the Commission asked issuers to revise or enhance disclosures in future financial statements.

Key issues identified in the application of NZ IFRS included presenting the correction of prior period errors as transition adjustments, the incorrect labelling of comparatives and the treatment of GST in the preparation of the cash flow statement.

The application of previous NZ GAAP raised key issues on the treatment of an item as a fundamental error and reviewing investments for impairment.

Recent reviews have identified two specific areas of divergence from NZ GAAP: the accounting for reverse acquisitions and the consolidation of securitisation trusts. The issuers involved informed the Commission that the treatment adopted in these areas is 'common practice' albeit non-compliant with NZ GAAP. The Commission is of the view that common practice does not justify a departure from NZ GAAP.

The Commission has been pleased with the cooperation from issuers and their willingness to improve the quality of their financial reporting.

The Commission will continue its Financial Reporting Surveillance Programme.

INTRODUCTION
1.
The Securities Commission is New Zealand's main regulator of investments. Our purpose is to strengthen investor confidence and foster capital investment in New Zealand by promoting the efficiency, integrity and cost-effective regulation of our securities markets.


2.
The Commission regards financial reporting by issuers1 to be fundamentally important to the fairness, efficiency and transparency of New Zealand's securities markets.

The Commission's Financial Reporting Surveillance Programme
3.
The Securities Commission is required under section 10(c) of the Securities Act 1978, "to keep under review practices relating to securities, and to comment thereon to any appropriate body".


4.
As part of its work to carry out this function the Commission established the Financial Reporting Surveillance Programme.


5.
The aim of the Commission's Financial Reporting Surveillance Programme is to encourage New Zealand issuers to improve the quality of their financial reporting so that:
(a)
issuers' financial report disclosures are clear and comprehensive;


(b)
investors can have confidence in the credibility of financial information provided by issuers; and


(c)
high quality financial reporting contributes to the integrity of New Zealand's securities markets.




6.
The Financial Reporting Surveillance Programme involves biannual reviews of selected issuers' financial reports. At the end of each cycle review the Commission publishes a public report on this surveillance work that provides market participants with a summary of the findings. Copies of reports for previous cycles of review are available on the Commission's website www.seccom.govt.nz.

New Zealand Generally Accepted Accounting Practice (NZ GAAP)
7.
Issuers are required under the Financial Reporting Act 1993 to prepare financial statements that comply with NZ GAAP and provide a true and fair view of the matters to which they relate2.


8.
The financial reports of issuers are reviewed against NZ GAAP. For the purpose of the Financial Reporting Act 1993, financial statements and group financial statements comply with NZ GAAP only if those statements comply with:
(a)
applicable financial reporting standards; and


(b)
in relation to matters for which no provision is made in applicable financial reporting standards and that are not subject to any applicable rule of law, accounting policies that:
i.
are appropriate to the circumstances of the reporting entity; and


ii.
have authoritative support within the accounting profession in New Zealand.






9.
The term "applicable financial reporting standard" is defined in the Financial Reporting Act 1993 to mean an approved financial reporting standard that applies to that reporting entity (or the group) and to that accounting period in accordance with a determination of the Accounting Standards Review Board (ASRB) for the time being in force or any election made under section 27 of this Act.


10.
In December 2002 the ASRB determined that entities required to comply with NZ GAAP under the Financial Reporting Act 1993 would be required to apply NZ IFRS in the preparation of their financial statements for periods commencing on or after 1 January 2007, with the option to apply from reporting periods beginning on or after 1 January 2005.


11.
The purpose of the Commission's cycle reviews is to form a view on:
(a)
the level of compliance with NZ GAAP by issuers in their financial statements prepared under the Financial Reporting Act 1993;


(b)
whether any breaches of NZ GAAP identified in those financial statements were likely to cause the financial statements to not show a true and fair view or were likely to be materially misleading to users in the context of information disclosure (for investment decision-making) as envisaged under the Securities Act 1978 and therefore require enforcement action; and


(c)
the overall quality of financial reporting practices by issuers.




12.
The Commission has used the term 'previous NZ GAAP' in this report to mean the basis of accounting that an issuer uses for preparing historical financial information before adopting NZ IFRS. The Commission acknowledges that previous NZ GAAP is still current for issuers that have not yet adopted NZ IFRS.

1. An issuer is defined by the Securities Act 1978 to mean:

(a)

In relation to an equity security or debt security, or to an advertisement, investment statement, prospectus, or registered prospectus that relates to an equity security or a debt security, or to a trust deed that relates to a debt security, the person on whose behalf any money paid in consideration of the allotment of the security is received:

(b)

In relation to a participatory security, or to an advertisement, investment statement, prospectus, or registered prospectus, or to a deed of participation that relates to a participatory security, the manager:

(c)

In relation to an interest in a contributory mortgage offered by a contributory mortgage broker, or to an advertisement that relates to such an interest, the contributory mortgage broker;

(d)

In relation to a unit in a unit trust, or to an advertisement, investment statement, prospectus or registered prospectus that relates to such a unit, the manager:

(e)

In relation to a life insurance policy, or to an advertisement, investment statement, prospectus, or registered prospectus that relates to a life insurance policy, the life insurance company that is liable under the policy:

(f)

In relation to an interest in a superannuation scheme, or to an advertisement, investment statement, prospectus, or registered prospectus that relates to such an interest, the superannuation trustee of the scheme.

2. Part II of the Financial Reporting Act 1993 requires every 'reporting entity' to prepare financial statements that comply with generally accepted accounting practice and to provide any additional information required to ensure those statements are a true and fair view of the matters to which they relate.

Part I defines a reporting entity as :

(a)

An issuer; or

(b)

A company, other than an exempt company; or

(c)

A person that is required by any Act, other than this Act, to comply with this Act as if it were a reporting entity.

CYCLE 5: AN OVERVIEW

Scope
25.
In Cycle 5, the Commission reviewed the financial reports of 40 issuers with balance dates from 31 March 2006 to 30 September 2006.


26.
The selection of 40 issuers was made up of:
(a)
34 issuers listed on the NZSX/NZDX;


(b)
3 issuers listed on the NZAX; and


(c)
3 issuers who are not listed.




27.
Twelve first-time adopters of NZ IFRS were reviewed in this cycle. In this report, the Commission draws particular attention to findings on the adoption of NZ IFRS to provide feedback and comments for issuers yet to transition to NZ IFRS.

Overall Comments
28.
Sixteen of the 40 reports reviewed had matters that prompted the Commission to write to the issuer. This included seven first-time adopters of NZ IFRS. One issue identified in Cycle 5 is being considered separately as an enforcement matter.


29.
The overall findings of Cycle 5 were similar to the results of earlier cycles. Although no serious issues were identified, the Commission continues to note areas of non-disclosure or poor quality disclosures as in previous cycles. The Commission also continues to find errors in the published financial statements, a clear indication that greater care could be taken in their preparation.


30.
The Commission has identified slightly fewer significant matters in this cycle compared with earlier cycles. There are a number of factors that drive the incidence of significant matters. While the surveillance programme has identified some improvement, there is room for further improvement.


31.
The Commission acknowledges that a great deal of effort is required in transitioning to NZ IFRS and considers that the level of compliance with NZ IFRS for the early adopters was generally good.

34.
The Commission's definition of significant matters and other matters are set out in paragraphs 15 and 16 above.


35.
Table 1 shows the outcome of significant matters raised with issuers in Cycle 5.

Table 1: Outcome of matters raised in letters to issuers

Notes to the Table
(1)
Resolved: a satisfactory explanation was provided by the issuer on the matters raised.


(2)
Point taken / change agreed: the issuer has acknowledged the point made / agreed to make changes in subsequent financial statements.


(3)
Second letter sent: a second letter closed the matter but reiterated the points made.


(4)
Other follow-up action: more action required, e.g. the need for subsequent correspondence to seek answers to follow-up questions.





36.
Satisfactory agreement was reached with issuers on 79% of significant matters raised in this cycle.


37.
Feedback on the Commission's findings (from paragraph 42 to 123) is separated into findings on the application of NZ IFRS and findings on the application of previous NZ GAAP.


38.
No occurrences of statutory non-disclosures were found in the Cycle 5 review.


39.
It is also encouraging to note that there was no occurrence of failure to date and/or sign the financial report in Cycle 5.

Follow-up action
40.
At the date of publication of this report the Commission agreed to refer two matters identified in Cycle 5 to NZICA.


41.
Work on another matter is ongoing.

FUTURE ADOPTION OF NZ IFRS


42.
FRS-41: Disclosing the Impact of Adopting New Zealand Equivalents to International Financial Reporting Standards disclosures showed improvement from previous cycles. In Cycle 5 all issuers made some disclosure explaining the impact of transition to NZ IFRS in their financial statements.


43.
The Commission was disappointed to find that 32% of issuers (9 out of 28) were still unable to identify key changes that may result from adoption of NZ IFRS.


44.
Given the date of transition to NZ IFRS is imminent, it was also surprising to note that approximately 18% of issuers reviewed in this Cycle had not yet undertaken any formal exercise to identify the key accounting policy differences that may arise from the adoption of NZ IFRS.


45.
While many issuers have already adopted NZ IFRS, those that are still to adopt are encouraged to consider early their planning and approach to transitioning to NZ IFRS. Entities should not underestimate the business implications and the amount of work involved. There are a number of significant changes from previous NZ GAAP, some of which will have a wider impact than on the entity's financial statements alone.

CYCLE 5 FINDINGS ON THE APPLICATION OF NZ IFRS
46.
The findings of the review of financial statements prepared in accordance with NZ IFRS is separated into:
(a)
significant matters; and


(b)
other matters.




47.
In addition we make comments on improvements in disclosures noted through the review.

Significant matters
48.
Significant matters were raised in relation to NZ IFRS 1 transition adjustments and NZ IAS 7.

NZ IFRS 1 First-time Adoption of New Zealand Equivalents to International Financial Reporting Standards

NZ IFRS 1 transition adjustments
49.
NZ IFRS 1 (para. 38) requires an entity to explain how the transition from previous NZ GAAP to NZ IFRS affected its opening financial position, financial performance and cash flows. To comply with this paragraph an entity's first NZ IFRS financial statements are required to include reconciliations of equity, profit and loss and cash flows reported under previous NZ GAAP to that reported under NZ IFRS.


50.
All twelve issuers reviewed provided reconciliations required under NZ IFRS 1.


51.
However, two issuers incorrectly included the correction of prior period errors in their transition reconciliation.


52.
One issuer recognised an executory contract on the balance sheet in its previous NZ GAAP accounts. In the first set of NZ IFRS financial statements this treatment was changed, the contract derecognised, and disclosed as a transition adjustment. The Commission is of the view that the recognition of executory contracts on the balance sheet did not ever comply with previous NZ GAAP and, as a result, the change in accounting policy for executory contracts is not a transition adjustment but the correction of a prior period error.


53.
Another issuer that prepared their consolidated financial statements using reverse acquisition accounting disclosed an adjustment when transitioning to NZ IFRS. Accounting for reverse acquisitions under previous NZ GAAP and NZ IFRS are sufficiently similar that there should be no transition adjustment when adopting NZ IFRS. From further investigation the Commission was of the view that the issuer's accounting for a reverse acquisition did not comply with previous NZ GAAP. Therefore, the change made when transitioning to NZ IFRS, was not a transition adjustment but the correction of a prior period error.


54.
The Commission highlighted in its Cycle 4 Report that this practice of including the correction of prior period errors as transition adjustments is not acceptable. The Commission reminds issuers that only adjustments arising from a change in accounting policy as a result of applying NZ IFRS for the first time should be included in the reconciliations required under NZ IFRS 1.


55.
All adjustments that are not transition adjustments, including those arising from the correction of prior period errors or change in accounting estimates, must be clearly distinguished and disclosed in a separate note.


56.
The Commission reminds issuers that while the transition to NZ IFRS is a good opportunity to review reporting practices and compliance with the relevant accounting standards, issuers must not portray the correction of errors as NZ IFRS transition adjustments.

Incorrect labelling of comparatives
57.
One early adopter incorrectly labelled its comparatives as prepared under previous NZ GAAP.


58.
An entity's first NZ IFRS financial statements are required to include at least one year of comparative information under NZ IFRS (NZ IFRS 1 (para.36)).


59.
The issuer did explain that the change to NZ IFRS had not resulted in a restatement of comparative figures and the effect of moving to NZ IFRS had not resulted in a material change in accounting treatment. However, given the specific NZ IFRS 1 requirement and for greater clarity to readers of the financial statements, the Commission is of the view that the comparatives should have been labelled as prepared under NZ IFRS with no reference to previous NZ GAAP.

NZ IAS 7 Cash Flow Statements and the treatment of GST
60.
In one review, the Commission identified significant differences between the comparative figures in the cash flow statement and the prior year's cash flow statement. Further investigation revealed that the differences were due to a change in the basis of preparing the cash flow statement on first-time adoption of NZ IFRS (specifically NZ IAS 7).


61.
NZ IAS 7 (para. 18(a)) requires major classes of gross cash receipts and gross cash payments be disclosed. NZ IAS 7 does not explicitly address the treatment of GST.


62.
The International Financial Reporting Interpretations Committee (IFRIC) has identified that the treatment of GST is unclear under IAS 7 and has referred it to the International Accounting Standards Board (IASB). IFRIC has recommended that the treatment of the tax component is considered as part of the review of IAS 7 being carried out within the IASB's project on performance reporting.


63.
The issuer in our sample presented cash receipts and cash payments gross of GST in its first cash flow statement under NZ IFRS. The issuer did not disclose the change nor explain that the change was due to the entity's first-time adoption of NZ IFRS. The Commission believes that an explanation should be provided so that readers understand changes resulting from the adoption of NZ IAS 7.


64.
NZ IFRS 1 (para. 40) specifically requires such changes to be explained, stating that if an entity presented a cash flow statement under its previous NZ GAAP and comparatives are restated, any material adjustments should be explained.


65.
In addition, NZ IAS 1 (para. 103 (a)) requires the notes to the financial statements to present information about the basis of preparation of the financial statements and the specific accounting policies used.

Other matters

Common non-disclosures
66.
A number of common non-disclosures were found in Cycle 5. Some NZ IAS 1 and NZ IAS 24 disclosures were poor.

NZ IAS 1 Presentation of Financial Statements
67.
The Commission noted the following non-disclosures of NZ IAS 1 requirements.

Disclosure of management judgements
68.
NZ IAS 1 (para. 113) requires an entity to disclose the judgements management have made in the process of applying the entity's accounting policies that have the most significant effect on the amounts recognized in the financial statements.


69.
Some examples of areas that require management to make judgements are provided in NZ IAS 1 (para. 114).


70.
Five issuers describe in their financial statements that judgements were made by management in the process of applying the entity's accounting policies, but failed to disclose what these judgements were as required by NZ IAS 1.


71.
Another issuer indicated in its accounts that significant judgements were made by management but, on enquiry, the issuer confirmed that in fact no such judgements were made in applying the issuers accounting policies. The issuer has appeared to use boiler plate language for this disclosure without management properly considering making disclosures specific to the issuer.


72.
The Commission is of the view that to comply with the requirement of NZ IAS 1 it is not sufficient to simply state that significant management judgements have been made. Issuers need to explain what these judgements were and the accounting policies that were affected by these judgements.

Key assumptions and sources of estimation uncertainty
73.
NZ IAS 1 (para. 116) requires an entity to disclose "information about the key assumptions concerning the future and other key sources of estimation uncertainty at the balance sheet date that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities."


74.
Three issuers describe in their financial statements that directors made estimates and assumptions that affected reported assets and liabilities, but did not disclose what those estimates and key assumptions were.


75.
Three other issuers provided no disclosures on key sources of estimation uncertainty in their financial statements.


76.
The Commission believes that it is good business practice for the boards of issuers to consider the assumptions and estimates that have a significant risk of causing material adjustments to the carrying amounts of assets and liabilities before finalising the financial statements.

NZ IAS 24 Related Party Disclosures


77.
The objective of NZ IAS 24 is "to ensure that an entity's financial statements contain the disclosures necessary to draw attention to the possibility that its financial position and profit or loss may have been affected by the existence of related parties and by transactions and outstanding balances with such parties."


78.
Details of terms and conditions of settlement of outstanding balances with related parties, including whether they are secured, and the nature of the consideration to be provided should be disclosed (NZ IAS 24 (para. 17)).


79.
The Commission found that in some cases the amounts of the transactions with related parties during the period were not disclosed. In one instance the terms and conditions of those outstanding balances were not provided.


80.
NZ IAS 24 (para. 9) defines a related party as including key management personnel of the entity and requires specific disclosures of key management personnel compensation.


81.
One entity disclosed key management personnel compensation with regard to directors and overlooked the chief executive officer of the company.


82.
Another entity provided disclosures about key management personnel compensation in the statutory information section. The Commission believes disclosures required by accounting standards should be made within the audited financial statements.

Minor matters
83.
Minor matters identified were:

NZ IFRS 7 Financial Instruments: Disclosures

• inadequate disclosure of credit risk.

NZ IAS 12 Income Taxes

• non-disclosure of a deferred tax liability; and
• non-disclosure of the nature of evidence supporting recognition of a deferred tax asset.

NZ IAS 32 Financial Instruments: Presentation

• non-disclosure of risk management objectives and policies relating to financial instruments.

NZ IAS 33 Earnings per Share

• earnings per share calculation incorrectly performed using the number of shares at the end of the period instead of the weighted average over the period.

Improvements in disclosures
84.
The Commission has reviewed 21 first-time adopters of NZ IFRS, 9 in Cycle 4 and 12 in Cycle 5. In Cycle 5, early-adopters showed improvement in some disclosures required by NZ IAS 1 and NZ IAS 8.

NZ IAS 1 Presentation of Financial Statements
85.
The Commission noted fewer instances of non-disclosure in this cycle with only one issuer failing to provide all of the following disclosures;

• a statement as to whether an entity is a profit-oriented entity or a public benefit entity (NZ IAS 1: NZ13.1(b));
• a statement that the financial statements have been prepared in accordance with NZ GAAP, together with a description of the financial reporting standards applied by that entity (NZ IAS 1: NZ13.1(d));
• for an entity whose financial statements comply with IFRS, an explicit and unreserved statement of such compliance in the notes (NZ IAS 1.14);
• each component of the financial statements to be identified clearly, in particular, the name of the reporting entity or other means of identification, which has to be repeated if necessary (NZ IAS 1.46(a));
• the entity's presentation currency and the level of rounding used in presenting amounts in the financial statements (NZ IAS 1.46(d) and (e));

86.
The Commission encourages issuers preparing financial statements under NZ IFRS to be well informed about the new reporting requirements, especially for their first set of NZ IFRS financial statements.

NZ IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors
87.
NZ IAS 8 (para. 30) states that "when an entity has not applied a new Standard or Interpretation that has been issued but is not yet effective, the entity shall disclose this fact and known or reasonably estimable information relevant to assessing the possible impact that application of the new standard or interpretation will have on the entity's financial statements in the period of initial application."


88.
In Cycle 5, 6 of the 12 issuers reviewed did not provide this disclosure compared with all nine issuers not making this disclosure in Cycle 4.

CYCLE 5 FINDINGS ON THE APPLICATION OF PREVIOUS NZ GAAP
89.
The findings of the review of financial statements prepared in accordance with previous NZ GAAP is separated into:
(a)
significant matters; and


(b)
other matters.


90.
In addition we make comments on improvements in disclosures noted through the review.

Significant matters
91.
Significant matters were raised in relation to FRS-7 and impairment of investments.

FRS-7: Extraordinary Items and Fundamental Errors
92.
FRS-7 (para. 4.2) defines an error as fundamental where it is so significant that it destroys the fair presentation of the financial report taken as a whole.




93.
One issuer has reported the expensing of an item in the prior period as a fundamental error. After further investigation the Commission concluded that the fundamental error adjustment was not warranted. The issuer's parent agreed to pay for these costs, but only subsequent to the issuer's 2005 balance date. The Commission considers that the correct accounting treatment would have been for the issuer to recognise this recovery as part of its 2006 results.


94.
FRS-7 (para. 4.3) explains that errors in the financial statements result from, among other things, the oversight or misuse of facts that existed at the time the financial statements were prepared. In the case of this issuer the likelihood of recovery of items expensed was not known at the time the financial statements were prepared. Such items cannot be treated as a fundamental error.

Impairment of investments


95.
The Commission raised a significant matter with an issuer regarding their assessment of impairment to an investment in an associate. The associate had negative equity and several years of continuing losses.


96.
FRS-38 (para. 5.42) requires that if the recoverable amount of an investment in an associate is less than its carrying amount, the carrying amount of the investment must be written down to its recoverable amount.


97.
The Standard explains that the carrying amount of an investment in an associate should not exceed its recoverable amount. A comparison of carrying amount and recoverable amount should therefore be made at each reporting date (FRS-38 (para. 5.44)).


98.
The Commission asked the issuer to clarify the reasons for assessing that there was no impairment in the value of its investment in the associate. Although the issuer has responded to the initial query, the Commission have been prompted to ask more general questions relating to impairment of investments held by the issuer. At the date of publication of this report these matters were not resolved to the satisfaction of the Commission.

Other matters

Common non-disclosures
99.
A number of common non-disclosures were found in Cycle 5. Disclosures required by SSAP-22 and FRS-30 were poor.

SSAP-22: Related Party Disclosures
100.
The following related party non-disclosures were noted:
(a)
three issuers failed to disclose the value of transactions with related parties (SSAP-22 (para. 5.1(c)).


(b)
one issuer also failed to disclose the outstanding balance and terms of settlement (SSAP-22 (para. 5.1(d))).


(c)
another issuer failed to identify each related party and the value of related party transactions (SSAP 22 (para. 5.1(c))).




101.
The Commission reminds issuers to provide the relevant related party disclosures so that the requirements of SSAP-22 are met.

FRS-30: Reporting Share Ownership Arrangements Including Employee Share Ownership Plans (ESOP)
102.
The Commission found that the following disclosures were not been made by one or more issuers:
(a)
who was entitled to participate in the ESOP (FRS-30 (para. 5.1(a));


(b)
the percentage of shares held by the ESOP (FRS-30 (para. 5.1(b));


(c)
the rights of the entity or its related parties to acquire shares held by the scheme (FRS-30 (para. 5.1(d)); and


(d)
the disclosure of all persons and entities that control the ESOP (FRS-30 (para. 5.2).




103.
Where there is more than one scheme in operation, entities are encouraged to clearly distinguish them in the annual report.


104.
The requirements of this standard provide users of financial reports with important information on share ownership arrangements, particularly where there are ESOPs.

Minor matters
105.
Minor matters identified were:

FRS-1: Disclosure of Accounting Policies

• non-disclosure of an accounting policy for research and development.

FRS-9: Information to be Disclosed in the Financial Statements

• non-disclosure of fees paid to auditors for other services provided to the issuer;
• incorrect exclusion of interest revenue from the total operating revenue figure; and
• material gain from sale of fixed assets not separately disclosed in the statement of financial performance or notes to the financial statements.

FRS-10: Statement of Cash Flows

• non-disclosure of reason for netting certain cash flows.

SSAP-18: Leases

• unguaranteed residual values of leased assets not disclosed;

SSAP-23: Financial Reporting for Segments

• non-disclosure of segment assets; and
• non-disclosure of the fact that the issuer operates predominantly in one industry.

FRS-31: Disclosure of Information by about Financial Instruments

• non-disclosure of concentration of credit risk.

FRS-33: Disclosure of Information by Financial Institutions

• interest expense not disclosed for each of the different classifications of funding presented in the statement of financial position.

FRS-36: Accounting for Acquisitions Resulting in Combinations of Entities or Operations

• non-disclosure of an acquisition during the year in the investor's consolidated financial statements.

Improvements in disclosures
106.
The Commission has noted improvement in disclosures by issuers reporting under previous NZ GAAP.


107.
Only two issuers failed to disclose the total recognised revenues and expenses line in the Statement of Movement in Equity (FRS-2 (para. 7.3(a)). This is an improvement on earlier cycles.

QUALITY OF FINANCIAL REPORTING
108.
As stated earlier, the Commission regards financial reporting by issuers to be fundamentally important to the fairness, efficiency and transparency of New Zealand's securities markets.


109.
Issuers are reminded that the objective of financial statements as defined in the NZ Framework is to provide information about the financial position, performance, and changes in financial position of an entity that is useful to a wide range of users in making economic decisions.


110.
The NZ Framework states that financial statements also show the results of the stewardship/accountability of management for the resources entrusted to it.


111.
Throughout the year, considerable effort is applied by management in ensuring an entity operates efficiently and profitably. Errors, inconsistencies and inadequate disclosures in the published financial statements undermine these efforts as they give readers and investors a negative impression of the entity.


112.
The financial statements of two issuers in this cycle contained numerous clerical errors and inconsistencies.


113.
Errors and inconsistencies in the financial statements can be easily eliminated by incorporating a thorough internal review process and taking greater care in the preparation of the financial statements.


114.
Fifty four percent of matters raised by the Commission (including 10 significant matters) were resolved in correspondence with the issuer. This indicates that questions would not have been raised had the issuer's original disclosure been clearer or more transparent.


115.
The Commission recommends issuers review information provided in the financial statements with reference to the four attributes of useful information (understandability, relevance, reliability and comparability) defined by the NZ Framework.

ALTERNATIVE NON-GAAP MEASURES
116.
Non-GAAP measures or alternative performance measures can provide investors with appropriate additional information if properly used and interpreted.


117.
In Cycle 5, the Commission noted one issuer's EBITDA figure could not be reproduced using the NZ GAAP figures reported in the financial statements. On investigation the entity confirmed that an error had been made in the calculation.


118.
This example highlights the importance of ensuring appropriate quality assurance over the calculation of such figures.


119.
Some issuers provide alternative non-GAAP performance measures such as EBITDA (earnings before interest, taxation, depreciation and amortisation) to supplement statutory earnings information when they communicate to the market.


120.
The Commission supports additional disclosures that improve investors' understanding of financial statements, as long as they are properly communicated and consistently applied year on year and are not attempting in any way to be a substitute for the statutory financial information that is required by NZ GAAP.


121.
The Committee of European Securities Regulators (CESR) has addressed this concern about non-GAAP measures by publishing certain guidelines for the use of alternative non-GAAP performance measures for issuers in Europe. The Financial Services Authority (FSA) has recommended these guidelines as best practice for UK issuers.


122.
The CESR recommendation:
(a)
defines alternative performance measures;


(b)
provides guidance on the presentation of alternative performance measures; and


(c)
suggests the disclosure of any audit review of those alternative performance measures.




123.
This CESR recommendation is available on the CESR website, www.cesr-eu.org.

REFERRALS TO THE NEW ZEALAND INSTITUTE OF CHARTERED ACCOUNTANTS (NZICA)
124.
To date the Commission has made or has decided to make the following referrals under the Financial Reporting Surveillance Programme.

Cycle 1
125.
One review from Cycle 1 resulted in the referral of the auditor to NZICA.


126.
The Commission raised concerns about a fundamental error adjustment in the financial statements of the issuer. The adjustment had a material impact on the financial statements of the issuer.


127.
Further investigation suggested that the auditor had failed to review sufficient appropriate audit evidence in order to reach an appropriate opinion on the financial statements of the issuer.


128.
NZICA's Professional Conduct Committee (PCC) initially reached a decision that "inadequate procedures had been followed by the member [i.e. the auditor], in breach of auditing standards."


129.
As part of the process the PCC considered whether the documents the auditor should have been aware of were made available to the auditor.


130.
The PCC concluded that they were concerned at the level of disclosure by the issuer to the auditor. The PCC is satisfied that the evidence provided did not establish that the auditor had breached NZICA's Code of Ethics. The PCC resolved to take no further action on this complaint.


131.
This referral highlights to auditors the importance of obtaining and carefully reviewing key documents during an audit. It also highlights the responsibility of the entity to provide all important documentation to their auditors.

Cycle 3
132.
One review from Cycle 3 resulted in the referral of two directors and the issuers' auditor to NZICA.


133.
The Commission raised concerns relating to preparation and audit of the financial statements of the issuer. The matter relates to two items that were inappropriately accounted for in the parent financial statements.


134.
NZICA is currently considering this matter.

Cycle 4
135.
Findings in Cycle 4 have raised two specific areas of concern in relation to the application of FRS-36 and FRS-37.


136.
The issuers involved informed the Commission that the treatment adopted in these areas is 'common practice' albeit non-compliant with NZ GAAP. The Commission is of the view that common practice does not justify a departure from NZ GAAP.

FRS-36: Accounting for Acquisitions Resulting in Combinations of Entities or Operations
137.
In Cycle 4, one issuer's accounting for a reverse acquisition in its consolidated financial statements did not comply with the requirements in FRS-36.


138.
The issuer had identified the wrong party as the investor. The issuer believed their adopted treatment was common practice.


139.
The Commission is concerned about the existence of 'common' accounting practices that do not comply with the principles set out in an approved financial reporting standard. The Commission is of the view that departure from the requirements of FRS-36 is not justifiable on the basis of 'common practice'.


140.
The Commission reminds issuers who have entered into reverse acquisition transactions to review their accounting and ensure that they meet the principles and requirements under NZ GAAP. For example, under previous NZ GAAP FRS-36 (paras. 4.49 to 4.53) explains the 'investor' and 'investee' relationship and the reverse acquisition scenario.


141.
The Commission also urges issuers who have incorrectly accounted for any reverse acquisition transactions under previous NZ GAAP to clearly distinguish these corrections from adjustments that have resulted from a change in accounting policy arising from the adoption of NZ IFRS.


142.
The Commission has decided to refer this matter to NZICA.

FRS-37: Consolidating Investments in Subsidiaries
143.
In Cycle 4, the Commission noted one issuer failed to consolidate several controlled entities in its group financial statements. These unconsolidated entities were established as securitisation trusts by the issuer and the issuer was of the view that they did not control these securitisation trusts.


144.
FRS-37 (para 4.13) states that control by one entity over another entity is established when two conditions are met. The controlling entity must have the capacity to determine the financing and operating policies of the other entity (unless where such policies have been irreversibly predetermined or where the determination of such policies is unable to materially impact the level of potential benefits) and be entitled to a significant level of ownership benefits from that entity. FRS-37 provides extensive guidance on the assessment of whether control exists.


145.
The Commission's review of the relevant documentation confirmed that both conditions in FRS-37 were met and that the securitisation trusts were controlled by the issuer and therefore should have been consolidated.


146.
Material information was not disclosed in the financial statements of the issuer as a result of the non-consolidation.


147.
The issuer has since consolidated the securitisation trusts into the group's 2007 consolidated financial statements.


148.
The Commission has decided to refer this matter to NZICA.

Cycle 5

FRS-7: Extraordinary Items and Fundamental Errors
149.
One issuer in Cycle 5 incorrectly accounted for an item as a fundamental error (discussed in paragraphs 92 to 94).


150.
The Commission has decided to refer this matter to NZICA.

FRS-36: Accounting for Acquisitions Resulting in Combinations of Entities or Operations
151.
In Cycle 5, another issuer's accounting for a reverse acquisition in its consolidated financial statements did not comply with the requirements in FRS-36. This matter is very similar to the one identified in Cycle 4 with the issuer identifying the wrong party as the investor.


152.
The Commission has decided to refer this matter to NZICA.

ADOPTION OF IFRS GLOBALLY
153.
Jurisdictions around the world are adopting IFRSs. Nearly 100 countries currently require, or permit the use of, or have a plan to converge their national standards with, IFRSs.

International observations
154.
Financial reporting surveillance work is undertaken by regulators around the world including those in Australia, Europe, the United Kingdom and the United States. One of the aims of this type of surveillance work is to ensure consistent application of accounting principles by issuers of securities in these securities markets.


155.
The results of some of the surveillance work undertaken by regulators around the world has been made available on the internet:
(a)
the US regulator, the Securities and Exchange Commission (SEC), publishes its findings on its website: www.sec.gov/divisions/corpfin/ifrs_staffobservations.htm;


(b)
the UK regulator, the Financial Reporting Review Panel (FRRP), publishes its findings on its website: www.frc.org.uk/frrp; and


(c)
the French regulator, Autorité des marchés financiers (AMF), provides an extensive document of its findings on its website: www.amf-france.org.

IOSCO
156.
The International Organization of Securities Commissions (IOSCO) is the worldwide association of national securities regulatory commissions. IOSCO is recognised as the international standard setter for securities markets. All securities regulators have a strong stake in the quality of financial reporting.


157.
IOSCO is committed to the application of one set of global standards in the preparation of financial statements and has recently set up an IFRS database on the application of IFRS globally. Members can exchange information about problems and non-compliance with IFRS.


158.
Information in this database will be assessed by IOSCO, and, where it reveals varying interpretations, IOSCO intends referring these to the International Accounting Standards Board (IASB) or the International Financial Reporting Interpretation Committee (IFRIC) for consideration.


159.
Variations can occur in regulatory interpretation and enforcement of accounting standards, and those variations potentially undermine the whole purpose of moving to IFRS. The aim of the IOSCO database is to enable consistency of regulatory interpretation of IFRS.


160.
The database became fully operational in January 2007 and is maintained by the IOSCO General Secretariat, based in Madrid. So far, 46 securities regulators have entered into an agreement with IOSCO to take part in the database. The New Zealand Securities Commission will contribute IFRS issues to this database.

ONGOING REVIEW AND ENFORCEMENT
161.
The Commission will continue to review issuers' financial reporting as part of the Financial Reporting Surveillance Programme and to take any appropriate steps to encourage compliance with Financial Reporting Standards and other aspects of NZ GAAP.

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