REVIEW OF FINANCIAL REPORTING BY ISSUERS
CYCLE 7

OVERVIEW OF ALL SEVEN CYCLES

Overall comment

151. Table 2 sets out selected issuer statistics for the seven Cycles of the FRSP. The statistics for Cycle 7 are also included for comparison.

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.

155. Table 3 summarises selected statistics for matters raised and other matters on which the Commission has written to issuers.

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% for matters raised and 98% on other matters).
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.

Common matters raised in the Cycles

161. Over the seven Cycles, the main matters that have prompted the Commission to write (both under previous NZ GAAP and under NZ IFRS) included matters in respect of:
     • financial instruments (raised in all seven Cycles);
     • related parties (raised in five Cycles);
     • disclosures by financial institutions (raised in four Cycles);
     • accounting policies (raised in four Cycles);
     • Statement of Cash Flows (raised in four Cycles);
     • prospective financial information (raised in four Cycles); and
     • signing and dating of financial statements (raised in five Cycles).
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.

Statement of Cash Flows

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.
165. NZ IAS 7 sets out the benefits of cash flow information as follows:
     
     "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.

Prospective financial information

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).

Signing and dating of financial statements

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.

Audit work

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.

Transition issues

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.
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.

Concluding comments

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
     • organisations to ensure that systems are in place to cater to NZ IFRS.
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.

ONGOING REVIEW AND ENFORCEMENT

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). 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.