Financial Reporting Newsletter June 2017

By Kylee Byrne - July 17, 2017

In this month’s Financial Reporting newsletter, we highlight ASIC’s areas of focus for June 2017.
  1. Accounting estimates - Impairment testing and asset values
  2. Accounting policy choices - Revenue recognition
  3. Accounting policy choices - Expense deferral
  4. Accounting policy choices - Off-balance sheet arrangements
  5. Accounting policy choices - Tax accounting
  6. Key disclosures - Estimates and accounting policy judgements
  7. Key disclosures - Impact of new revenue, financial instrument, lease and insurance standards

For further details refer below or download the ASIC release

While in the past these may have been of interest only to the auditor, the increased focus on areas of judgment, accounting policies, and disclosures mean that these are items which those preparing and signing off on financial statements i.e. Directors and Those Charged With Governance should pay particular attention to.

Accounting Estimates

1. Impairment testing and asset values

The recoverability of the carrying amounts of assets such as goodwill, other intangibles and property, plant and equipment continues to be an important area of focus.

It is important for directors and auditors to ensure:

a) cash flows and assumptions are reasonable having regard to matters such as historical cash flows, economic and market conditions, and funding costs. Where prior period cash flow projections have not been met, careful consideration should be given to whether current assumptions are reasonable and supportable;
b) discounted cash flows are not used to determine fair value less costs of disposal where forecasts and assumptions are not reliable. Fair value less costs to sell should not be viewed as a means to use unreliable estimates that could not be used under a value in use model;
c) value in use calculations:

  • use sufficiently reliable cash flow estimates
  • do not use increasing cash flows after five years that exceed long term average growth rates, and without taking into account offsetting impacts on discount rates, and
  • do not include cash flows from restructures and improving or enhancing asset performance

d) cash flows used are matched to carrying values of all assets that generate those cash flows, including inventories, receivables and tax balances;
e) different discount rates are used for cash generating units (CGUs) where the risks are different and the CGUs are located in different countries, and that similar discount rates are used where the risks are similar;
f) CGUs are not identified at too high a level, including where cash inflows for individual assets are not largely independent;
g) CGUs for testing goodwill are not grouped at a higher level than the operating segments or the level at which goodwill is monitored for internal management purposes;
h) corporate costs and assets are allocated to CGUs on an appropriate basis where it is reasonable to allocate them; and
i) appropriate use of fair values for testing exploration and evaluation assets during the exploration and evaluation phase.

Further information can be found in ASIC Information Sheet 203 Impairment of non-financial assets: Materials for directors (INFO 203).

Particular consideration may need to be given to values of assets of companies in the extractive industries or providing support services to extractive industries, including assets during the exploration and evaluation phase.

In addition to considering asset values in the extractive industries, directors and auditors should also focus on the adequacy and treatment of any liabilities required for mine restoration and closure costs.

Asset values may also be affected by the risk of digital disruption.

Focus should also be given to the pricing, valuation and accounting for inventories, including the net realisable value of inventories, possible technical or commercial obsolescence, and the substance of pricing and rebate arrangements.

Directors and auditors should focus on the valuation of financial instruments, particularly where values are not based on quoted prices or observable market data. Fair values should be based on appropriate models, assumptions and inputs. This includes the valuation of financial instruments by financial institutions.

Further note this follows ASICs call for companies to adopt realistic valuations for asset values, appropriate accounting policies and better communication of that information in the lead-up to the end of financial year reporting season, as part of its areas of focus for 2016. Find out more here.

Accounting policy choices

2. Revenue recognition

Directors and auditors should review an entity’s revenue recognition policies to ensure that revenue is recognised in accordance with the substance of the underlying transactions. This includes ensuring that:

a) services to which the revenue relates have been performed;
b) control of relevant goods has passed to the buyer;
c) where revenue relates to both the sale of goods and the provision of related services, revenue is appropriately allocated to the components and recognised accordingly;
d) assets are properly classified as financial or non-financial assets; and
e) revenue is recognised on financial instruments on the basis appropriate for the class of instrument.

The appropriate timing of revenue recognition may also need careful consideration in industries with complex sale and licensing arrangements that may include continuing obligations, such as software providers.

3. Expense deferral

Directors and auditors should ensure that expenses are only deferred where:

a) there is an asset as defined in the accounting standards;
b) it is probable that future economic benefits will arise; and
c) the requirements of the intangibles accounting standard are met, including:

  • expensing start-up, training, relocation and research costs;
  • ensuring that any amounts deferred meet the requirements concerning reliable measurement; and
  • development costs meet the six strict tests for deferral.

4.  Off-balance sheet arrangements

Directors and auditors should carefully review the treatment of off-balance sheet arrangements, the accounting for joint arrangements and disclosures relating to structured entities.

5.  Tax accounting

Tax effect accounting can be complex and preparers of financial reports should ensure that:

a) there is a proper understanding of both the tax and accounting treatments, and how differences between the two affect tax assets, liabilities and expenses;
b) the impact of any recent changes in legislation are considered;  and
c) the recoverability of any deferred tax asset is appropriately reviewed.

Key disclosures

6. Estimates and accounting policy judgements

Disclosures regarding sources of estimation uncertainty and significant judgements in applying accounting policies are important to allow users of the financial report to assess the reported financial position and performance of an entity. Directors and auditors should ensure disclosures are made and are specific to the assets, liabilities, income and expenses of the entity.

Disclosure of key assumptions and a sensitivity analysis are important. These enable users of the financial report to make their own assessments about the carrying values of the entity’s assets and risk of impairment given the estimation uncertainty associated with many asset valuations.

Preparers should be particularly mindful to make these disclosures as this information may be revealed under key audit matter disclosures in the new enhanced audit reports for listed entities.  Preparers should note that the key audit matter disclosures may also refer to matters that should have been discussed in the Operating and Financial Review.

7. Impact of new revenue, financial instrument, lease and insurance standards

Directors and auditors should ensure that notes to 30 June 2017 financial statements disclose the impact on future financial position and results of new requirements for recognising revenue, for valuing financial instruments, and accounting for leases. New accounting standards in these areas will apply to future financial reports and may significantly affect how and when revenue can be recognised, the values of financial instruments (including loan provisioning and hedge accounting), and assets and liabilities relating to leases.  The International Accounting Standards Board has also issued a new accounting standard for insurance companies.

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