Financial reporting surveillance programme. Review of financial reporting by issuers Cycle 12 [2010] NZSecCom 16 (31 October 2010)

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

ALTERNATIVE PERFORMANCE MEASURES ........................................................................... 3

INTRODUCTION ................................................................................................................................ 5

CYCLE 12 FINDINGS ........................................................................................................................ 6

Scope and issuer selection .................................................................................................... 6

Overall comments on Cycle 12 ............................................................................................. 6

Outcome of matters raised .................................................................................................... 7

Specific comments on Cycle 12 findings.............................................................................. 9

Financial instruments: disclosures ..............................................................................................9

Financial instruments: measurement and recognition ............................................................. 12

Impairment of non-financial assets ........................................................................................... 13

Description of non-audit services provided................................................................................ 15

Other matters............................................................................................................................... 16

SECURITIES COMMISSION WORKSHOP ................................................................................. 17

ALTERNATIVE PERFORMANCE MEASURES ......................................................................... 19

CONCLUSION ................................................................................................................................... 20

LOOKING AHEAD ........................................................................................................................... 20

APPENDIX 1: BACKGROUND TO THE SECURITIES COMMISSION’S FINANCIAL REPORTING SURVEILLANCE PROGRAMME......................................................................... 21

The Commission’s Financial Reporting Surveillance Programme..................................... 21

New Zealand Generally Accepted Accounting Practice..................................................... 22

Selecting issuers .................................................................................................................. 23

Identifying matters and taking action ................................................................................. 23

The Financial Reporting Surveillance Programme (FRSP) is designed to encourage high- quality financial reporting that enhances the credibility of financial information provided by issuers and, therefore, strengthens investor confidence.

Our FRSP report informs directors, chief financial officers and other financial statement preparers, auditors and financial analysts on what the New Zealand Securities Commission considers could, and should, be improved. The Commission’s Cycle 12 review of selected issuers shows better compliance in some areas of NZ IFRS than past reviews have.

We comment on matters arising from our Cycle 12 review and on two additional areas of financial reporting – impairment testing of goodwill and the disclosure of information not prepared under New Zealand Generally Accepted Accounting Practice (non-GAAP measures).

We raised with issuers many matters to do with financial instrument disclosures and measurement, which reflects the high proportion of financial institutions included in the Cycle 12 review.

(a) financial instruments – in particular, inadequate or incorrect disclosure of concentrations of credit risk by security type and fair-value assumptions;

(b) financial instruments measurement – in particular, the incorrect classification of financial assets and accounting policies for impairment that were inconsistent with NZ IFRS;

(d) property, plant and equipment – in particular, inadequate disclosure of significant assumptions underlying valuations.

No matters warranted Commission enforcement action or referrals to any other body.

Impairment testing of goodwill and its disclosure need to improve in order for the information to be useful. Properly accounted for and disclosed, information on goodwill impairment can be used to assess management’s past decisions on particular acquisitions and as an indication of management’s view of the future of those acquisitions.

The Commission supports additional non-GAAP disclosures that improve a user’s understanding of financial statements, provided these are properly disclosed and

communicated, consistently applied, do not replace the statutory NZ GAAP financial information and are not disclosed more prominently than NZ GAAP financial information.

During the Cycle 12 review, the Commission held a workshop for directors, chief financial officers, other financial statement preparers and auditors focusing on matters repeatedly raised with issuers. The exchange of information was valuable and timely, given the number of years that NZ IFRS has been applied by issuers and the number of years that the FRSP has been conducted.

The Commission will continue to monitor compliance with NZ IFRS 8 Operating Segments

Also, the Commission is in the process of considering whether to include a list of the issuers reviewed in each cycle in its future public reports. However, if it does so, the Commission would not identify to which issuers it had written.

1. This report sets out findings from Cycle 12 of the Commission’s ongoing Financial Reporting Surveillance Programme (FRSP). It covers 21 issuers with balance dates ranging from 30 June 2009 to 31 January 2010.

2. Appendix 1 sets out the programme’s background, including how the Commission selects issuers for review, and deals with any issues it identifies.

3. This report is intended to inform directors, chief financial officers and other financial statement preparers, auditors and financial analysts on financial reporting areas the Commission considers could and should be improved.

4. While the FRSP primarily encourages improvements in financial reporting, it can result in enforcement actions. If a matter warranting enforcement is identified, it is removed from the FRSP and immediately becomes an enforcement matter. There were no such instances in this cycle.

5. The Commission reviewed the annual reports of 21 issuers with balance dates ranging

(a) financial instruments – in particular, inadequate or incorrect disclosure of concentrations of credit risk by security type and fair value assumptions;

(b) financial instruments measurement – in particular, the incorrect classification of financial assets and accounting policies for impairment that were inconsistent with NZ IFRS;

(d) property, plant and equipment – in particular, inadequate disclosure of significant assumptions underlying valuations.

9. These 17 letters drew issuers’ attention to a total of 39 matters raised.

¹Matters raised are important matters or those needing further clarification or information. (See Appendix 1, paragraph 20 for a further explanation.)

Notes	Table 1: Outcome of matters raised Outcome	Matters raised ²	%
(1)	Resolved	12
(2)	Point taken/change agreed	26
	*Agreement reached*	38	97%
(3)	Second letter sent	1
(4)	Other follow-up action	0
		1	3%
	Total matters raised	39	100%

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

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

(4) Other follow-up action: more action required eg a written request for answers to further questions; or referral to another body, such as the National Enforcement Unit of the Companies Office, for consideration of enforcement action.

10. Some issuers explained and clarified the matters raised with them. In many other cases, issuers agreed, as a result of the Commission raising an issue, to change their next set of financial statements. We continue to urge issuers and their directors to correctly apply NZ IFRS and to ensure financial statements contain all the information necessary for users to make informed decisions.

11. Our Cycle 11 report highlighted matters consistently raised from Cycles 9 to 11 of the FRSP. These included errors in key management personnel disclosure and lack of an unreserved statement of compliance with NZ IFRS. In Cycle 12 these matters were raised in only three instances, indicating improved disclosures in these areas.

²Matters raised exclude instances where the Commission wrote directly to audit firms and/or directors of issuers.

12. Table 2 compares statistics from previous FRSP cycles with Cycle 12 results. Under NZ IFRS the Commission has written to more issuers and raised, on average, more issues per issuer than under previous NZ GAAP³. We would like to see this situation improve.

Cycle #	NZ GAAP	Number of issuers reviewed	Number of issuers we wrote to	Issuers written to %	Matters raised	Matters per issuer written to
1	Previous NZ GAAP	40	15	38%	22	1.5
2	Previous NZ GAAP	46	19	41%	24	1.3
3	Previous NZ GAAP	45	19	42%	27	1.4
4	Previous NZ GAAP	40	17	43%	27	1.6
5	Previous NZ GAAP	40	16	40%	19	1.2
6	Previous NZ GAAP	30	20	67%	37	1.9
7	Previous NZ GAAP/NZ IFRS	44	17	39%	29	1.7
8	NZ IFRS	40	35	88%	97	2.8
9	NZ IFRS	24	17	71%	31	1.8
10	NZ IFRS	20	17	85%	50	2.5
11	NZ IFRS	24	20	83%	34	1.7
12	NZ IFRS	21	17	81%	39	2.3

³Previous NZ GAAP is the financial reporting regime existing in NZ prior to the implementation of NZ IFRS.

13. Figure 1 shows matters most frequently raised with issuers. Matters the Commission wishes to highlight are detailed in subsequent paragraphs.

14. Of 39 matters raised, 15 (38%) related to financial instruments disclosure or measurement, reflecting the large proportion of financial institutions included in Cycle 12.

15. It is important that financial statements clearly address matters relating to financial instruments, given the recent history of finance sector failures and investors’ increasing reliance on this information.

16. In spite of a high number of matters raised in this area, our review revealed nothing warranting further enforcement action. A significant proportion of matters raised related to one industry group. As part of our follow-up work, we are having further dialogue with this group with the aim of improving its financial reporting.

17. Financial instruments include financial assets and financial liabilities. Financial assets include cash, shares in other entities, trade receivables and derivatives that are “in the money”. Financial liabilities include trade payables, loans received and derivatives that are “out of the money”. NZ IFRS 7 Financial instruments: Disclosures and NZ IAS 32 Financial instruments: Presentation sets out the disclosure and presentation requirements for financial instruments.

18. Such disclosures are important because they allow users to assess the liquidity, market risk and credit risk of an entity’s financial instruments.

19. Matters raised in this area seldom relate to just one aspect of financial instruments.

Our view is that the absence of, or errors in, disclosures relating to various aspects of an entity’s financial instruments usually mean the disclosures, taken as a whole, are inadequate.

20. Directors and management have the responsibility for financial statement preparation, and must review disclosures in this area considering whether the disclosures comply with applicable NZ IFRS, are adequate and transparent, and provide financial report users with coherent and meaningful information. Auditors have the role of assessing these disclosures from an independent perspective.

21. Assessing the adequacy of disclosures in this area includes looking specifically at:

(a) the principles of NZ IFRS 7 has the issuer disclosed sufficient information to enable users of its financial statements to evaluate:

(i) the significance of its financial instruments and their impact on the issuer’s financial position and performance; and

(ii) the nature and extent of risks arising from its financial instruments to which the issuer is exposed at the end of the reporting period;⁴and

(b) whether the issuer’s qualitative and quantitative disclosures of credit, liquidity and market risk reflect the processes and information provided internally to key management personnel.⁵

22. NZ IFRS 7 requires all entities to disclose concentrations of risk arising from financial instruments where it is not apparent from disclosures already provided (paragraph 34(c)).

23. A main contributor to the significant loan impairments of property finance companies has been high levels of subordinated lending on failed investments in their loan portfolios. Therefore, in addition to the specific requirement to disclose geographic, industry and counterparty credit risk concentrations, financial institutions should also consider information about their credit risk concentrations by security type. Where an issuer is a subordinated lender for significant portions of its loans and advances, this information is likely to be material and should be provided.

24. We note that a number of issuers now provide this information by way of a security dissection which shows the value of loans by security type eg first mortgage, second mortgage, loans secured by charge of personal property and unsecured loans.

25. In Cycle 12 we wrote to four issuers about the security held on their loan portfolios, including instances where:

(a) the issuer had not provided a security dissection; (b) the issuer had provided a security dissection but:

(i) had not distinguished between loans secured by first or subsequent ranking mortgages;

(ii) the value of loans represented in the dissection was substantially less than the total loan portfolio and it was unclear what type of security, if any, existed over the remaining loans.

26. All four issuers agreed to provide further disclosures in future financial statements.

27. Currently, under NZ IFRS 7, issuers are required only to provide where it is practicable an estimate of the fair value of collateral held by the entity as security. However, for periods beginning on or after 1 January 2011, for all financial instruments issuers must disclose a quantification of the extent to which collateral and other credit enhancements mitigate credit risk.⁶We strongly encourage issuers to consider whether providing this information prior to its effective date would enhance their disclosures.

28. Other matters raised with issuers on financial instruments disclosures included:

(a) 3 instances where issuers failed to disclose the methods and, where a valuation technique was used, the assumptions used to value their financial instruments.⁷One issuer had used a third party to value the financial instrument in question. In such a case, the issuer should ensure the third party provides sufficient information underlying the valuation to enable the issuer to

(b) 1 instance where financial instruments were recognised on the balance sheet at fair value, but a breakdown of how the instruments were valued in accordance with the hierarchy defined in NZ IFRS 7 was not provided;⁸

(c) 3 instances where reconciliations of individually impaired assets and/or related impairment allowances were not disclosed or the disclosures were incomplete. Financial institutions should note that, in complying with Appendix E of NZ IFRS 7, these reconciliations must be provided for sub- classes of impaired assets such as restructured assets, financial assets acquired through the enforcement of security and other individually impaired assets.⁹

⁶_{This new requirement was introduced in May 2010 as part of
the IASB’s Annual Improvements Project.}

29. In Cycle 12 we raised six matters relating to NZ IAS 39: Financial instruments: measurement and recognition. The Commission wishes to highlight the following two matters.

30. Most entities have certain financial assets measured at amortised cost – such as loans and accounts receivables. Under NZ IAS 39 financial, assets measured at amortised cost need to be tested for objective evidence of impairment as follows:

(a) first, individually for financial assets that are individually significant; and

(b) second, individually or collectively for financial assets that are not individually significant.

31. Where an entity has determined that no objective evidence of impairment exists for an individually assessed financial asset it includes the asset in a group of financial assets with similar credit risk characteristics and collectively assesses them for impairment.

32. We observed that some issuers’ stated accounting policy for determining their collective impairment allowance was:

(a) first, determine past due financial assets and group these by how long they had been overdue; and

33. However, as outlined above, NZ IAS 39 requires that a collective impairment allowance is based on all financial assets not individually determined to be impaired, whether past due or otherwise.

34. We also emphasise that statistical or formula-based methods for determining collective impairment allowances, such as using industry rates, are only permitted where these are consistent with the requirements of NZ IAS 39. This includes:

(a) ensuring that industry rates or formulas used are consistent with the historical loss experience for assets with similar credit risk characteristics adjusted for current market conditions; and

35. Failure to do this could result in a material misstatement in an issuer’s impairment allowance.

36. Under NZ IAS 39 held-to-maturity investments are measured at amortised cost rather than fair value. To classify a financial asset as a held-to-maturity investment it must have fixed or determinable payments and a fixed maturity. In addition, the entity must have the positive intention and ability to hold that instrument to maturity.¹¹

37. We noted that some issuers classified their financial assets as held-to-maturity investments notwithstanding that the assets have no fixed payment or maturity. Further investigation revealed that, while the issuers intended to hold the items indefinitely, the assets should have been classified as available-for-sale financial assets.¹²We acknowledge that, where an issuer does intend to hold such assets indefinitely, classifying them as available-for-sale financial assets, as required by NZ IAS 39, may appear to misinform. In such situations, we suggest that issuers make additional disclosures to clarify their long-term holding intentions.

38. The issuers written to agreed to reclassify their assets from held-to-maturity investments to available-for-sale financial assets.

39. Disclosures of goodwill impairment testing are a commonly raised issue in the FRSP.

We recently reviewed a sample of goodwill disclosures in the financial statements of certain issuers to identify areas for improvement.

40. Under NZ IFRS 3 Business Combinations, goodwill from a business combination is calculated as the excess of the consideration paid over the identifiable net assets acquired. This goodwill must be allocated to the cash generating units (CGUs) expected to benefit from the business combination.

41. Under NZ IAS 36 Impairment of assets, CGUs to which goodwill is allocated must be tested for impairment at least annually, and where there is an indicator of impairment.¹⁴This involves calculating the recoverable amount of the CGU, usually using discounted cash flow models based on the future profitability of the CGU.

42. Such testing can be subjective as it requires management judgement about key assumptions. NZ IAS 36 therefore requires a series of disclosures to inform users of the methodology and assumptions used by the entity. Disclosure of impairment testing of goodwill provides relevant information to users in at least two ways:

¹²Available-for-sale financial assets need to be measured at fair value with limited exceptions. For example, an available for sale financial asset may be measured at cost where the financial asset is an investment in an equity instrument that does not have a quoted price in an active market and whose fair value cannot be determined

¹³See article in the December 2009 issue of the New Zealand Institute of Chartered Accountants’ Journal by

(a) Confirmatory information – it indicates to users management’s ability to make good investment decisions. Goodwill is supported by the profitability of the underlying CGU to which it is allocated. Therefore, an impairment of goodwill indicates that future returns from the CGU as a result of the acquisition are not as high as initially expected. Conversely, no impairment of goodwill indicates that CGUs are operating as, or more profitably than, initially expected. This information enables users to evaluate management's past decisions through confirming or correcting past evaluations.

(b) Predictive information – disclosure of expected growth rates, budget assumptions and discount rates provides users with an indication of management’s expectations for the future of that particular CGU.

43. In general, we note that disclosures provided by issuers about impairment testing of goodwill limited the usefulness of the information. Issues identified included:

(i) non-disclosure of key assumptions underlying the budgets and how these key assumptions were determined – disclosures are often too brief and too generic to be useful;¹⁶

(ii) unclear disclosure of the expected growth prospects and risks associated with a particular CGU, as, for example, where a range of assumptions is applied across several CGUs;

(d) use of the same discount rates across all CGUs when CGUs are located in different jurisdictions, are different types of businesses or have different risk profiles.¹⁷

44. The above are key areas in the impairment testing of goodwill where we consider both related accounting and disclosures could be improved. We emphasise that disclosures must be provided for each CGU to which goodwill allocated is significant. Issuers may consider using tables as a clear and concise way of providing this information.

(a) had not described the key assumptions underlying the valuation of its CGU’s recoverable amount or its approach to determining those assumptions;

(b) had generally described, but did not disclose, the specific growth rate used beyond the initial forecast period; and

¹⁷Discount rates should take into account current market assessments of the time value of money and risks specific to each CGU – see NZ IAS 36 paragraph 30 and 55.

46. The issuer has agreed to include additional information on its valuation and specific disclosures of the discount and growth rates used in its future disclosures.

47. We wrote to four entities about their disclosure of the nature of non-audit services received from their auditors. We note that, while entities usually disclose fees paid by the required categories, some do not describe the nature of those services as required by NZ IAS 1 (paragraph NZ105.1).

48. The requirement is designed to increase the transparency of the auditor-issuer relationship, enabling annual report readers to make their own judgement over the level of independence between auditor and issuer.

49. The Commission wrote to two issuers about valuation of their property, plant and equipment. NZ IAS 16 Property, plant and equipment (paragraph 77(c)) requires that, where items of property, plant and equipment are stated at revalued amounts, entities must disclose “the methods and significant assumptions applied in estimating the items’ fair values”.

50. These entities provided only a general description of the methods and significant assumptions applied. We question whether this complies with NZ IAS 16 (paragraph 77(c)).

51. The types of assumptions to disclose will depend on the type of property, plant and equipment.

52. Issuers have cited commercial confidentiality and sensitivity in relation to certain assumptions and information. However, the Commission’s view is that commercial sensitivity is no reason for non-disclosure.

53. In this area, issuers must assess the extent of their disclosures against the objective of ensuring they provide a fair presentation. We consider disclosure of significant assumptions can usually be achieved by providing a range rather than point data.

54. We wrote to one issuer because it indicated that the group’s property, plant and equipment are used as partial security for bank facilities. However, it did not provide details of the extent of assets pledged as security.

The financial statements shall also disclose: (a) the existence and amounts of restrictions on title, and property, plant and equipment pledged as security for liabilities;

56. NZ IFRS 8 Operating Segments is a new standard that became mandatory for annual reporting periods beginning on or after 1 January 2009. It requires certain entities to publish segment information consistent with that reported to their management, so the market has the same perspective.

An entity shall disclose information to enable users of its financial statements to evaluate the nature and financial effects of the business activities in which it engages and the economic environments in which it operates.

58. We wrote to one issuer asking how their operating segment reporting aligned with

59. The matter was resolved with the issuer, but the Commission encourages issuers to provide a level of disclosure consistent with the standard’s core principle. The Commission will continue to monitor disclosures in this area.

60. The Commission wrote to three issuers about their disclosures in the Statement of Cash Flows. All three issues were resolved but the Commission would like to highlight the following point.

61. We queried with one issuer why a certain cash transaction was classified as a cash flow from operating activities rather than as a cash flow from financing activities in the Statement of Cash Flows.

62. The issue was resolved by further clarification from the issuer. However, it would have been useful if the financial statements had included a clearer explanation of the nature of the transaction to enable users to understand the basis of its classification.

63. The Commission reminds issuers they should ensure that the necessary disclosures are made to explain material items presented in financial statements.

64. As part of a programme to encourage further improvement in financial reporting and also to initiate dialogue on recurring issues, the Commission held a financial reporting preparer and auditor workshop in Auckland on 1 July 2010. Feedback from participants was that the workshop was useful. We highlight the following points discussed at the workshop.

65. The Commission believes that reviewing disclosures against the principle of “telling the story to users” should help preparers decide the level of detail to include in or exclude from financial statements.

66. We encourage issuers to carefully consider matters raised with them and to challenge these if they believe they have good NZ GAAP reasons for a particular accounting treatment.

67. Participants agreed that, for improved financial reporting, greater transparency and more readable financial statements, preparers need to focus on materiality when making relevant NZ GAAP judgements during the preparation and audit of their financial statements. The Commission considers that issuers should:

(b) Document key judgments, and have them approved by the directors and/or the audit committee. These can then be provided to auditors and/or regulators on request.

(d) Customise accounting policies and cross-reference the policies to the entity’s underlying economic activity. Entities should not regurgitate the whole standard but should explain NZ IFRS in plain English.

(e) Prioritise notes in financial statements and emphasise key areas of judgement and disclosures that reflect how the entity is actually managed (eg it is useful to link qualitative and quantitative disclosures).

(f) Align information in any entity news releases to better reflect the information in financial statements and vice versa.

¹⁸The Commission has not developed its own set of guidelines but through its membership of IOSCO is aware that a number of overseas regulators have released papers on the issue of assessing materiality in the context of financial reporting under IFRS that issuers may find useful. The Danish Securities Council has issued a paper entitled The Danish Securities Council’s general considerations and deliberations on the assessment of materiality in relation to its financial reporting enforcement activities

The Irish Auditing & Accounting Supervisory Authority has released a document Observations on Materiality in Financial

68. Support for this approach can also be found in the work of the UK Financial Reporting Review Panel¹⁹. It believes the following characteristics make for a good annual report:

(a) a single story – material throughout the report is consistent and the narrative properly explains the numbers;

(b) how the money is made – the report includes an explanation of the company’s business model and the salient features of the company’s performance;

(c) what worries the board – the risks and uncertainties facing the board are appropriately described and the links to accounting estimates and judgements are clear;

(d) consistency – highlighted or adjusted figures, key performance indicators and non-GAAP measures are clearly reconciled to main heading figures in the financial statements and any adjustments are clearly explained;

(g) summarise – there is an appropriate level of aggregation; (h) explain change;

(i) true and fair – the spirit, as well as the letter, of the financial reporting standards is followed.

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

70. Some issuers provide alternative non-GAAP performance measures such as underlying profit to supplement statutory earnings information when communicating with the market.

71. The Commission supports additional disclosures that improve investors' understanding of financial statements, as long as they are properly disclosed and communicated, consistently applied year on year and are not attempting in any way to substitute for the statutory financial information required by NZ GAAP. Neither should such non-GAAP measures be disclosed more prominently than financial information required by NZ GAAP.

72. The Commission intends to closely review any non-GAAP measures disclosed and take action if required.

73. The Committee of European Securities Regulators (CESR) has addressed this concern about non-GAAP measures by publishing guidelines for issuers in Europe using alternative non-GAAP performance measures.²⁰

²⁰CESR Recommendation on Alternative Performance Measures issued October 2005 (available at http://www.cesr-eu.org/popup2.php?id=3601).

76. The Commission’s review of selected issuers in Cycle 12 indicates improved compliance in some areas of NZ IFRS raised in past reviews. However, we consider there is still room for issuers to improve compliance with NZ IFRS in many other areas, including those for financial instruments and impairment testing of goodwill. Moreover, while the Commission supports additional non-GAAP disclosures that improve a user’s understanding of financial statements, it cautions that such information should not be substituted for the statutory financial information required by NZ GAAP.

77. The Commission’s workshop attended by directors, chief financial officers, other financial statement preparers and auditors resulted in valuable and timely exchange of information.

78. In order for financial statements to remain transparent and coherent, issuers and their directors must comply with the principles underlying NZ IFRS. This requires assessing the materiality of information in terms of whether its inclusion or omission could influence economic decisions made by users of financial statements.

79. The Commission will continue to monitor compliance with NZ IFRS 8 Operating

80. Also, the Commission is in the process of considering whether to include a list of the issuers reviewed in each cycle in its future public reports. However, if it does so, the Commission would not identify to which issuers it had written.

APPENDIX 1: BACKGROUND TO THE SECURITIES COMMISSION’S FINANCIAL REPORTING SURVEILLANCE PROGRAMME

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 issuers²¹to be fundamental to the fairness, efficiency and transparency of New Zealand’s securities markets.

3. Section 10(c) of the Securities Act 1978 requires the Securities Commission “to keep under review practices relating to securities, and to comment thereon to any appropriate body”.

4. As part of carrying out this function the Commission established an ongoing 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 reviewing selected issuers’ financial statements. At the end of each cycle the Commission publicly reports on this surveillance work by providing 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 the allotment of the security is

(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:

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. The Financial Reporting Act 1993 requires issuers 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 relate²².

8. The Commission reviews issuers’ financial statements 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 Financial Reporting Act defines “applicable financial reporting standard” 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. All issuers are required to apply NZ IFRS in the preparation of their financial statements for annual accounting periods commencing on or after 1 January 2007.

(a) the level of issuer compliance with NZ GAAP in 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 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

²²Part II of the Financial Reporting Act 1993 (section 11) requires every ‘reporting entity’ to prepare financial statements that comply with generally accepted accounting practice and to provide any additional information required to ensure those statements are a true and fair view of the matters to which they relate.

Part I, Section 2 of the Financial Reporting Act 1993 defines a reporting entity as : (a) An issuer; or

11. The FRSP aims to review all issuers listed on NZX Limited (NZX) at least once over a three to four year period.

12. In reviewing all listed issuers, dual and overseas listed issuers may also be selected.

Overseas listed issuers are issuers domiciled or incorporated outside New Zealand that have a recognised stock exchange as the home exchange and are also listed on NZX.

13. Dual listed issuers are issuers incorporated in Australia that are on the Australian

14. Where dual and overseas listed issuers are selected, 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 it has, the Commission does not review them. Where the issuer has not been reviewed by the overseas regulator, the Commission reviews the annual report, NZX announcements and, if applicable, the current prospectus. Where appropriate, findings are communicated to the overseas regulator. If the Commission communicates what it considers to be a significant matter about an issuer to an appropriate 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.

15. Issuers trading on the Unlisted²³exchange and issuers not listed on any exchange may be also included in cycle reviews.

16. Issuers may be selected on the basis of criteria determined by the Commission: on areas of particular risk affecting the issuer; the sector the issuer is in at the time of selection; and/or their balance dates. Issuers can also be reselected for a later review where the nature of issues identified in an earlier cycle raised concerns.

17. The Commission reviews an issuer’s annual report when reviewing its financial statements and, in the case of listed issuers, this includes a review of any NZX announcements for the period and any relevant prospectuses. While 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.

18. Matters identified in the review are referred to as matters raised²⁴or other matters.

²³Unlisted 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.

²⁴Prior to Cycle 6, the Commission referred to matters raised as significant matters.

19. Matters raised are those that are important or where further clarification or information is needed. The Commission is likely, for example, to write to an issuer where a matter:

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

21. 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.

22. When writing to an issuer about matters raised, the Commission includes other matters found in the review in relation to that issuer. Other matters are miscellaneous matters the Commission considers could be better disclosed.

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

24. 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 maintain and improve the standard of financial reporting. It also alerts an auditor to the particular aspects of its client’s financial statements that may concern the Commission.

25. 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.

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

27. Referrals are also made to appropriate bodies where matters identified in the FRSP