Discussion Documents: REVIEW OF FINANCIAL REPORTING BY ISSUERS - CYCLE 5

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

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

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

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

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

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

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

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

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

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

In Cycle 4, one issuer's accounting for a reverse acquisition in its consolidated financial statements did not comply with the requirements in FRS-36.

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

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

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

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

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

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

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

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

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

One issuer in Cycle 5 incorrectly accounted for an item as a fundamental error (discussed in paragraphs 92 to 94).

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

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