A case of déjà vu as ASIC continues to request realism and clarity in financial reports

Every six months, ASIC publishes its areas of surveillance on financial reports soon to be lodged by reporting entities.

For 30 June 2016, ASIC has reiterated its focus that financial reports clearly articulate the approach to valuation of assets and accounting policy choices.  This is continuing the theme from ASIC’s review of 31 December 2015 financial reports when ASIC Commissioner, John Price, stated:

‘The largest number of our findings continue to relate to impairment of non-financial assets and inappropriate accounting treatments. Directors and auditors should continue to focus on values of assets and accounting policy choices.’

ASIC’s media release mirrors its requests from previous financial reporting periods, and asks for directors to apply ‘realism and clarity’ to their financial reports.  ASIC is particularly concerned with companies:

• impairment of goodwill, inventory and other assets, which may be based on unrealistic cash flows and assumptions
• accounting policies such as the treatment of off-balance sheet arrangements, revenue recognition, expensing of costs that should not be included in asset values, tax accounting, and inventory pricing and rebates, and
• material disclosure of information that would be useful to investors and others who would use the financial reports.  These disclosures include assumptions supporting accounting estimates, significant policy choices and the impact of new reporting requirements.

Impairment and asset valuations accounted for almost half of ASIC’s enquiries for 31 December 2015 financial reports, and were a key factor in ASIC requiring material changes to a number of financial reports.  Companies should ensure that:

• cash flows and assumptions used are reasonable having regard to matters such as historical cash flows, economic and market conditions and funding costs
• discounted cash flows are not used to determine the fair value less costs of disposal where the forecasts and assumptions are not reliable
• value in use calculations do not include cash flows from restructurings and improving asset performance
• cash flows used are matched to carrying values of all assets that generate those cash flows
• different discount rates are used for cash generating units (CGUs) where the risks are different and the CGUs are in different countries
• CGUs are not identified at too high a level including where the cash inflows for individual assets are not largely independent
• corporate costs and assets are allocated to CGUs on an appropriate basis
• the impairment test in AASB 136 Impairment of assets is used for exploration and evaluation assets after feasibility and viability have been demonstrated, and
• there is an appropriate use of fair values for testing exploration and evaluation assets during the exploration and evaluation phase.

While it is not expected that directors have expertise in accounting processes, ASIC notes that statutory and common law duties of care and diligence extend to ensuring that a company’s financial records adopt appropriate accounting policies and standards. As such, ASIC asks that directors seek explanations and advice regarding the accounting methods used and challenge accounting estimates and processes where appropriate.  ASIC provides specific guidance for directors regarding their duties for financial reporting (see Information Sheet 183 – Directors and financial reporting and Information Sheet 201 – Impairment of non-financial assets: Materials for directors).

ASIC will be selecting a range of 30 June 2016 financial reports for review, focusing on risk-based criteria and also from a random selection.  Directors should therefore be particularly mindful of the importance of accounting methodologies used, with particular regard to the matters highlighted above.

Reece Walker, Ben Wood, Naomi Benton