Financial reporting surveillance programme - Review of financial reporting by issuers cycle 7 [2008] NZSecCom 6 (6 August 2008)

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EXECUTIVE SUMMARY .................................................................................................................. 3

INTRODUCTION................................................................................................................................. 6

The Commission’s Financial Reporting Surveillance Programme ................................. 6

New Zealand Generally Accepted Accounting Practice ................................................... 7

Selecting issuers.................................................................................................................... 8

Identifying matters and taking action ................................................................................ 9

CYCLE 7: FINDINGS........................................................................................................................ 10

Scope and issuer selection ................................................................................................. 10

Overall comments on Cycle 7............................................................................................ 11

Outcome of matters raised ................................................................................................. 12

Specific comments on Cycle 7 findings ............................................................................ 13

Related party information............................................................................................................. 13

Financial institutions and financial instruments information ....................................................... 15

Essential disclosures..................................................................................................................... 17

Matters under other standards ......................................................................................... 22

Interim financial statements of finance companies......................................................... 24

Auditors’ reports and audit firm referral ....................................................................... 25

Other services provided by an auditor.......................................................................................... 25

Referral of audit firm.................................................................................................................... 26

Market matters................................................................................................................... 26

Substantial security holder information ....................................................................................... 26

Directors’ interests and share dealings ......................................................................................... 28

Update on enforcement of a market matter .................................................................................. 29

OVERVIEW OF ALL SEVEN CYCLES......................................................................................... 30

Overall comment ................................................................................................................ 30

Common matters raised in the Cycles ............................................................................. 32

Statement of Cash Flows .............................................................................................................. 32

Prospective financial information ................................................................................................ 33

Signing and dating of financial statements................................................................................... 34

Audit work .......................................................................................................................... 35

Transition issues................................................................................................................. 35

Concluding comments ....................................................................................................... 36

ONGOING REVIEW AND ENFORCEMENT ............................................................................... 37

The Securities Commission of New Zealand has completed Cycle 7 of its Financial Reporting Surveillance Programme (FRSP). This report presents our findings on Cycle 7 and provides an overview of all our work over the seven Cycles.

The Commission is pleased with the overall quality of financial reporting in New Zealand and with the cooperation from issuers and auditors over the last seven Cycles.

A massive effort has been undertaken by various market participants in the last few years to ensure that New Zealand has a set of globally accepted New Zealand Equivalents to International Financial Reporting Standards (NZ IFRS).

To reap the maximum benefit from NZ IFRS adoption the Commission is keen to ensure that NZ IFRS is rigorously applied by issuers. Financial statements of issuers must contain high quality, transparent and comparable information. Issuers must be committed to transparency in their financial reporting. If disclosures beg a further question, the Commission considers that transparency has not been achieved.

• review any “common industry practice” adopted to ensure that it also complies with

The Commission encourages issuers to focus on new requirements under NZ IFRS, in particular those relating to:

The Commission has an established and ongoing programme to review the financial reporting practices of issuers. The aim is to encourage New Zealand issuers to improve the quality of their financial reporting.

Cycle 7 represents the conclusion of the Commission’s first round of its FRSP which began in 2005. At the conclusion of Cycle 7, all NZX Limited (NZX) listed issuers, other than some dual or overseas listed entities, have been reviewed at least once. The next Cycle will begin the next round where listed issuers will be selected again for review. Given the requirement for issuers to adopt NZ IFRS, the second round will focus on issuers’ compliance with NZ IFRS.

In Cycle 7 the Commission reviewed the financial statements of 44 issuers with balance dates from 31 December 2006 to 30 September 2007. Eighteen of the 44 issuers were finance companies. The Commission also reviewed the interim financial statements of five of those finance companies to assess their compliance with, in particular, NZ IFRS 7 Financial Instruments: Disclosures.

Overall, the quality of financial reporting by issuers was good: the Commission did not have cause to write to 27 of the 44 issuers reviewed.

The Commission wrote to 17 of the 44 issuers reviewed. It raised matters mainly about inadequate disclosures relating to:

The Commission notes that many of the matters identified in Cycle 7 are similar to those identified in previous Cycles. The matters are reiterated in this report as the Commission considers them to be important.

• wrote to five issuers on matters relating to the disclosure of information about directors’ interests or directors’ trading in the securities of the issuer and substantial security holder information;

• wrote to two substantial security holders about their obligations under the Securities

• referred an audit firm to the New Zealand Institute of Chartered Accountants (NZICA) in relation to whether fee dependency posed a possible threat to the audit firm’s independence; and

• wrote to two audit firms about the non-disclosure in their audit reports of other services provided to issuers.

The Commission is also considering matters raised in respect of two issuers reviewed as part of its enforcement work on finance companies. No other enforcement action was undertaken in relation to the issuers reviewed in Cycle 7.

Twenty-five percent of all matters written to issuers about in Cycle 7 were resolved through further information and clarification. In 67% of those cases issuers agreed to revise or enhance disclosures in their future financial statements. In 8% of cases a second letter or subsequent correspondence was entered into with issuers to close the matters off by

reiterating the Commission’s comments. In relation to those matters raised and closed off through a second letter, the Commission will review the issuers’ accounting treatment or disclosure in the next round.

Over the 7 Cycles the Commission reviewed a total of 285 issuers, an average of 41 issuers in each Cycle (44 issuers in Cycle 7).

In Cycles 1 to 3 the financial statements of all issuers reviewed were prepared in accordance with previous New Zealand Generally Accepted Accounting Practice (previous NZ GAAP). Since Cycle 4 the financial statements of a total of 49 issuers reviewed were prepared in accordance with NZ IFRS (21 issuers in Cycle 7).

The Commission wrote to 126 issuers over the seven Cycles, an average of 18 issuers in each Cycle (17 issuers in Cycle 7). The number of matters raised, including market matters, totalled 185, an average of 26 in each Cycle (29 in Cycle 7). The number of other matters was 296, an average of 42 in each Cycle (54 in Cycle 7).

The Commission is satisfied with the level of agreement reached with issuers over all seven Cycles. Over those Cycles agreement was reached on 89 % of all matters written to issuers after further explanation or clarification (resolved) or commitment from issuers to incorporate the matters or improve their subsequent financial statements (change agreed). In the other

11% of matters, a second letter or other follow-up was necessary. Some of these matters were subsequently resolved. In other cases referrals were made to NZICA.

The Commission considers that the high percentage of the matters that were settled with issuers over the past seven Cycles bodes well for the future of high quality financial reporting in New Zealand. The Commission is particularly gratified by the many positive comments from issuers and audit firms on our Cycle reviews.

As the deadline for issuers to apply NZ IFRS approached the FRSP and the Cycle reports have focused on NZ IFRS matters to provide feedback and information to issuers who have just transitioned to, or are transitioning to, NZ IFRS.

Applying NZ IFRS may be challenging for many issuers. The Commission believes it assists issuers to raise the standard of financial reporting through the educative approach of its FRSP. However the Commission will not hesitate to take enforcement action where necessary.

1. The Securities Commission is the main regulator of the New Zealand securities market.

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 quality financial reporting by issuers¹to be fundamental to the fairness, efficiency and transparency of New Zealand’s securities markets.

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 (FRSP) in 2004, with its first Cycle review taking place in 2005. The FRSP is an ongoing surveillance programme.

5. The aim of the Commission’s FRSP is to encourage New Zealand issuers to improve the quality of their financial reporting so that:

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

6. The FRSP involves biannual reviews of selected issuers’ financial statements. At the end of each Cycle the Commission publishes a report on this surveillance work to provide market participants with a summary of its findings. Copies of reports for all Cycles are available on the Commission’s website www.seccom.govt.nz.

(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

(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.

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

8. The Commission reviews financial statements of issuers 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:

(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:

9. The term “applicable financial reporting standard” is defined in the Financial Reporting Act to mean an approved financial reporting standard that applies to a reporting entity (or group) and to an accounting period (or interim 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 the Financial Reporting 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 annual accounting periods commencing on or after 1 January 2007 with the option to early adopt from annual accounting periods commencing on or after 1 January 2005.

(a) the level of compliance with NZ GAAP by issuers in their financial statements prepared under the Financial Reporting Act;

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

²Part 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.

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. Previous NZ GAAP is still current for issuers that have not yet adopted NZ IFRS.

13. The FRSP aimed to review all listed issuers at least once over a three to four year period. Cycle 7 represents the conclusion of the Commission’s first round of its FRSP which began in 2005. On completion of Cycle 7 the Commission has achieved this aim. Except for some dual or overseas listed entities, all NZX Limited (NZX) listed issuers have been reviewed. The next Cycle will begin the second round of reviews where listed issuers will be selected again for review. The focus of the next round will be on financial statements prepared under NZ IFRS.

14. Issuers trading on Unlisted³and issuers not listed on any exchange are also included in the Cycle reviews. No issuers on Unlisted were selected for review in Cycle 7. Seventeen issuers not listed on any exchange were reviewed in this cycle.

15. Issuers may also be selected based on particular criteria as determined by the Commission: issuers may be selected based on areas of particular risk affecting the issuer and/or the sector the issuer is in at the time of selection. Issuers may also be selected based on the balance date of the issuer to ensure timely feedback of information. Issuers can be reselected for a subsequent review where the nature of issues identified in an earlier Cycle raised concerns. Two issuers were reselected for review in this Cycle. The Commission did not write to these two issuers in Cycle 7.

16. In reviewing all listed issuers, dual and overseas listed issuers are also selected.

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. One overseas listed issuer, with a primary listing in the UK, was selected for review in this Cycle.

17. Dual listed issuers are issuers incorporated in Australia which are on the Australian Stock Exchange’s (ASX) Official List and which are also listed on the NZX. Two dual listed issuers were reviewed in Cycle 7.

18. In the case of 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 review of the annual report, NZX announcements and, if applicable, the current prospectus. Where appropriate, findings are communicated to the overseas regulator. If the Commission communicates a matter

³Unlisted is an unregistered securities trading facility; it is not a registered stock exchange or authorised securities exchange under the Securities Markets Act 1988. Unlisted provides a facility for trading previously allotted securities.

about an issuer that it considers to be significant to an applicable overseas regulator and the overseas regulator proposes to take no action, the Commission will write directly to the overseas or dual listed issuer on the matter. In Cycle 7 no matters were raised in relation to the dual listed or overseas issuers to prompt the Commission to communicate any findings to the overseas regulators.

19. The Commission reviews an issuer’s financial statements when reviewing its annual report and, in the case of listed issuers, this includes a review of any NZX announcements for the period. While the NZX announcements are not comprehensively reviewed, any market matters relating to continuous disclosure, disclosure of relevant interests by directors and officers, and substantial security holder disclosure, are followed up where necessary.

20. Matters identified in the review are referred to as matters raised⁴or other matters.

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

22. Matters raised are matters that are important or where further clarification or information is needed. For example, the Commission is likely to write to an issuer where a matter:

23. The Commission writes to an issuer requesting additional information and in some cases asks the issuer to revise or enhance disclosures in future financial statements.

24. When writing to an issuer in respect of matters raised the Commission also includes other matters found in the review in relation to that issuer. Other matters are miscellaneous matters that the Commission considers could be better disclosed.

25. The Commission’s policy is not to write to an issuer whose financial statements raised only other matters, unless the number of those matters is so numerous that it is useful to provide feedback to the issuer. In this respect the Commission is mindful of its educative role in the FRSP.

⁴Prior to Cycle 6, the Commission referred to matters raised as significant matters.

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. It also alerts an auditor to the particular aspects of its client’s financial statements that may be of concern to the Commission.

27. 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 the integrity of financial reporting and to the efficiency and integrity of the securities markets.

28. Where a matter is identified that may have a significant market impact the matter is removed from the FRSP and considered separately as an enforcement matter.

29. Referrals are also made to relevant bodies where matters identified in the FRSP are considered likely to be a breach of the:

30. In Cycle 7 the Commission reviewed the financial statements of 44 issuers with balance dates from 31 December 2006 to 30 September 2007.

(a) 16 issuers listed on the New Zealand Stock Market (NZSX) (including 1 overseas listed issuer);

32. In this Cycle, 21 issuers prepared their financial statements in accordance with NZ IFRS, one in accordance with UK GAAP, and two in accordance with Australian IFRS. The 20 issuers who prepared their financial statement in accordance with previous NZ GAAP will be required to produce NZ IFRS financial statements in their next financial year.

33. The findings of Cycle 7, including those relating to previous NZ GAAP, are discussed in the context of NZ IFRS to provide feedback to issuers who have just adopted NZ IFRS and those yet to adopt NZ IFRS.

34. Eighteen finance companies were selected for review in Cycle 7. All the finance companies but one had prepared their financial statements in accordance with previous NZ GAAP. Three of these companies were listed on the NZDX or NZAX; the rest were not listed companies.

35. In addition to the review of the annual financial statements of the issuers under the FRSP, the Commission selected and reviewed the interim financial statements of five of the finance companies that were prepared for the first time in accordance with NZ IFRS to assess their compliance, in particular, with NZ IFRS 7 Financial Instruments: Disclosures. The findings relating to these interim financial statements are reported separately in paragraphs 114 to121.

36. Generally, issuers’ compliance with NZ GAAP is good. The Commission did not write to 27 of the 44 issuers reviewed. The Commission did find other matters in relation to some of these issuers. However, they did not warrant the Commission writing to the issuers. Matters common among the issuers are discussed later in this report.

37. In relation to the 18 finance companies reviewed, the Commission did not write to those issuers that went into receivership, or reached a moratorium with its investors, during the period of the Cycle 7 review. Matters raised in relation to two finance companies are being considered as part of the Commission’s enforcement work on finance companies.

38. Seventeen of the 44 issuers reviewed in Cycle 7 had matters that prompted the Commission to write to them. The 29 matters raised included 10 matters relating to substantial security holders, directors’ interests and directors’ share dealings. In writing to the issuers on these matters raised, the Commission also drew the attention of those issuers to 54 other matters. In most cases, issuers agreed to make the necessary changes in their next financial statements.

39. In Cycle 7, the Commission wrote to two auditors to draw their attention to the non- disclosure in their audit reports of services, other than audit services, that they had provided to the issuers (see paragraphs 122 to 126).

40. The Commission also wrote to two substantial security holders of an issuer to draw their attention to their obligations under the Securities Markets Act 1988 to disclose their substantial security holdings to the issuer and NZX (see paragraphs 136 to 138).

41. The Commission referred an audit firm to NZICA in relation to the audit of the financial statements of two related issuers in respect of the question whether fee dependency might have affected the audit firm’s independence (see paragraphs 127 to

42. The Commission is encouraged by the commitment of issuers and their auditors to comply with NZ GAAP and to improve the quality of their financial reporting. The Commission is particularly gratified by the many positive comments that it has received from issuers and audit firms on our Cycle reviews.

Notes	Table 1: Outcome of matters raised Outcome	_{Matters raised}⁵	%
(1)	Resolved	9
(2)	Point taken/change agreed	15
	*Agreement reached*	24	83%
(3)	Second letter sent	5
(4)	Other follow-up action	0
		5	17%
	Total matters raised	29	100%

(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

(3) Second letter sent: a second or subsequent 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.

44. As in previous Cycles the Commission notes that the responses from issuers explained and clarified many of the matters raised.

45. The high percentage (83%) of agreement reached with issuers based on just the initial letter from the Commission is pleasing.

46. It is important to note that the Commission considers that, in many cases, writing to the issuers may well have been unnecessary had the issuers’ disclosures been adequate and more transparent. The Commission continues to encourage issuers to ensure that all disclosures are sufficiently clear to adequately explain matters included in their financial statements.

⁵The matters raised exclude the instances where the Commission had written direct to the audit firms

47. In cases where a second or subsequent letter is sent, those matters are closed off through the Commission reiterating its comments. When the Commission reviews the issuers’ financial statements in the next round the Commission intends to assess whether the issuer applied the correct accounting treatment or disclosure in accordance with the appropriate standards with regards to the matters raised.

48. In discussing the Cycle 7 findings the Commission’s focus is on providing feedback and information to issuers who have already adopted and those yet to adopt NZ IFRS. In this regard references to standards and legislation in this report refer to the most recent equivalent paragraph or section, notwithstanding that an earlier version of the standard or legislation may have been applicable at the time of writing to the issuers.

49. Related party transactions are a normal feature of commerce and business. However, their nature necessitates financial reporting standards to prescribe certain disclosures to draw attention to the possibility that the financial performance, financial position and the cash flows of an entity have been affected or influenced by related party relationships.

50. In Cycle 7 the Commission wrote to seven issuers relating to nine instances of inadequate disclosure or possible non-disclosure of related party information. These matters included the non-disclosure or possible non-disclosure and inadequate disclosure of:

(b) the nature of the relationship between related companies (NZ IAS 24 Related

(c) key management personnel information (NZ IAS 24, paragraphs 16 and 17); (d) the identity of related entities (SSAP-22 Related Party Disclosures, paragraph

(e) the types of transactions between related parties (SSAP-22, paragraph 5.1); (f) related party transactions (SSAP-22, paragraph 5.1); and

51. Issuers committed to make better disclosures in their next financial statements in relation to six related party matters raised and the Commission’s queries on two matters were resolved through additional information from issuers. The Commission reiterated its view for better disclosure through a second letter to one issuer.

52. The Commission wrote to an issuer about the non-disclosure of key management personnel information as required by NZ IAS 24 (paragraph 16). In this case the issuer clarified that it had no key management personnel: the issuer was managed under a

contract by an entity related to a director of the issuer. The entity related to the director also provides management services to entities other than the issuer.

53. The issuer considered that the remuneration of the key management personnel of the management company was not directly attributable to the services it provided to the issuer. However, the issuer committed to more comprehensively disclose the nature of this transaction in its future financial statements. The Commission accepted the clarification and change proposed by the issuer to its next financial statements.

54. Issuers should note the extensive related party information requirements of NZ IAS 24, particularly the requirement to also disclose certain information relating to key management personnel.

55. In relation to issuers that have no staff or key management personnel, the Commission draws the attention of issuers to the definition of "key management personnel" in NZ IAS 24. It refers to “those persons having the authority and responsibility for planning, directing and controlling the activities of the entity, directly or indirectly, including any director (whether executive or otherwise) of that entity” (paragraph 9). As such, “key management personnel” is not limited to a person directly in the employ of the reporting entity.

56. Moreover, the definition of "compensation" (NZ IAS 24, paragraph 9) includes all forms of consideration paid in exchange for services rendered to the entity.

57. The Commission considers these requirements, taken together, would require the disclosure of key management personnel information where a related party compensates key management personnel on behalf of the reporting entity. Where the reporting entity contracts out its key management functions or has those functions performed on its behalf by another entity the reporting entity’s key management personnel compensation is paid, in substance, on its behalf (whether or not the reporting entity pays management fees to the other entity).

58. As these services are usually rendered on the issuer’s behalf by the directors and officers of the other entity, the Commission considers that the key management personnel of the other entity are also the key management personnel of the reporting entity. As such, the relevant remuneration of the other entity’s directors and officers should be disclosed by the reporting entity. This is particularly so if the other entity only manages or renders services to the reporting entity and to no other entities.

59. In Cycle 7 the Commission noted that entities within a group of finance companies entered into a large number of inter-company transactions involving significant amounts in many instances. While the material related party transactions were usually identified and disclosed, four finance companies failed to disclose all information required to be disclosed by NZ IAS 24 about these transactions.

60. The Commission considers that adequate and transparent disclosure of related party transactions is important, particularly for finance companies where securitisations or mortgage sales take place between related parties and, as a result, financial assets are derecognised in the transferring company. It is not always clear from the financial statements whether the transfers should have been derecognised.

61. The Commission considers the high incidence of inadequate or possible non-disclosure of related party information by issuers unsatisfactory, given the effect related party relationships can have on an entity’s financial performance and financial position. The importance of related party disclosures is heightened in the current climate of tight liquidity and finance company collapses as users look to the information to determine the extent to which related party transactions, and possibly any preferential terms, have affected the financial position, performance and cash flows of the finance company.

62. The Commission considers that the disclosure of material related party information is necessary for an understanding of the potential effect of the relationship and/or the amounts involved on the financial statements. Materiality should be considered in the context of the nature of the relationship and not just quantitatively.

63. The Commission considers that transactions with related parties should be clearly disclosed in financial statements. Such disclosures should contain sufficient information and be meaningful to enable users to gain an understanding of the potential effect of those transactions and whether they are at carried out at arm’s length.

64. Issuers should note that non-compliance with NZ IAS 24 subjects the issuer to the penalty provisions of the Financial Reporting Act (section 36(2)) for non-compliance with an approved standard. This is in contrast to previous NZ GAAP where there were no specific penalties provided in the Financial Reporting Act for Statements of Standard Accounting Practice (SSAP) and SSAP-22 was not legally enforceable in that regard. Issuers can no longer be complacent when complying with NZ IFRS.

65. The review of finance companies raised many disclosure matters, particularly in relation to their financial instruments. Of the 18 finance companies reviewed, the Commission raised a total of twenty-five matters with six finance companies. These matters included 12 matters raised and 13 other matters. The financial statements of these six finance companies were prepared in accordance with previous NZ GAAP.

66. The majority of the matters related to FRS-33: Disclosure of Information by Financial Institutions. In some instances, the matters were raised with more than one finance company. The following matters relating to inadequate and possible non-disclosure of information were raised with the finance companies:

(c) contractual re-pricing or expected maturity periods for each class of financial asset and financial liability (paragraph 12.2);

(e) interest expense separately for each classification of funding presented in the

(g) fair value of exchange rate swaps (paragraphs 9.1 to 9.3); (h) unrecognised financial assets (paragraph 8.1); and

(i) each class of financial liability based on the priority of creditors’ claims over the entity’s assets in a winding up (paragraph 6.3).

67. Agreement was reached on 23 of the matters with finance companies committing to make the necessary changes in their next set of financial statements. The Commission closed off the last two matters through a second letter to an issuer reiterating the Commission’s comments on those matters. For one of the issuers we highlighted to the issuer in our second letter that quantitative, not just qualitative, information was also required to be disclosed by NZ IFRS 7.

68. The Commission took no enforcement action in relation to these matters as they did not render the financial statements misleading. However, the Commission considers it unsatisfactory that these finance companies did not comply fully with all the disclosures requirements of FRS-33, a Standard that is designed specifically to capture information about the transactions and activities of a financial institution that is relevant to a user.

69. While the finance companies that the Commission wrote to in Cycle 7 had financial statements prepared in accordance with previous NZ GAAP, the Commission draws the attention of finance companies (and issuers generally) to the more extensive requirements relating to financial instruments required under NZ IFRS. These requirements are set out in NZ IAS 32 Financial instruments: Presentation, NZ IAS 39 Financial Instruments: Recognition and Measurement and NZ IFRS 7. These are additional new standards and deal not just with disclosures but also with the recognition and measurement of financial instruments. Moreover, these standards apply not only to financial institutions but to all entities with financial instruments.

70. The impact of the above standards on finance companies (and other financial institutions) will be much greater than on other entities generally: the requirements of these standards directly affect the accounting for financial instruments that are core business activities of a finance company. Compliance with these standards by finance companies is essential to ensure that their financial statements contain the necessary information to enable users to understand their operations.

71. It should be noted that NZ IFRS 7 also contains additional New Zealand-specific disclosures applicable to financial institutions (in Appendix E to NZ IFRS 7).

72. More importantly, NZ IFRS 7 puts onus on issuers and management to disclose more information about the various types of risks (credit, liquidity and market risks) facing an entity. Besides qualitative and quantitative information about the risks, entities are now also required to identify and disclose objectives, policies and processes for managing, and methods used to measure, those risks. This information needs to be presented from the perspective of management and in the form provided internally to management.

73. To meet the requirements of NZ IFRS 7 will require management to disclose information that is specific to the issuer to ensure that the operations and transactions

of the entity are recognised, measured and disclosed to users in a relevant and understandable manner. “Boiler-plate” and “standardised” accounting policies and notes copied from the standards themselves or from audit firm templates are not acceptable as they may include material that is not applicable to the entity or may not fully or accurately reflect the issuer’s transactions and activities.

74. The Commission considers that the following are essential disclosures that an issuer is required to make regardless of the industry it is in and the transactions it enters into. In the preparation of financial statements the Commission considers it important that issuers get these “basics” right.

75. 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.

76. In transitioning to NZ IFRS, financial statements prepared in accordance with NZ IFRS should provide all the disclosures required by NZ IFRS 1 First-time Adoption of New Zealand Equivalents to International Financial Reporting Standards, NZ IAS 1 and NZ IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.

77. It should be noted that many of these matters were also raised in previous Cycles. The matters are reiterated here as the Commission considers that they are essential disclosures.

78. Accounting policies are the specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting its financial statements (NZ IAS 8, paragraph 5). For a set of financial statements to be understandable to its users it is fundamental that all significant accounting policies are disclosed.

79. The Commission is concerned that in eight instances, accounting policies relating to various aspects that the Commission considers material to the issuers’ business were not disclosed. These related to non-disclosure of accounting policies for:

(a) the basis of preparation of the cash flow statement in relation to an issuer that is a retailer;

(b) revenue recognition (trading, mortgage fee revenue, leased assets) in relation to an issuer that is a finance company with a retailing segment, and in relation to other issuers that are finance companies;

(d) securitisations, mortgage sales and/or derecognition of financial assets in relation to issuers that are finance companies; and

(e) distributions to its members in relation to an issuer that is a cooperative.

80. In one instance, the Commission wrote to an issuer querying an accounting policy that appeared incorrect even though the amount involved for that year was immaterial. Given the nature of the issuer’s operations the Commission considered that there was a potential that the item might become material in future. In this instance the issuer agreed to amend the incorrect accounting policy. However, given the small amount that was left to be amortised, the issuer considered that the item would likely be eliminated by the following year.

81. The Commission is committed to ensure that the correct policy is adopted by an issuer where it considers that the policy is significant due to the nature of the issuer’s operations. This is notwithstanding that the amounts involved may not have been material in the current and previous years.

82. The Commission considers it unacceptable for companies to fail to adequately disclose accounting policies that are core to their operations and which are critical for an understanding by users of the information presented. For example, the following core accounting policies should have been disclosed but were not, or were inadequately, disclosed by some finance companies:

(a) the recognition of revenue from trading, mortgages and leased assets; (b) determining the carrying value of impaired assets; and

83. Issuers committed in seven instances to make the necessary changes to their accounting policies or other disclosures in their next financial statements. In one instance, the matter was resolved after further clarification from the issuer.

84. Under previous NZ GAAP, FRS-1 requires general purpose financial statements to include a clear and concise statement of all the accounting policies adopted by an entity in the preparation of its financial statements where such accounting policies are material to those financial statements.

85. Under NZ IFRS, NZ IAS 8 (paragraph 7) requires that when an NZ IFRS specifically applies to a transaction, other event or condition, the accounting policy or policies applied to that item shall be determined by applying the NZ IFRS, including consideration of any relevant Implementation Guidance approved by the ASRB for the NZ IFRS.

86. NZ IAS 1 (paragraph 122) requires an entity to disclose, in the summary of significant accounting policies or other notes, the key sources of the judgements apart from those involving estimations that management has made in the process of applying the entity’s accounting policies that have the most significant effect on the amounts recognised in the financial statements.

87. Closely related to paragraph 122 is the requirement under NZ IAS 1 (paragraph 125) to disclose information about the assumptions an entity makes about the future and other major sources of estimation uncertainty at the end of the accounting period that have a

significant risk of resulting in material adjustment to the carrying amounts of assets and liabilities including their nature and their carrying amounts as at the end of the reporting period.

88. The Commission wrote to two issuers in relation to three instances of non-disclosure or inadequate disclosure of the requirements of NZ IAS 1, paragraphs 122 and 125. The issuers committed to make these disclosures in future.

89. The disclosure of key sources of judgements and information about assumptions and sources of estimation uncertainty are important new requirements. They were not explicitly required under previous NZ GAAP. While, as stated in NZ IAS 1 (paragraph

124), some of this information is required under specific NZ IFRS, not all standards require information about estimation uncertainty.

90. The Commission considers the information required under paragraphs 122 and 125 of NZ IAS 1 to be critical. The information complements the significant accounting policies of the issuer. The paragraphs require disclosure of management’s judgements in applying the entity’s accounting policies that can have a significant effect on the amounts recognised in the financial statements, for example, judgements about the classification of financial assets and whether, in substance, significant risks and rewards of ownership of financial assets have been transferred to other entities. The paragraphs also require information about assumptions made about the future in determining the carrying amounts of assets and liabilities, for example, any future-oriented estimates used to measure the recoverable amount of property, plant and equipment and pension obligations.

91. The Commission discourages issuers from using “boiler-plate” type disclosures in complying with paragraphs 122 and 125 of NZ IAS 1. The Commission expects the disclosures to vary in nature and be specific to entities to meaningfully represent the nature of the issuers’ activities and business.

92. The Commission is concerned to find in some financial statements an item “other expenses” (or similar) that represented a significant percentage of total expenses and “adjusted expenses” (total expenses excluding cost of sales), with no further information in the notes to explain the composition of the item. In many cases the amount of other expenses exceeded the amounts of other separately disclosed expense items.

93. As a result the Commission conducted a separate analysis of this item for all the 21 issuers reporting under NZ IFRS to determine the incidence and percentage figures involved. The results of the separate review prompted the Commission to include a discussion of the disclosure of other expenses in this report.

94. The Commission is concerned with the materiality of the percentages involved. In sixteen⁶cases where the issuer disclosed other expenses, only nine were other expenses

⁶The remaining 5 issuers’ financial statements did not include an “other expenses” item.

10% or less of total expenses. In all the other cases, other expenses represented between 14% and 62%⁷of total expenses.

95. This pattern is similar when other expenses are compared to adjusted expenses. In four cases, other expenses were 10% or less of adjusted expenses. In all other cases, other expenses represented between 11% and 62% of adjusted expenses.

96. The Commission considered it unsatisfactory that such a material item in financial statements remained unexplained.

97. In the two cases where the Commission wrote to issuers on this matter, one issuer agreed to make further disclosures in its next financial statements. The Commission wrote to another issuer to close off the matter by reiterating the need for separate disclosure of all material items of expenses.

98. Under previous NZ GAAP, a statement about materiality is included in each Financial Reporting Standard. NZ IFRS do not contain such a statement about materiality in each NZ IFRS. However, materiality is no less important under NZ IFRS.

99. The concept of materiality is discussed in the New Zealand Equivalent to the IASB Framework for the Preparation and Presentation of Financial Statements (NZ Framework (paragraphs 29-30)) as part of the discussion on the qualitative characteristics of financial statements. In addition, NZ IAS 1 defines “materiality” (paragraph 7) and, under the section Materiality and Aggregation (paragraph 29), requires an entity to present separately each material class of similar items. An entity is also required to present separately items of a dissimilar nature or function unless they are immaterial. An item that is not sufficiently material to warrant separate presentation in the statements may warrant separate disclosure in the notes (paragraph

30). The Commission encourages issuers to bear in mind the materiality of items and their separate disclosure when preparing financial statements.

100. 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. Cycle 7 included 21 issuers that had prepared their financial statements under NZ IFRS.

101. The Commission is pleased with the quality of the issuers’ financial statements that were prepared under NZ IFRS, given the significant effort required to implement and adopt NZ IFRS. However, the Commission considers that the NZ IFRS issuers can still improve their financial statements by ensuring their accounting policies relate to their activities and their financial statements include full and clear disclosures and other information where necessary. The Commission hopes that this will improve over time as issuers gain more experience and become more familiar with the detailed requirements of NZ IFRS. The Commission considers that issuers should aim for transparency in their financial reporting.

⁷In this case where the item was 62% of total expenses, the item “operating expenses” was disclosed with no further information on the composition of the item.

102. In relation to the NZ IFRS financial statements, the Commission drew the attention of six issuers to the requirement in NZ IAS 1 (paragraph 16) which requires an explicit and unreserved statement of compliance with IFRS. The Commission is highlighting this matter in an effort to stamp out at this early stage an unsatisfactory practice that appears to have become common practice.

103. The Commission noted that in many cases issuers attempted to make a statement of compliance but such statements are usually along the lines that the financial statements comply with NZ IFRS “which ensures compliance with IFRS”. While compliance with NZ IFRS will generally ensure compliance with IFRS, such a statement does not represent an explicit and unreserved statement of compliance by the entity in respect of its financial statements as required by NZ IAS 1. An issuer should make an explicit and unreserved statement of compliance with IFRS where the issuer’s financial statements do comply.

104. In Cycle 7 the Commission noted one audit report where the auditor stated that the issuer’s “financial statements also comply with IFRS” even though such a statement was not made in the financial statements by the issuer itself. In another case the issuer made the explicit and unreserved statement that its parent entity’s financial statements “comply with IFRS”, but included only compliance with NZ IFRS “which ensured compliance with IFRS” in respect of its group financial statements.

105. It should be noted that New Zealand is a jurisdiction that has adopted IFRS and compliance by a profit-oriented entity, including an issuer, with NZ IFRS will generally mean that the issuer’s financial statements also comply with IFRS. However, in the absence of an explicit and unreserved statement of compliance, it is not immediately clear to users whether the issuer’s financial statements do comply with IFRS.

106. A recent Working Paper⁸by the European Commission calls on entities in countries like New Zealand which are already applying IFRS equivalents to make an explicit and unreserved statement of such compliance. Similarly, the International Organisation of Securities Commissions (IOSCO), of which New Zealand is a member, has also issued a statement⁹where it has recommended that annual and interim financial statements prepared in compliance with IFRS as issued by the IASB should clearly state that this is the case.

107. The Commission considers compliance with the requirements of NZ IAS 1 in this respect to be important, as an explicit and unreserved statement of compliance with IFRS allows users, including those from outside New Zealand, to differentiate those financial statements prepared under NZ IFRS that also comply with IFRS from those that only comply with NZ IFRS.

⁸Report on convergence between International Financial Reporting Standards (IFRS) and third country Generally Accepted Accounting Principles (GAAPs) and on progress towards the elimination of reconciliation requirements that apply to Community issuers under the rules of third countries. (22 April 2008)

⁹IOSCO Technical Committee Statement on Providing Investors with Appropriate and Complete Information on Accounting Frameworks Used top Prepare Financial statements. (6 February 2008)

108. NZ IAS 8 (paragraph 30) requires entities to disclose certain information relating to the standards and interpretations that have been issued but are not yet effective.

109. The Commission wrote to six issuers on this matter. The Commission draws to the attention of issuers this requirement and also to the need to include interpretations that have been issued but are not yet effective.

110. The Commission considers this disclosure important because of the number of new standards and interpretations that are continually being issued. These usually have delayed adoption periods. It is therefore important for issuers to disclose not only those standards and interpretations that they have adopted early but also those that they have not, as well as the possible impact that those pronouncements may have on the issuer on their adoption when they become effective.

111. The following matters were also raised with issuers in Cycle 7, either as a matter raised or as an other matter. In some instances the Commission wrote to more than one issuer on each of the matters.

(ii) the non-disclosure of the level of rounding used in presenting the amounts in the financial statements (paragraph 51(e));

(iii) the non-disclosure of the identity of the parent and, if different, the ultimate parent of the entity producing the financial statements (paragraph 138(c));

(i) the non-disclosure of the reasons for presenting cash flows on a net basis (paragraph NZ 24.1); and

(i) the recognition of provisions that might not meet the definition of a provision (paragraph 14); and

(ii) possible non-disclosure of material provisions separate from other provisions (paragraph 85);

(d) NZ IAS 38 Intangible Assets in respect of the possible non-disclosure of the aggregate amount of research and development expenditure recognised as expense during the year (paragraph 126);

(e) NZ IFRS 2 Share-based Payment in respect of the possible non-disclosure of information relating to:

(i) the number and weighted average exercise prices of share options and the number of share options outstanding at the end of the period (paragraph 45);

(i) possible incorrect classification of investing and financing cash flows as cash flows from operating activities (paragraphs 4.7, 4.10 and 4.15); and

(i) the possible non-disclosure in the books of the issuer as lessor of the unguaranteed residual values of leased assets (paragraph 5.18); and

(ii) the non-disclosure of certain information in the financial statements of the issuer as lessee, including significant financing restrictions, classification of lease liabilities by periods, and the disclosure of finance charges relating to lease liabilities separate from lease and rental charges on operating leases (paragraphs 5.14 and 5.15).

112. In relation to finance companies there was also non-compliance with other standards.

(a) the non-disclosure of information from which it is possible to identify and evaluate the entity’s exceptional risks of operating (FRS-9, paragraph 8.14);

(b) the possible incorrect classification of operating lease assets as lease receivables rather than as fixed assets in the books of the lessor (SSAP-18 and FRS-3: Accounting for Property, Plant and Equipment); and

(c) the inconsistent and unclear current/non-current classification of financial assets between the financial statements and in the notes.

113. There were also two issuers whose financial statements contained inconsistencies.

One related to applying a depreciation accounting treatment that was inconsistent with its stated accounting policy. Another issuer’s financial statements had numerous typographical errors. The Commission considers it unacceptable that the financial statements of a public issuer should contain such errors and inconsistencies. The Commission urges all issuers to ensure that their financial statements are properly reviewed before publication to avoid the impression that other aspects of the financial statements might also contain errors and inconsistencies.

114. In Cycle 7 the Commission selected five finance companies that had published interim financial statements that were prepared for the first time under NZ IFRS. The Commission was interested to preview the quality of finance companies’ financial statements, particularly in relation to NZ IFRS 7 disclosures.

115. Overall, the quality of disclosures of the five companies was mixed. The Commission was prompted to write to two of the five companies. The matters raised in relation to another finance company are being considered as part of the Commission’s enforcement work on finance companies.

116. The Commission wrote to the two finance companies relating to the completeness of disclosures in their interim financial statements on the following matters:

(ii) concentrations of funding (Appendix E, paragraph E11(a)); (iii) priority of creditors’ claims (Appendix E, paragraph E4);

(v) methods and assumptions used in sensitivity analyses (paragraph 40); (b) NZ IAS 39 relating to:

(i) incorrect accounting policy adopted to account for available-for-sale financial assets (paragraphs 55(b) and 67 to 70);

(i) NZ IAS 24 - non-disclosure of key management personnel information and the sale of investments to a related party;

(iii) NZ IFRS 1 - non-disclosure of the effect of transition to NZ IFRS (equity); and

(iv) NZ IAS 27 Consolidated and Separate Financial Statements - unclear policy on consolidations.

117. Agreement was reached with the finance companies on 14 out of the 15 matters written. The remaining matter was closed off through a second letter reiterating the

Commission’s comments. The Commission will assess whether the appropriate disclosure is made when the issuers are reviewed again in the next round of reviews.

118. The Commission took no enforcement action in relation to these matters as they related mainly to incomplete disclosures. They did not cause the financial statements to be misleading.

119. The Commission is concerned to note the response from one of the issuers that their internal systems are not set up to capture some of the information required under NZ IFRS 7. (This is discussed further in paragraphs 184 to 187.)

120. NZ IFRS 7 requires entities to report summarised information based on that used internally by management to manage financial instrument risk. This includes both qualitative and quantitative information. The Commission notes, while the issuers included qualitative information, there was a tendency amongst the issuers to report similar information, particularly quantitative information, as reported under previous NZ GAAP. Issuers should note that this will not meet the requirements of NZ IFRS 7 in a number of instances. This is evidenced by the numerous other matters that were raised with two finance companies.

121. The requirements in these standards, both qualitative and quantitative, are particularly relevant to a financial institution and are necessary to ensure that the core activities and transactions of a finance company are explained, recognised, measured and presented for the information of users.

122. In past Cycles the Commission had written to issuers about not disclosing, or not separately disclosing, in the financial statements fees paid to auditors for services other than audit services as required by FRS-9 (paragraph 6.13) or NZ IAS 1 (paragraph NZ 105.1).

123. However, in Cycle 7 the Commission wrote to two auditors about the disclosure in their respective audit reports that they had no other relationship with the issuers or any of their subsidiaries other than in their capacity as auditor. In both cases the issuers’ financial statements made the necessary disclosures about the nature of the relationship and the amounts involved. However, the audit reports omitted the disclosures.

124. The Commission drew the auditors’ attention to paragraph 25(e) of New Zealand Auditing Standard AS-702 The Audit Report on an Attest Audit. The Standard requires auditors to make a statement as to the existence of any relationship, other than that of auditor, between the auditor and the entity in their audit report.

126. The Commission considers it important for auditors and issuers to ensure that there is disclosure of all fees paid to the company’s auditor. It is important that there is transparency in the types of services (other than audit services) and the related fees that are paid to an entity’s auditor. The provision of other services, particularly where the amounts involved are large in relation to the total fees paid to an auditor, could compromise an auditor’s independence in carrying out audit work.

127. The Commission has referred an audit firm to NZICA for it to consider if there is sufficient independence between the audit firm and two related issuers that it had audited.

128. The Commission was concerned with a possible threat to the independence of the audit firm. The Commission considered that the size of the audit fees paid by the two related issuers together in relation to the size of the audit firm raises the question of whether the total fees generated by the audit firm from the issuers represented a large proportion of the firm’s total fees. There is a concern that there might be an undue dependence on the issuers by the audit firm that could create a self-interest threat on the part of the audit firm.

129. The Commission raised several matters relating to disclosures of substantial security holder information, directors’ interest, and director share dealings with issuers.

130. Section 35F of the Securities Markets Act 1988 requires every public issuer¹⁰that is a company to send a notice to each of its shareholders with or in its annual report (sent under section 209 of the Companies Act 1993) or, in a notice sent under section 209, stating the following:

(a) the names of all persons who, according to the file kept under section 35C of the Securities Markets Act, are substantial security holders in the public issuer at the record date¹¹; and

(b) the number and class of voting securities of the issuer (as per the register) which forms part of each substantial holding in the issuer as at the record date; and

¹⁰The Securities Markets Act 1988 (section 2(1)) defines a public issuer to mean: (a) a person who is a party to a listing agreement with a registered exchange;

(b) 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.

¹¹The “record date” is a date stated in the notice that is not earlier than three months before the notice is sent

(a) the number of substantial security holdings disclosed in the annual report being inconsistent with those in the notice filed with NZX;

(b) no substantial security holder information being disclosed in the annual report in respect of some substantial security holders;

(d) non-disclosure in the annual report of the date of the substantial security information and the total number of voting securities in the issuer.

133. The Securities Markets Act imposes certain obligations on a person who is a substantial security holder in a public issuer. A substantial security holder is a person who has a relevant interest in the listed voting securities of a public issuer that comprises 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).

134. 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 35C of the Securities Markets Act requires the issuer to maintain a register of substantial security holder notices received.

135. Two out of the four issuers written to confirmed that their annual reports contained errors or omissions relating to the disclosure of substantial security holder information and committed to make the necessary corrections. Matters relating to two other issuers were resolved. In one instance, and in relation to one of the matters resolved, the issuer clarified that a substantial security holder’s holdings was not required to be disclosed in the annual report as the holdings were held in the name of a trust which complied with the substantial security filing requirements and whose holdings were disclosed in the annual report (Securities Markets Act, section 30).

136. The Commission wrote to two substantial security holders in an issuer who had not disclosed their substantial security holdings to the issuer or to NZX. They assumed that they were exempted under section 30 of the Securities Markets Act from the disclosures. This was because a substantial majority of those shares were held by related trusts that had complied with the substantial security filing requirements.

137. Section 30 of the Act states that a person (A) need not comply with any of sections 22 to 25 of the Act in relation to a substantial holding in a public issuer if

another person is required to comply and does comply and that person (A) has that substantial holding merely for one or more of the reasons in section 30(b).

138. In this case, however, the relevant interests of the two substantial security holders were not held merely for one or more of the reasons in section 30(b). As such, the section 30 exemption did not apply to their substantial holdings. Both substantial security holders have now made the necessary disclosures to the NZX and to the issuer.

139. 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 came into force on 29 February 2008 and are explained on the website www.newsecuritieslaw.govt.nz.

140. The failure to comply with substantial security holder obligations is now 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.

141. The Commission reminds issuers to take their obligations under the Securities Markets Act seriously, notwithstanding that the primary obligation for such disclosures is on the substantial security holders. Issuers should ensure their annual disclosures are accurate and comply with the Securities Markets Act. The Commission intends to review these disclosures more closely in future and take action where appropriate.

142. The Commission wrote to five issuers in relation to the non-disclosure or inadequate disclosure of directors’ interests and share dealings in their annual reports as required by the Companies Act, the Securities Markets Act and NZX Listing Rule 10.5.3(c).

143. The Commission wrote to the five issuers on the following matters (some issuers had more than one matter raised with them):

(b) the inconsistent disclosure of total share holdings between the current and previous annual reports without any disclosure of share transactions having taken place during the year;

(d) the non-disclosure of consideration paid or received for directors’ share dealings; (e) the inconsistent disclosure of the total number of shares held by a director

(f) the non-filing of NZX notices for changes in the holdings of persons associated with the directors.

144. The Commission also wrote to an issuer on three instances of typographical errors in the information on directors’ interest and share dealings.

145. In all instances, the issuers agreed that their annual reports contained the errors that were drawn to their attention.

146. The Companies Act (section 211(1) (e)) requires that the annual report of a company states the particulars of entries in the interests register made during the accounting period. Section 148 of the same Act requires directors to disclose their share dealings to the Board and ensure that those disclosures have 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.

147. 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.

148. 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.

149. Many of the above matters related to less than full compliance with all the requirements of the law. The Commission reminds issuers to ensure that all aspects of these requirements are complied with.

150. During Cycle 5 a matter related to a suspected breach of continuous disclosure provisions of the Securities Markets Act was removed from the FRSP and treated as an enforcement matter. This inquiry has been concluded and no further action taken.

Table 2 Issuer statistics over seven Cycles
	All Cycles *Number*	All Cycles %	Cycle 7 *Number*	Cycle 7 %
*Types of issuers’ financial statements*
Previous NZ GAAP	229	80%	20	45%
NZ IFRS	49	17%	21	48%
Other	7	3%	3	7%
Total	285	100%	44	100%
*Issuers written to/not written to*
Issuers written to	126	44%	17	39%
Issuers not written to	159	56%	27	61%
Total	285	100%	44	100%
*Types of issuers’ financial statements written to*
Previous NZ GAAP	98	78%	8	47%
NZ IFRS	28	22%	9	53%
Other	0	0%	0	0%
Total	126	100%	17	100%

152. In total, 285 issuers have been selected for review over all seven Cycles. Of these,

229 issuers (80% of total issuers reviewed) had prepared their financial statements under previous NZ GAAP, 49 issuers (17% of total reviewed) had prepared their financial statements under NZ IFRS, and 7 (3% of total reviewed) had prepared their financial statements under overseas GAAP. Comparatively, in Cycle 7, the percentage of previous NZ GAAP issuers has decreased to 45% of Cycle 7 issuers and the percentage of NZ IFRS issuers has increased to 48%. The Commission expects the figures for the next Cycle for NZ IFRS to be even higher as the remaining issuers transition to NZ IFRS.

153. Over the seven Cycles the Commission wrote to 44% (126 issuers) of the 285 issuers.

Comparatively, the Commission wrote to only 39% of issuers in Cycle 7. No matters were raised with the overseas and dual listed issuers reviewed in all seven Cycles.

154. Of the issuers written to over the seven Cycles 78% were issuers who had prepared their financial statements under previous NZ GAAP and 22% were issuers who had prepared their financial statements under NZ IFRS. Comparatively, for Cycle 7, the percentage of previous NZ GAAP issuers written to fell to 47% and NZ IFRS issuers written to rose to 53%. Again, the Commission expects that, in the next Cycle, all issuers that it writes to will be NZ IFRS issuers.

Table 3 Summary of matters – statistics over seven Cycles
	All Cycles *Total*	All Cycles %	Cycle 7 *Total*	Cycle 7 %
*Matters raised*
Resolved	58	31%	9	31%
Change agreed	96	52%	15	52%
Agreement reached	154	83%	24	83%

Second letter	19	10%	5	17%
Other follow-up	12	7%	0	0

Total matters raised	185	100%	29	100%

*Other matters*
Resolved	104	35%	12	22%
Change agreed	169	57%	41	76%
Agreement reached	273	92%	53	98%

Second letter	16	5%	1	2%
Other follow-up	7	2%	0	0

Total other matters	296	100%	54	100%

156. Over the seven Cycles, the Commission is pleased with the high percentage (83%) of the matters raised with issuers on which agreement was reached just through the Commission’s initial letters. A similar high percentage (92%) of agreement was also reached with issuers on other matters, also through initial letters.

157. Cycle 7 had a comparable high percentage of agreement reached with issuers (83%

158. Some matters were classified as “other follow-up” at the end of each of the seven Cycles. These relate mainly to referrals of auditors and directors to NZICA. The rest of the other follow-up matters have subsequently been resolved or closed off through further correspondence.

159. The Commission is particularly pleased with the high percentages associated with “change agreed”. While these indicate that disclosures could have been more transparent, they also indicate the willingness and commitment of issuers to make the necessary changes when matters were brought to their attention.

160. The Commission appreciates that financial reporting requires the exercise of professional judgement. In some cases agreement was not reached with issuers. Instead, the Commission closed off those matters through a second letter reiterating the Commission’s preferred approach. The Commission’s view on those matters was that they did not render the financial statement false or misleading and, accordingly, no enforcement action has been taken. In future reviews the Commission will be examining these issuers to ensure that appropriate accounting treatments have been applied.

161. Over the seven Cycles, the main matters that have prompted the Commission to write

162. The matters relating to financial instruments, related parties, disclosures by financial institutions, and accounting policies are matters that were also raised in Cycle 7. The Commission’s comments on these matters, specific to Cycle 7 and more generally, are discussed in the specific comments on Cycle 7 findings section of this report.

163. In the following sections, the Commission comments on matters relating to the Statement of Cash Flows, prospective financial information and the signing and dating of financial statements. In addition, the Commission also comments on audit work and transition matters.

164. 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.

“A statement of cash flows, when used in conjunction with the rest of the financial statements, provides information that enables users to evaluate the changes in net assets of an entity, its financial structure (including its liquidity and solvency) and its ability to affect the amounts and timing of cash flows in order to adapt to changing circumstances and opportunities. Cash flow information is useful in assessing the ability of the entity to generate cash and cash equivalents and enables users to develop models to assess and compare the present value of the future cash flows of different entities. It also enhances the comparability of the reporting of operating performance by different entities because it eliminates the effects of using different accounting treatments for the same transactions and events.

Historical cash flow information is often used as an indicator of the amount, timing and certainty of future cash flows. It is also useful in checking the accuracy of past assessments of future cash flows and in examining the relationship between profitability and net cash flow and the impact of changing prices.” (paragraphs 4 and 5)

166. The Commission wrote to issuers on cash flow related matters in four out of the seven Cycles of the FRSP. These matters relate mainly to netting of cash flows, inclusion of non-cash items and the incorrect classification of cash flows from financing and investing activities as cash flows from operating activities.

167. The Commission is surprised that some of the Statement of Cash Flows matters had to be raised with NZ IFRS issuers since NZ IAS 7 does not impose new requirements on issuers: the requirements of FRS-10 and NZ IAS 7 are essentially the same¹². The Commission considers that issuers have no compelling reason for not complying fully with NZ IAS 7.

168. Issuers are required, under certain circumstances (for example, on the initial flotation of equity securities, and on the issue of participatory securities) to include certain prospective financial information in a registered prospectus. FRS-9 (paragraph 5.4) requires that, where an entity has published general purpose prospective financial information in the period of the financial statements, the entity must present a comparison of the prospective financial information with the historical financial information being presented, including explanations for major variations.

169. The Commission wrote to previous NZ GAAP issuers in four out of the seven Cycles raising matters about the non-disclosure of the comparative information under FRS-9.

170. While the requirement in FRS-9 applies to entities that produce prospective financial information, the requirement is particularly pertinent to issuers who are required under certain circumstances under securities legislation to include prospective financial information in a registered prospectus or who voluntarily include such information. The Commission considers the comparison between prospective and actual financial information important to give users feedback on the relative reliability of the prospective financial information that has been disclosed.

171. The Commission reminds issuers of the requirement to provide comparative prospective and actual financial information in financial statements. These requirements remain unchanged under NZ IFRS and are included in NZ IAS 1 (paragraphs NZ 46.1 and NZ 46.2).

¹²Other than a small difference in the definition of “cash” (in FRS-10, paragraphs 4.1 to 4.4) and “cash and cash equivalents” (in NZ IAS 7, paragraphs 6 to 9), the requirements of the two Standards are essentially the same.

172. The Commission is concerned that it had to write to a number of issuers about their failure to sign and date their financial statements in five out of the seven Cycles of the FRSP. In some Cycles, the Commission wrote to more than one issuer. However, this matter was not identified in Cycle 7. The Commission hopes that this is an indication of an improvement in this aspect of an issuer’s financial statements.

173. The Commission considers this to be a basic legislative requirement of the Companies Act and the Financial Reporting Act. 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.

174. FRS-5: Events After Balance Date (paragraph 6.1) and NZ IAS 10 Events After the Reporting Period (paragraph 17) also contain requirements for the financial statements to be signed off by disclosing the date on which the financial statements were authorised for issue. It is considered important to disclose this date because it represents the date the financial statements were authorised for issue and because the financial statements do not reflect non-adjusting events that happen after this date.

175. The Commission reminds issuers, as a matter of best practice, to date the various components of the annual report (for example, the financial statements, the Chairman’s report and the Chief Executive’s report) as well as dating the report as a whole. These sign-offs are important because they indicate that the directors have reviewed all the material in those documents and inform investors of the date on which the parts of the document were signed.

176. Auditors have a responsibility to ensure that there is no other information in the annual report that conflicts materially with the financial statements (Auditing Standard AS-518

Other Information in a Document Containing an Audited Financial Report (paragraph 14) as issued by NZICA). As required by AS-518 (paragraph 15), either the auditor arranges to see other material before signing the audit report, or the auditor follows the guidance in paragraphs 28-33 where the other annual report material is produced after the auditor signs the audit report.

177. The Commission encourages issuers to actively manage the final stages of their year end reporting process for finalising the annual report. It seems to the Commission that, while most companies appear to successfully manage this process, some issuers do not appear to have managed the final stages of the reporting process very well.

178. The annual report, comprising the financial report and other statutory disclosures, should be reviewed before being dated and signed by the directors. Auditor sign-off should follow signing of the financial report by the directors.

179. To date in all seven Cycles, the financial statements of the issuers that have been reviewed have all contained unqualified audit reports¹³.

180. Through the seven Cycles, the Commission has referred the audit work of nine auditors and four audit firms to NZICA.

181. In some instances the Commission had to question the work of auditors, particularly where the financial statements included an incorrect treatment of a material transaction or the non-disclosure of a material matter. One example from a previous Cycle related to a reverse acquisition that was incorrectly treated under previous NZ GAAP. On transition to NZ IFRS, the correction of the previous period error was included, again incorrectly, as a transition to NZ IFRS adjustment. While it is the responsibility of the issuer to ensure that the correct accounting treatment is applied, in this instance the auditor failed to identify the incorrect original treatment and the incorrect transition adjustment.

182. The Commission’s practice in the Cycle reviews has been to send a copy of the letter sent to an issuer to the issuer’s auditors. This ensures that auditors are aware of the matters that have prompted the Commission to write in relation to the particular set of financial statements that the auditor has audited.

183. The Commission urges auditors to be even more vigilant in the audit of financial statements, particularly in this period of transition to NZ IFRS. While many of the concepts, accounting, and practices of previous NZ GAAP and NZ IFRS are similar, there are also many new areas of accounting under NZ IFRS. More importantly, in some instances NZ IFRS contain many detailed accounting and disclosure requirements. In many areas there is no existing practice or treatment on which issuers can draw in order to present their financial statements under NZ IFRS. The Commission urges auditors to take this opportunity to ensure that their clients, on transitioning to NZ IFRS, start with a good quality base that complies with NZ IFRS.

184. The Commission understands anecdotally from commentators and issuers that some issuers do not have the necessary systems in place to collect certain information required to be disclosed about financial instruments. One example was the inability to collect information on past due assets.

185. The Commission appreciates that changing systems to cater to new requirements in financial reporting standards may be difficult. However, New Zealand decided in December 2002 that all entities required to comply with NZ GAAP in accordance with the Financial Reporting Act must apply NZ IFRS for annual periods commencing on or after 1 January 2007. One of the reasons for the delay in the adoption of NZ IFRS was to allow entities sufficient time to get their systems in place.

¹³In one instance, the audit report of an entity contained a fundamental uncertainty.

186. In addition, FRS-41: Disclosing the Impact of Adopting New Zealand Equivalents to International Financial Reporting Standards, issued in 2005, by requiring the disclosure of an entity’s planning for the transition to NZ IFRS, should have been the impetus for an issuer to consider systems changes.

187. In previous Cycles (Cycles 3 to 5), the Commission had written to issuers about their non-disclosure or inadequate disclosures under FRS-41. The Commission had expressed its surprise that some issuers had not, even at a very late stage, started planning for their transition to NZ IFRS. The Commission urges all issuers to ensure that appropriate systems are put in place to collect all the necessary information required to be disclosed by NZ IFRS.

188. Since the ASRB determined in December 2002 to base New Zealand financial reporting standards on IFRS, a massive effort has been undertaken, particularly by:

• New Zealand’s standard setters (the Financial Reporting Standards Board (FRSB) of NZICA and ASRB) to ensure that a set of NZ IFRS is ready for application by preparers;

• the accounting profession to ensure that they are familiar with NZ IFRS to advise their clients or to apply the standards in their organisations; and

189. The adoption of NZ IFRS is particularly important to issuers. The main aim of adopting NZ IFRS was to ensure that the financial statements of profit-oriented entities contain information that is high quality, transparent and comparable to those of entities in other capital markets. This is essential to strengthen investor confidence and foster capital investment in New Zealand. High quality financial reporting by issuers is also considered integral to New Zealand having a fair, efficient and transparent securities market.

190. The Commission has raised, over the seven Cycles many issues with issuers. It is the aim of the Commission to raise the quality of financial reporting in New Zealand. To reap the maximum benefits of the adoption of NZ IFRS the Commission considers that it is important that NZ IFRS are rigorously applied by issuers.

191. This requires compliance with core requirements of financial reporting standards and legislation. In the transition period to NZ IFRS the Commission is taking the opportunity to ensure that such “basics” are complied with. Many of these basic disclosures need only be dealt with once on initial adoption of NZ IFRS and, unless circumstances change subsequently, will not need to be readdressed. As such, it is important for these to be incorporated into financial reports correctly at the outset.

192. The Commission is also committed to ensure that “bad habits” of less than full compliance with NZ IFRS do not become entrenched as “common market practice” in the future. Issuers have in past Cycles cited “common industry practice” for the incorrect treatment of some transactions, for example, the accounting for reverse acquisitions.

193. The Commission considers that “common industry practice” can only be relied upon where, in complying with NZ GAAP, authoritative support is used to account for a transaction. This happens where no provision is made in an applicable financial reporting standard or in an applicable rule of law. Where provision is made in an applicable standard (as in the case of a reverse acquisition¹⁴) those requirements should be complied with. Common industry practice should not result in a departure from NZ GAAP. The Commission is thus keen to “nip in the bud” bad practices before they become entrenched.

194. While the Commission accepts that in the transition period the many detailed disclosures and requirements of NZ IFRS may not have been fully met because the standards are being applied for the first time, the Commission strongly encourages issuers and their auditors to be diligent in ensuring that all applicable requirements are complied with. The Commission urges issuers adopting NZ IFRS to take the opportunity to have a fresh start and ensure that a high standard of financial reporting is adopted under NZ IFRS. This includes taking time to ensure that significant accounting policies and notes which are relevant to the operations and transactions of the entity are clearly disclosed. The Commission reiterates that “boiler-plate” type disclosures copied from standards or audit firm templates that bear no resemblance to the operations and transactions of the entity are not acceptable.

195. The Commission also considers that while the transition to NZ IFRS appears to be a major move, the concepts and principles for recognition and measurement underlying previous NZ GAAP and NZ IFRS are still essentially the same. The Commission considers that in many areas it may be a matter of a refinement in the disclosures and the increase in the number of disclosures to be made under NZ IFRS that might pose the greater challenge for most issuers. The Commission considers that all aspects, including the detailed requirements, of NZ IFRS should be complied with.

196. The Commission reminds issuers that, notwithstanding the above comment, NZ IFRS also has a number of standards and requirements that are new to New Zealand issuers, standards not included in previous NZ GAAP. These include the standards, for instance, on share-based payments, revenue, intangible assets, impairment, financial instruments, and agriculture. NZ IFRS also includes different or additional requirements in respect of, for instance, financial instruments, income taxes, operating segments, discontinued operations, and non-current assets held for sale.

197. The Commission will continue to review issuers’ financial reporting as part of the

Financial Reporting Surveillance Programme. It will begin Round 2 of its Cycle FRSP.

198. The Commission intends to continue to review the areas that have raised matters in the past (as discussed in this report). In addition, the Commission will also review the “new” standards and areas covered by NZ IFRS, in particular, valuation, impairment, financial instruments, and intangibles (including goodwill and cash generating units).

¹⁴FRS-36: Accounting for Acquisitions Resulting in Combinations of Entities or Operations (paragraphs 4.51 and 4.52).

Other areas that the Commission intends to focus on are the classification of financial instruments (as debt or equity) and the classification of debt (as current or non-current).

199. The Commission will take any appropriate steps to encourage and ensure compliance with NZ IFRS and other aspects of NZ GAAP.

New Zealand Securities Commission

Financial reporting surveillance programme - Review of financial reporting by issuers cycle 7 [2008] NZSecCom 6 (6 August 2008)