Financial reporting surveillance programme. Review of financial reporting by issuers cycle 6 [2008] NZSecCom 3 (29 February 2008)

	Home \| Databases \| WorldLII \| Search \| Feedback New Zealand Securities Commission

REVIEW OF FINANCIAL REPORTING BY ISSUERS
CYCLE 6
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.

In Cycle 6 the Securities Commission reviewed the financial reports of 30 issuers with balance dates from 31 December 2006 to 30 April 2007.

The Commission's review of financial statements prepared in accordance with New Zealand financial reporting requirements 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 20 of the 30 issuers reviewed had matters that prompted the Commission to write to the issuer. In some cases the Commission asked issuers to revise or enhance disclosures in future financial statements.

The Commission is encouraged by the fact that few matters were identified in the review of financial statements of first-time adopters of NZ IFRS and congratulates those issuers on their preparedness.

The Commission also raised matters relating to disclosures in respect of substantial security holder information, director share dealings and non-compliance with NZX Listing Rules. Issuers should review their compliance with statutory requirements as a critical step in the preparation and finalisation of an annual report.

Substantial security holders should be aware of changes to the Securities Markets Act 1988 relating to disclosure of changes in a substantial security holding. The legislative changes are effective from 29 February 2008.

The Commission also reminds issuers that changes to the Financial Reporting Act 1993, effective from 22 November 2006, now require all issuers to prepare consolidated financial statements.

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

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.

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:

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 report on this surveillance work that provides market participants with a summary of the findings. Copies of reports for previous Cycles 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 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, 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 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 would be required to apply New Zealand Equivalents to International Financial Reporting Standards (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 commencing 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;

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

Selecting issuers
13.
The Financial Reporting Surveillance Programme aims to review all listed issuers over a three to four year period. On completion of the next Cycle, Cycle 7, the Commission would have achieved this aim. Issuers listed on Unlisted3 and non-listed issuers are also included in the Cycle reviews.

14.
Issuers are also selected on particular criteria, including the risk profile of the entity and/or sector, and the balance date of the issuer to ensure timely feedback. Issuers can be reselected for a subsequent review where the nature of issues identified in an earlier Cycle raised concerns.

15.
In reviewing all listed issuers, dual and overseas listed issuers are also selected. Four overseas listed issuers were selected this Cycle.

16.
Dual listed issuers are issuers incorporated in Australia which are admitted on the Australian Stock Exchange's (ASX) Official List and are also listed on the New Zealand Exchange (NZX) (as defined in NZX Listing Rules 1.1.2).

17.
Overseas listed issuers are issuers domiciled or incorporated outside New Zealand which have a recognised stock exchange as the home exchange and are also listed on NZX (as defined in NZX Listing Rules 5.1.1 (b)).

18.
With dual and overseas listed issuers, the Commission first writes to the regulator in the overseas jurisdiction to determine whether a review of the financial reporting of the issuer has already been undertaken locally. If so, these issuers are not reviewed by the Commission. Where the issuer has not been reviewed by the overseas regulator the Commission undertakes a reasonableness review of the annual report, NZX announcements and current prospectus if applicable. Findings are communicated to the applicable overseas regulator.

Identifying issues and taking action
19.
A desk-top review of each financial report is performed in the wider context of the annual report and, in the case of listed issuers, any stock exchange announcements for the period. While these were not comprehensively reviewed, any obvious issue related to continuous disclosure, disclosure of relevant interests by directors and officers, and substantial security holder disclosure, is followed up.

20.
Matters identified in the review are referred to as matters raised or other matters. Previously the Commission has referred to matters raised as significant matters.

21.
The Commission's approach is to write to an issuer on a matter identified in a review where the nature of the matter prompts us to write to the issuer; because the matter is considered to be of regulatory importance or further clarification or information is needed. For example, the Commission is likely to write to issuers where a matter:
(a)
appears to be wrong;

(b)
does not appear to make sense;

(c)
is not clear and lacks transparency;

(d)
seems unusual or irregular;

(e)
raises questions about its validity; or

(f)
is insufficiently explained.

22.
The Commission writes to issuers requesting additional information and in some cases asks issuers to revise or enhance disclosures in future financial statements.

23.
When writing to an issuer in respect of matters raised, the Commission also includes other matters found in the review.

24.
The Commission's policy is not to write to issuers whose reports raised only other matters, unless the numbers of those matters are so numerous that it is useful to provide feedback to the issuer.

25.
Financial reporting requires the exercise of professional judgement. The Commission takes this into account when reviewing the financial reports and determining which matters to follow up.

26.
In each case where the Commission writes to an issuer, a copy of the letter is also sent to the issuer's auditor. This practice acknowledges the role of auditors in helping to maintain and improve the standard of financial reporting in New Zealand. Auditors have an important role in encouraging companies to comply not only with the statutory requirements but also with best practice. The Commission encourages auditors to be vigilant in the audit of financial statements. High quality external auditing is critical to integrity in financial reporting and to the efficiency and integrity of the securities markets.

27.
Where issues of a much more serious nature are identified that may have a significant market impact, the matter is removed from the Financial Reporting Surveillance Programme and considered separately as an enforcement matter. No such matters were identified in this Cycle.

28.
Referrals are made to relevant bodies where matters identified under the surveillance programme are likely to be considered a breach of the:
(a)
Financial Reporting Act; and/or

(b)
Rules or the Code of Ethics of the New Zealand Institute of Chartered Accountants (NZICA); and/or

(c)
NZX Listing Rules.

Scope
29.
In Cycle 6, the Commission reviewed the financial reports of 30 issuers (including 4 overseas listed issuers) with balance dates from 31 December 2006 to 30 April 2007.

30.
The selection of 30 issuers was made up of:
(a)
15 issuers listed on the New Zealand Stock Market (NZSX) or the New Zealand Debt Market (NZDX) (including 4 overseas listed issuers);

(b)
7 issuers listed on the New Zealand Alternative Market (NZAX);

(c)
3 issuers whose shares are traded on Unlisted; and

(d)
5 issuers who are not listed on any exchange.

31.
In this Cycle, 7 NZ IFRS financial statements (including those of 5 first-time adopters), 1 UK GAAP and 3 IFRS as adopted by the European Union financial statements were reviewed. The 19 issuers who prepared their financial statement in accordance with previous NZ GAAP will produce their first set of NZ IFRS financial statements in their next financial year.

32.
All the findings of this Cycle, including those for financial statements prepared in accordance with previous NZ GAAP, are discussed in the context of NZ IFRS to provide feedback to issuers yet to transition to NZ IFRS.

Overall comments
33.
Twenty of the 30 reports reviewed had matters that prompted the Commission to write to the respective issuers. This included all five of the first-time adopters of NZ IFRS reviewed in Cycle 6.

34.
Numerically there was a higher incidence of matters raised in this Cycle compared with previous Cycles. However, on reviewing the findings, the Commission does not believe that this higher incidence is symptomatic of poorer accounting given the nature of the findings. Generally, issuers' compliance with NZ GAAP is good and the Commission continues to be encouraged by the commitment of issuers and their auditors to comply with NZ GAAP and to provide a true and fair view of the state of affairs of those issuers.

35.
The Commission reiterates that issuers can ensure errors are minimised by:
(a)
consulting with their audit committee during the preparation and finalisation of the financial statements; and

(b)
incorporating a thorough quality review process when finalising the financial statements.

36.
Issuers should review their compliance with statutory requirements as a critical step in the preparation and finalisation of an annual report.

Outcome of matters raised
37.
Table 1 shows the outcome of matters raised in letters to issuers in Cycle 6.

Notes	Outcome	*Matters raised*	%

(1)	Resolved	11
(2)	Point taken/change agreed	23
	*Agreement reached*	34	92%

(3)	Second letter sent	2
(4)	Other follow-up action	1
		3	8%

	Total matters raised	37

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.

38.
Although some responses from issuers explained and resolved a matter the Commission notes that the original question may well not have been raised had the issuer's disclosure been clearer or more transparent. The Commission encourages issuers to ensure that all of their disclosures are sufficiently clear to explain adequately matters included in their financial reports.

39.
The other follow up action in the table above is the incorrect accounting for a reverse acquisition under previous NZ GAAP. The Commission has decided to refer this matter raised to NZICA (for further details refer to paragraphs 77 to 80).

Referral to NZX
40.
The Commission has referred one issuer to the NZX for failing to include material information in an annual report (for further details refer to paragraphs 146 to 148).

Moving to NZ IFRS
41.
In New Zealand, all issuers (other than dual and overseas listed issuers) are required to apply NZ IFRS in the preparation of their financial statements for periods commencing on or after 1 January 2007.

42.
The Commission is encouraged by the fact that most issuers who have adopted NZ IFRS for the first time in this Cycle have adequately disclosed the effect of the transition from previous NZ GAAP to NZ IFRS.

43.
In Cycle 6 we queried two issuers with regard to their disclosure about the effect of transition to NZ IFRS:
(a)
The first is a case where the issuer incorrectly accounted for a reverse acquisition in an earlier year when reporting under previous NZ GAAP. The correction of that prior period error in the subsequent year was incorrectly included as an NZ IFRS transition adjustment. This issue is discussed further in paragraphs 77 to 80. The Commission has decided to refer members involved in the preparation and audit of this issuer to NZICA.

(b)
The other case is where the issuer did not adequately explain how the transition from previous NZ GAAP to NZ IFRS resulted in a change to the timing of revenue recognition. The Commission considers that in this case, the disclosures could have provided greater detail.

44.
Issuers should be aware that NZ IFRS 1 (paragraph 40) requires the disclosure of "sufficient detail" to enable users to understand the material adjustments to the income statement.

45.
Issuers moving to NZ IFRS in their next financial statements will find that NZ IFRS generally requires more disclosures than previous NZ GAAP. The process of preparing and finalising financial statements must be thorough to ensure all NZ IFRS requirements are met.

Getting the "basics" right
46.
In the preparation of financial statements, both in accordance with previous NZ GAAP and NZ IFRS, it is important that issuers get the "basics" right. This means, for financial statements prepared in accordance with NZ IFRS, providing all the disclosures required by NZ IFRS 1, NZ IAS 1 Presentation of Financial Statements and NZ IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.

47.
For financial statements prepared in accordance with previous NZ GAAP, this means providing all the disclosures required by FRS-1: Disclosure of Accounting Policies, FRS-2: Presentation of Financial Reports and FRS-9: Information to be Disclosed in Financial Statements.

48.
Many of the disclosures required by the above Standards could be viewed as forming the "basic" building blocks of an issuer's financial report. It is important for this information to be disclosed.

49.
In the review of financial statements prepared in accordance with NZ IFRS, two issuers failed to disclose both:
(a)
the key assumptions concerning the future and other key sources of estimation uncertainty at the balance sheet date (NZ IAS 1 (paragraphs 116)); and

(b)
the level of rounding used in presenting amounts in the financial statements as required by (NZ IAS 1 (paragraphs 46(e))).

50.
Preparers should note that the disclosure of key sources of estimation uncertainty was not a requirement under previous NZ GAAP and is a new requirement under NZ IFRS.

51.
In the review of financial statements prepared in accordance with previous NZ GAAP, two issuers restated certain comparatives explaining that the reclassification was to reflect current year classifications but without explaining the nature of the reclassification as required by FRS-2 (paragraph 5.15).

52.
The Commission also wrote to an issuer whose financial statements did not disclose the statutory basis for preparing the financial statements as required by FRS-1 (paragraph 5.5(a)) and separately to another issuer for failing to disclose donations made to a trust as required by FRS-9.

53.
FRS-9 (paragraph 6.13) lists items of expense required to be disclosed separately including donations made. Paragraph 6.14 of FRS-9 states that "in most circumstances the items listed in paragraph 6.13 would, by their nature, be material" and thus require separate disclosure.

54.
The Commission's review of financial statements prepared in accordance with both NZ IFRS and previous NZ GAAP continued to find typographical errors and inconsistencies in the financial statements, four instances in this Cycle, that reflect negatively on the quality of issuers' financial statements:
(a)
historical errors in calculation of goodwill amortisation;

(b)
liquidity of assets incorrectly presented in the Statement of Financial Position;

(c)
comments in the Directors' Statement not reflecting information presented in the financial statements; and

(d)
inconsistencies in the narrative disclosures about the allocation of goodwill.

"Industry practices"
55.
The Commission is concerned that responses from issuers referred to "industry practices" to justify not complying with applicable financial reporting standards.

56.
Issuers need to be aware that NZ IFRSs and FRSs are the primary indicators of NZ GAAP. Where there is an applicable financial reporting standard on a subject matter and the issuer chooses to adopt "industry practices" that do not comply with the relevant applicable accounting standards, its financial statements will be in breach of NZ GAAP.

Reverse acquisitions
57.
The Commission has, in this and the last two Cycle reviews, identified three instances of incorrect accounting for a reverse acquisition under previous NZ GAAP. The Cycle 6 issuer stated that the "practice adopted by the company was in line with that adopted by other entities".

58.
The Commission has agreed that members involved in the preparation and audit of the financial statements of this issuer will be referred to NZICA.

Disclosures about liquidity management
59.
On a matter regarding the disclosure of an entity's management of liquidity, one issuer contested a disclosure matter raised by the Commission stating that "market practice" was to only disclose additional assumptions and basis of those assumptions where the estimated or expected maturity dates approach has been adopted in presenting the liquidity analysis of the entity.

60.
FRS-33: Disclosure of Information by Financial Institutions (paragraph 11.4) states that "whichever method is used to quantify the financial institution's liquidity position, disclosure should be supplemented by a discussion of the effects of the assumptions used and the basis for those assumptions".

61.
There are similar requirements under NZ IFRS. NZ IFRS 7 Financial Instruments: Disclosures (paragraph 39(b)) requires a description of how an entity manages the liquidity risk inherent in the maturity analysis of financial liabilities. In addition, NZ IFRS 7 Guidance on Implementing (IG31) lists some factors that an entity might consider in providing this disclosure.

62.
NZ IFRS 7 (IG 30) states, "if an entity manages liquidity risk on the basis of expected maturity dates, it might disclose a maturity analysis of the expected maturity dates of both financial liabilities and financial assets". To clarify that the expected dates are based on estimates, the entity should "explain how the estimates are determined and the principal reasons for differences from the contractual maturity analysis that is required by paragraph 39(a) of NZ IFRS 7".

CYCLE 6 SPECIFIC FINDINGS
63.
This section presents the matters raised with issuers in Cycle 6. The findings are presented as follows:
(a)
matters relating to NZ IFRS financial statements;

(b)
matters relating to previous NZ GAAP financial statements; and

(c)
market matters.

Matters raised
64.
The matters raised with issuers include:
(a)
inadequate disclosures relating to goodwill, including disclosures on cash-generating units, recoverable amount and impairment;

(b)
incorrectly presenting a prior period error as a NZ IFRS transition adjustment; and

(c)
incorrect disclosure of earnings per share.

Inadequate disclosures relating to goodwill, including disclosures on cash-generating units, recoverable amount and impairment
65.
The following NZ IAS 36 Impairment of Assets disclosures were not provided by one issuer:
(a)
the carrying amount of goodwill allocation to the unit (paragraph 134 (a));

(b)
the basis on which the recoverable amount has been determined (paragraph 134 (c));

(c)
as the recoverable amount was based on value in use (paragraph 134 (d)(i-v)):
(i)
a description of each key assumption on which management has based its cash flow projections;

(ii)
a description of management's approach to determining the value(s) assigned to each key assumption;

(iii)
the period over which management has projected cash flows;

(iv)
the growth rate used to extrapolate cash flow projections compared with the long-term average growth rate for the products, industries, or country or countries in which the entity operates;

(v)
the discount rate(s) applied to the cash flow projections.

66.
The Commission draws the attention of issuers to the accounting requirements of NZ IAS 36 and, in particular, to the extensive disclosures relating to estimates used to measure recoverable amounts of each significant cash-generating unit containing goodwill or intangible assets with indefinite useful lives (paragraphs 134 to 136)4. Issuers should note that the disclosures are required notwithstanding that there may be no impairment in the carrying amount of goodwill and intangible assets with indefinite useful lives.

67.
The disclosures in paragraphs 134 to 136 of NZ IAS 36 are new disclosures which are not required under previous NZ GAAP.

68.
NZ IAS 36 prescribes procedures that an entity applies to ensure that its assets are carried at no more than their recoverable amount. NZ IAS 36 also prescribes requirements relating to the impairment of goodwill and intangible assets with indefinite useful lives. NZ IAS 36 requires the carrying amount of goodwill and intangible assets with indefinite useful lives to be tested for impairment annually (paragraphs 10 and 90).

69.
NZ IAS 36 requires that, in assessing the recoverable amount of goodwill and intangible assets with indefinite useful lives for impairment purposes these assets be allocated to cash-generating units, "the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or group of assets" (NZ IAS 36, paragraph 6).

70.
One issuer that recognised impairment failed to disclose the discount rate that had been used to estimate the recoverable amount of a cash-generating unit. The financial statements explained that in relation to the current estimate of the recoverable amount (value in use) of a cash-generating unit that the discount rates used were based on a "weighted average cost of capital" applicable to the issuer. While the method of calculating the discount rate was disclosed by the issuer, specifically the discount rate that had been used was not.

71.
NZ IAS 36 (paragraph 130(g)) requires that for each material impairment loss recognised or reversed, if recoverable amount is value in use, the discount rate(s) used in the current estimate and the previous period (if any) should be disclosed.

72.
In the financial statements of another issuer where the carrying value of a 50% owned subsidiary was reduced by writing down the goodwill on acquisition, details relating to the impairment were not disclosed in the financial statements (even though those details were explained in the Chief Executive's Report). NZ IAS 36 requires an entity to disclose details about impairment in the financial statements.

73.
While the issuer provided certain impairment disclosures albeit not in the financial statements the following NZ IAS 36 disclosures were omitted:
(a)
the basis on which the unit's recoverable amount had been determined (ie value in use or fair value less costs to sell) (paragraph 134(c)); and

(b)
the methodology used to determine fair value less costs to sell (paragraph 134(e)).

74.
The financial statements of the same issuer also did not identify the subsidiary as the cash-generating unit for which recoverable amount had been determined. NZ IAS 36 (paragraph 130(d)) requires financial statements to describe the cash-generating unit for which recoverable amount has been determined, e.g. whether it is a production line, a plant, a business operation, a geographical area or a reportable segment.

Incorrectly presenting a prior period error as an NZ IFRS transition adjustment
75.
In the last three Cycles, the Commission's reviews have identified instances of incorrect accounting for reverse acquisitions under previous NZ GAAP by reviewing the issuers NZ IFRS transition adjustments. In this Cycle, a similar issue was identified. The issuer had incorrectly accounted for a reverse acquisition in a prior period under previous NZ GAAP but instead of presenting the change in accounting in the current period as a correction of prior period error the issuer has presented the change as a transition adjustment arising from the first-time adoption of NZ IFRS.

76.
Reverse acquisitions are dealt with in FRS-36: Accounting for Acquisitions Resulting in Combinations of Entities or Operations (paragraphs 4.50 to 4.53). Reverse acquisition accounting under FRS-36 and NZ IFRS 3 Business Combinations are similar.

77.
Applying FRS-36 should achieve the same reverse acquisition accounting results as under NZ IFRS 3. It should not result in an NZ IFRS transition adjustment in the consolidated financial statements.

78.
The issuer also incorrectly made adjustments to the parent entity's financial statements when reverse acquisition accounting applies only to group accounts.

79.
NZ IFRS 3, Appendix 2 (paragraph B8) notes that:

"Reverse acquisition accounting applies only in the consolidated financial statements. Therefore, in the legal parent's separate financial statements, if any, the investment in the legal subsidiary is accounted for in accordance with the requirements of NZ IAS 27 Consolidated and Separate Financial Statements on accounting for an investor's separate financial statements."

80.
The Commission has decided to refer members involved in the preparation and audit of this issuer to NZICA.

Incorrect disclosure of earnings per share

81.
One issuer disclosed earnings per share in a note to the financial statements instead of on the face of the Income Statement.

82.
NZ IAS 33 Earnings Per Share (paragraph 66) states that "an entity shall present on the face of the income statement basic and diluted earnings per share".

83.
We also queried another issuer about its earnings per share disclosures. The issuer's accounting policies included a note on basic and diluted earnings per share when the income statement only showed the basic earnings per share figure. It was not clear from the issuer's financial statements if the basic and diluted earnings per share are equal. In such instances we encourage issuers to clearly disclose the fact that the basic and diluted earnings per share figure is the same. NZ IAS 33 (paragraph 67) states that if basic and diluted earnings per share are equal, dual presentation can be accomplished in one line on the income statement.

Other matters
84.
Other matters contained in letters to issuers adopting NZ IFRS included:
(a)
non-disclosure of the application of Standards that have been issued but are not yet effective (NZ IAS 8 (paragraph 30));

(b)
NZ IFRS financial statements still using SSAP-12: Accounting for Income Tax terminology and presentation for reporting of income tax; and

(c)
non-disclosure of certain requirements of NZ IFRS 2 Share-based payments.

Matters raised
85.
The review of financial statements prepared in accordance with previous NZ GAAP raised the following matters:
(a)
non-consolidation of a wholly owned subsidiary;

(b)
non-disclosure of fees paid to the auditor for other services;

(c)
omission of signing and dating of the financial statements;

(d)
inaccuracies and non-disclosures related to the statement of cash flows;

(e)
inadequate disclosure of related party transactions; and

(f)
incorrect revenue for a subsidiary was reported in the registered prospectus.

Non-consolidation of a wholly owned subsidiary
86.
One issuer failed to consolidate a wholly owned subsidiary and to provide group financial statements as required by the Financial Reporting Act 1993 and FRS 37: Consolidating Investments in Subsidiaries (FRS-37).

87.
The issuer was unaware that section 13 of the Financial Reporting Act was amended by section 10 of the Financial Reporting Amendment Act 2006. This amendment, which now requires all issuers to prepare group financial statements, came into force on 22 November 2006.

88.
Section 13(2) of the Financial Reporting Act used to exempt all entities that are wholly owned by a reporting entity that is a body corporate that is incorporated in New Zealand or a nominee of such a body corporate from preparing group financial statements. Amendments made to the Financial Reporting Act by section 10 of the Financial Reporting Amendment Act 2006 means that this exemption no longer applies to entities that are issuers from 22 November 2006.

89.
Amended section 13(2) states:

"Group financial statements are not required in relation to a reporting entity that is a company if, on the balance date of the company, the company is not an issuer and the only shareholders of the company comprise a reporting entity that is-
(i)
A body corporate that is incorporated in New Zealand or a nominee of such a body corporate; or

(ii)
A body corporate that is incorporated in New Zealand or a nominee of such a body corporate and a subsidiary of such a body corporate or a nominee of such a subsidiary."

90.
FRS-37 (paragraph 5.1) states that "a parent that has one or more subsidiaries at its reporting date must present consolidated financial statements in accordance with this Standard".

Non-disclosure of fees paid to the auditor for other services
91.
Disclosures in the annual reports of three issuers (including one NZ IFRS issuer)indicated that other services were provided by the auditors of the issuers. However, separate disclosures of the fees paid to the auditors for those other services were not provided.

92.
The requirement to separately disclose fees paid to the auditor for other services provided is prescribed both in the Companies Act 1993 and FRS-9 and NZ IAS 1.

93.
The Companies Act (section 211(1)(j)) requires the annual report of a company to state the amounts payable to the auditor of the company as audit fees and, as a separate item, fees payable by the company for other services provided.

94.
FRS-9 (paragraph 6.13(e)(iii)) requires separate disclosure of other services provided to group entities by the auditor. Paragraph 6.14 of the same Standard states that "in most circumstances the items listed in paragraph 6.13 would, by their nature, be material". Fees paid to auditors for other services provided are just such an item and must be disclosed separately.

95.
Under NZ IFRS more detailed disclosures are required. NZ IAS 1 (paragraph NZ 94.1(a)(ii-iv))) requires separate disclosure of fees to each auditor of the parent for audit fees, audit related fees, tax fees and all other fees, as well as a description of the nature of the services provided.

Omission of signing and dating of the financial statements
96.
The financial statements of one issuer, contained in its annual report, were not signed and dated as required by the Companies Act, the Financial Reporting Act and FRS-5: Events after balance date.

97.
While the financial statements submitted by the issuer to the Companies Office were signed by four directors of the company and dated, the financial statements included in the issuer's published annual report were not signed and dated by the directors.

98.
Section 211 (1)(b) of the Companies Act requires the financial statements included in the annual report to be signed in accordance with section 10 of the Financial Reporting Act. Section 10 of the Financial Reporting Act requires that directors sign and date the financial statements.

99.
FRS-5 (paragraph 6.1) states that "an entity must disclose the date when the financial report was authorised for issue and who gave that authorisation".

100.
FRS-5 (paragraph 6.2) explains that it is important for the users to know when the financial statements were authorised for issue, as the financial report does not reflect events after this date.

Inaccuracies and non-disclosures in the statement of cash flows
101.
The Commission considers that the statement of cash flows is one of the core financial statements in the financial report of every issuer. It helps users of the financial statements assess the entity's ability to generate cash flows to meet its obligations when they fall due and its other cash operating, investing and financing needs. The statement of cash flows helps users assess factors such as the entity's liquidity, financial flexibility, profitability and risk.

102.
In Cycle 6 matters were raised with three issuers in relation to their statement of cash flows.

Non-cash transactions
103.
One issuer included a bonus share issue in the Statement of Cash Flows as financing activities. As this is a non-cash transaction it should not have been included in the Statement of Cash Flows.

104.
FRS-10: Statement of Cash Flows (paragraph 5.26) requires the statement of cash flow to "reflect only transactions wholly in cash and the cash element only of transactions that are partly in cash". This is explained further in FRS-10, paragraph 5.29: "Many investing and financing activities do not result in cash flows although they may affect the capital and asset structure of the entity...where such transactions do not involve cash flows, they are to be excluded from the statement of cash flows."

105.
FRS-10 (paragraph 5.27) requires non-cash investing and financing transactions which affect assets and liabilities that have been recognised, to be disclosed in a note to the financial report. The note should be referenced to the appropriate items in the financial statements.

Netting of cash flows

106.
One issuer's disclosures about its policies on netting of cash flows were inadequate. The issuer disclosed in the Statement of Accounting Policies that certain cash flows had been provided net and explained the nature of the netting. However, the Statement of Cash Flows, specifically the operating cash flows, included additional netting that was not covered by the accounting policies.

107.
FRS-10 (paragraph 5.33) states that "when a cash flow in the statement of cash flows combines receipts and payments to present a net cash flow, a note to the financial statement is required identifying such a cash flow". The entity is also required to give reasons why those receipts and payments have been netted off.

108.
FRS-10 (paragraph 5.35) reiterates that "where the statement of cash flows includes one or more net cash flows, disclosure by note is to identify those cash flows as net cash flows and is to provide the reasons for presenting those cash flows as net cash flows".

Operating versus financing cash flows
109.
The Commission wrote to one issuer enquiring about its disclosure of certain cash flows as operating cash flows rather than financing cash flows.

110.
A definition of operating activities and financing activities is provided in paragraphs 4.10 and 4.15 of FRS-10. Issuers must assess cash flows with reference to these definitions when classifying cash flows into the three groups as required by paragraph 5.3 of FRS-10. "The classification...provides information about the entity's cash performance and provides possible comparisons with other time periods, with other entities and with other industries" (FRS-10 (paragraph 5.5)).

Inadequate disclosure of related party transactions
111.
Two issuers failed to provide the following related party disclosures as required by SSAP 22: Related Party Disclosures:
(a)
the nature of the relationship with named companies that provided accounting and administrative services free of charge (as required by paragraph 5.1(a));

(b)
the nature of the relationship with a trust was unclear as a disclosure was not made in the related party note (as required by paragraph 5.1(a));

(c)
the outstanding balances at year end in relation to a lease agreement with a company related to one of the directors (as required by paragraph 5.1(d)); and

(d)
the value of the transaction, any outstanding balances, any debts written off or forgiven during the year in relation to a contract with a related party to provide certain services (as required by paragraph 5.1(c),(d) and (e)).

112.
One of the above issuers also failed to include director related interests in the related party note but did disclose them elsewhere in the annual report.

113.
As New Zealand entities are moving to adopt NZ IFRS, the Commission draws issuers' attention to the following discussion under NZ IFRS, in the Standard NZ IAS 24 Related Party Disclosures (paragraphs 5-8) which explains the importance of related party disclosures:

"Related party relationships are a normal feature of commerce and business...A related party relationship could have an effect on the profit or loss and financial position of an entity...even if related party transactions do not occur. The mere existence of the relationship may be sufficient to affect the transactions of the entity with other parties...For these reasons, knowledge of related party transactions, outstanding balances and relationships may affect assessments of an entity's operations by users of financial statements, including assessments of the risks and opportunities facing the entity."

Incorrect revenue for a subsidiary was reported in the registered prospectus
114.
One issuer did not apply a consistent basis for presenting revenue for a subsidiary in its financial statements and prospectus where the subsidiary's revenue was reported gross in the issuer's financial statements and the same subsidiary's revenue was reported net in the issuer's prospectus.

115.
On enquiry, the issuer clarified that the subsidiary's revenue shown in the issuer's prospectus as net revenue is incorrect and the gross revenue should have been presented. The issuer has undertaken to correct this in its next prospectus.

Other matters
116.
Other matters contained in letters to issuers included:
(a)
non-disclosure of specific information required by FRS-33; and

(b)
non-disclosure of information about financial instruments.

Non-disclosure of specific information required by FRS-33
117.
In Cycle 6, eight finance companies were reviewed. These are defined as financial institutions in NZ GAAP and are required, while under previous NZ GAAP, to comply with FRS-33.

118.
The Commission findings indicate that such financial institutions should pay closer attention to FRS 33 requirements when preparing their financial statements.

119.
FRS-33 prescribes the minimum standards of disclosure for financial institutions. The importance of these disclosures is commented on in the Introduction to this Standard:

"Financial institutions represent a significant and influential sector of economic activity. Most individuals and organisations make use of the financial institutions as depositors, borrows, investors or as users of payments services. Hence, besides shareholders and ordinary creditors, there is considerable interest among a wide range of other parties in the performance, financial position, and financial and investing activities of financial institutions, particularly their solvency and the relative degree of risk attaching to their different activities."

120.
The following disclosure matters were raised with issuers:
(a)
in relation to the liquidity management policy, for failing to disclose a discussion of the effects of assumptions used in quantifying the liquidity position and the basis for those assumptions (paragraph 11.4);

(b)
for failing to provide a description of how impaired assets are managed (paragraph 10.5);

(c)
for failing to disclose interest revenue from impaired assets, showing its sub-categories (paragraph 6.3(a)(iv));

(d)
for failing to disclose the movements in provisions for each class of assets (paragraph 10.4);

(e)
for failing to disclose the accounting policies for recognition of revenue and or principal payments received and accounting policies for revenue due but not received, in respect of impaired assets (paragraph 5.9); and

(f)
in relation to interest rate risk
(i)
for failing to disclose the methods used to monitor exposure to interest rate risk (FRS-33 paragraph 12.3(c)); and

(ii)
for failing to disclosure the systems and procedures for controlling interest rate risk (FRS-33 paragraph 12.3(d)).

121.
One issuer failed to explain in its financial statements the reasons for the change in the comparative period's asset classification from impaired to past due. The issuer's financial statements show those assets as past due, the same amount is shown as impaired in the issuer's prior period financial statements. On enquiry the issuer clarified that the classification shown in the prior period financial statements (as impaired assets) was an error and the classification shown in its current financial statements (as past due assets) is the correct classification. The issuer should have explained the error and its effect and presented clearly the change in asset classification as a correction of a prior period error.

122.
FRS-33 requires information about impaired assets to be disclosed in the financial statements, including the entity's accounting policies for impaired assets, criteria for classifying those assets, and policies for recognising and determining their carrying amounts in the statement of financial position. To enable users of financial statements to assess the quality of loans, financial institutions are required to disclose the movements from one reporting period to the next.

123.
The accounting policies of one issuer did not provide a clear explanation of items recognised as loans and advances. FRS-33 (paragraph 5.2) requires a financial institution to "disclose the accounting policies for financial instruments with respect to the basis for recognising financial instruments in the financial reports".

124.
FRS 1 (paragraph 5.1) states that "financial reports shall include clear and concise statements of all accounting policies adopted by an entity in the preparation of its financial reports, where such accounting policies are material to those financial reports". The Commission encourages issuers to provide clear and concise policies that accurately portray the practices of the issuer. For example, if an entity capitalises interest at the end of a contractual term when a new loan is advanced, the accounting policy should state this clearly.

125.
Accounting policy disclosure is a fundamental disclosure in financial statements. Users need this information to understand and interpret the financial statements.

126.
Issuers moving to NZ IFRS will find that accounting policy disclosures will need more consideration under NZ IFRS given that NZ IFRS contains some new requirements for certain types of transactions such as financial instruments.

Non-disclosure of information about financial instruments

127.
One issuer failed to disclose the contractual repricing or maturity periods on term loan facilities as required by FRS-31: Disclosure of Information about Financial Instruments (paragraph 6.14(b)).

Market matters
128.
The Commission raised several matters relating to disclosures of substantial security holder information, director share dealings and non-compliance with NZX Listing Rules.

Substantial security holder information
129.
Three issuers failed to provide substantial security holder information to their shareholders. Two other issuers provided incorrect substantial security holder information to their shareholders due to omissions on the part of the issuer, or in some instances, the substantial security holders.

Failing to provide substantial security holder information to shareholders
130.
The annual reports of three public issuers did not include information on substantial security holders and on enquiry the three issuers confirmed that they had not sent a note to shareholders with the required substantial security holder information. These are instances of breaches of section 26(1) of the Securities Markets Act 1988. In all three cases, the appropriate disclosures were made by the substantial security holder to the registered exchanges and the issuers concerned.

131.
Section 26(1) of the Securities Markets Act requires the public issuer to provide a note stating the substantial security holder's name, number of voting securities in which the holder has a relevant interest and the total number of issued voting securities of the public issuer. This note is to be sent to each of its shareholders with the annual report sent under section 209 of the Companies Act or the financial statements or summary financial statements sent under section 210 of the Companies Act.

132.
Section 26(4) of the Securities Markets Act states that "a public issuer who fails to comply with a requirement of this section commits an offence and is liable on summary conviction to a fine not exceeding $10,000".

133.
Issuers are reminded to take their obligations under section 26(1) of the Securities Markets Act seriously, notwithstanding that the primary obligation for such disclosures is on the substantial security holders. The Commission will review these disclosures more closely in future.

Providing incorrect or incomplete substantial security holder information to shareholders
134.
Substantial security holder information on the number of shares held and/or percentage of holding disclosed in the annual reports of two issuers did not agree with information disclosed in the Substantial Security Holder Notice filed with NZX for the same period.

135.
In one instance the error was due to the substantial security holder sending an incorrect notice. This matter was brought to the attention of the substantial security holder to ensure a corrected notice was filed with NZX.

136.
The Securities Markets Act imposes certain obligations on a person who is a substantial security holder in a public issuer5 . A substantial security holder is a person who has a relevant interest in listed voting securities that comprise 5% or more of a class of listed voting securities of the public issuer (section 21(2)). The substantial security holder is required to disclose changes in that relevant interest (in number or nature) to the issuer and to every registered exchange on which the securities of the issuer are listed (sections 23 and 24).

137.
The primary obligation is on the substantial security holder to file such notices to ensure that the market is kept informed at all times, but the Securities Markets Act also imposes obligations on the public issuer of the securities. Section 25 of the Securities Markets Act requires the issuer to maintain a file of substantial security holder notices received.

138.
In a separate instance the issuer omitted certain substantial security holders from the annual report disclosures.

139.
The two issuers, referred to in paragraphs 135 and 138, confirmed that their annual reports contained errors. Issuers should ensure their annual report disclosures are accurate and comply with the Securities Markets Act.

140.
The Securities Markets Act provisions relating to substantial security holder disclosures were amended by regulations approved by the Cabinet on 3 December 2007. These regulations come into force on 29 February 2008 and are explained on the Commission's website www.newsecuritieslaw.govt.nz.

141.
In future, failure to comply with substantial security holder obligations will be a criminal offence, subject to a fine of up to $30,000. Civil penalties of up to $1 million can be imposed by the Court, which can also make a range of orders relating to any holding of securities, including orders to forfeit or dispose of securities.

Director share dealings
142.
Three issuers did not disclose director share dealings during the year in their annual reports as required by the Companies Act, the Securities Markets Act and NZX Listing Rule 10.5.3(c).

143.
The Companies Act (section 211(1)(e)) requires the annual report of a company to state the particulars of entries in the interests register made during the accounting period. Section 148 of the same Act requires a director to disclose their share dealings to the Board and ensure that that disclosure has been entered into the company's interests register. The Securities Markets Act (section 19U) also requires the directors of the issuer to disclose their relevant interests, and acquisitions or disposals in the interests register.

144.
NZX Listing Rule 10.5.3(c) requires the annual report of a company to contain the information required by section 211 of the Companies Act.

145.
In disclosing the particulars of the interests register, as required by the Companies Act, the issuer is required to state the following (section 148(2)):
(a)
the number and class of shares in which the relevant interest has been acquired or disposed of; and

(b)
the nature of the relevant interest; and

(c)
the consideration paid or received; and

(d)
the date of the acquisition or disposal.

NZX referral
146.
One issuer failed to disclose material information, related to a restriction on the timing of any future acquisition of a business, in its annual report in accordance with the NZX Listing Rules.

147.
NZX Listing Rule 10.5.1(d) requires the annual report of the issuer to contain all information required in a preliminary announcement. Appendix 1(j) states that this includes any significant information needed by an investor to make an informed assessment of the entity's financial performance and financial position.

148.
This matter has been referred to the NZX.

ONGOING REVIEW AND ENFORCEMENT
149.
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.

a person who was previously a party to a listing agreement with a registered exchange, in respect of any action or event or circumstances to which this Act applied while the person was a party to a listing agreement with a registered exchange.

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:

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:

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;

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:

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:

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.

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

New Zealand Securities Commission

Financial reporting surveillance programme. Review of financial reporting by issuers cycle 6 [2008] NZSecCom 3 (29 February 2008)