Feature Financial yearend reporting headaches

  • Date:01 May 2010
  • Type:CompanyDirectorMagazine
The global financial crisis may have eased, but as Domini Stuart reports, directors still face a range of accounting headaches as they ready for financial year-end reporting.

Financial year-end reporting headaches

Accounting challenges for directors

  • Coming to grips with almost 30 changes to the accounting standards
  • Ensuring accounts comply with a series of inconsistent rules
  • Preparing for a raft of further changes
  • Reporting on non-financial measurements

This time last year, we were in the thick of the global financial crisis (GFC). Accounting standards were being stretched to their limits, the most basic concern of stakeholders was whether the company was going to survive and directors’ heads were spinning with fair-value calculations, cash flows, borrowing covenants, banking arrangements, rollovers and asset impairment.

Now that the markets have improved, the focus has shifted – good news, of course, but there is still potential for headaches. Reversing impairments, for instance, isn’t necessarily as simple as it sounds. “Some of the increases in value can be treated as a profit item while others might go straight into equity,” says Michael Coleman FAICD, regional leader – Asia Pacific Quality & Risk Management at KPMG and chairman of the Australian Institute of Company Directors’ Reporting Committee.

“It depends on what asset you wrote down in your previous accounts. The other thing to watch out for is the ‘asset cap’, which means not all the impairment loss previously recognised can be reversed. This can all be confusing for directors.”

There have also been close to 30 changes to the accounting standards. “Directors don’t need to be involved in the detail, but they do need to ensure these changes have been addressed through their risk-management processes,” says Kerry Hicks, head of reporting for the Institute of Chartered Accountants (ICA) and a member of the Australian Institute of Company Directors’ Reporting Committee.

The new Statement of Comprehensive Income may demand closer attention.

Introduced this year as part of a move to bring Australia in line with US Generally Accepted Accounting Principles (GAAP), it can be presented either as an income statement with a separate statement or as a single statement combining the two.

“As this appears right at the front of the accounts, it’s an area of focus for shareholders and investors, and so for directors,” says Hicks.

American influence can also be seen in changes to Australian Accounting Standard AASB 8 Operating Segments.

In the US, a similar management-based approach to reporting was introduced some time ago to help analysts ascertain how boards were managing and evaluating performance and also to prevent companies from falsely reporting that they operated in one segment only. This year, Australian companies also need to disclose individual operating segments in the way the executive receives these results. Segment information must also be consistent across the directors’ report, the annual review and any analyst presentations.

“A lot of directors will be concerned that this means disclosing more competitive information,” says Coleman. “They need to be more conscious of what they are disclosing and also be prepared for more questions from the marketplace. “

Directors of listed companies should also be thinking carefully about remuneration reporting.

“It’s important to get the balance right between explaining to the market what must be disclosed and explaining what shareholders really want to know, which is how much these executives are actually receiving,” says Coleman. (For more information on remuneration reporting, see p50).

Underlying profit

Martin Kriewaldt FAICD, a non-executive director and former president of the Australian Institute of Company Directors’ Queensland Division Council, believes the most difficult task for directors is ensuring the accounts comply with a series of rules with little logic, cohesion or consistency.

“In such an environment, where financial statements may not provide an accurate view of company performance, directors are naturally turning to underlying profits to explain to shareholders what really happened,” he says.

It’s true that, since the Australian Institute of Company Directors and the Financial Services Institute of Australasia (Finsia) released Underlying Profit: Principles for Reporting of Non-Statutory Information in April last year, many more directors are aware of the importance of disclosing underlying profits, particularly as fair-value accounting continues to throw up results directors consider misleading. However, Coleman again urges caution.

“You need to be sure you’re not over-emphasising the underlying profit and de-emphasising the statutory results,” he says.

“The Australian Securities and Investments Commission (ASIC) is particularly focused on the need for statutory results to be clear cut.”

While the Underlying Profit guidelines encourage greater consistency and transparency in reporting, the numbers are not audited.

“That means there’s still an opportunity for the unprincipled to ignore the guidelines and ‘cook the books’,” says Kriewaldt.

“These underlying results have been criticised in the media as a way of making things look better than they really are. Unfortunately, that may be true in some cases, and the honest get tarred with the same brush.”

Will it, won’t it?

Treasurer Wayne Swan has announced that the much-anticipated Henry tax review will be made public on 2 May, before the budget is delivered on 11 May. While directors might want to be aware of any changes, they are unlikely to take effect this year.

There is also some uncertainty around the Corporations Amendment (Corporate Reporting Reform) Bill. This should be passed before 24 June, the last day of Parliament’s winter sitting, and take immediate effect, but there’s a slim chance there won’t be time.

Generally viewed as a “good news” bill, it covers three major areas:

  • Dividend rules. As the law stands, a dividend may only be paid out of profits, which are not defined and can be difficult to predict. This process is to be replaced by a three-pronged test which includes a requirement that an entity’s assets exceeds it liabilities.
  • Parent entity accounts. A note containing information about the parent will replace full parent entity information in consolidated financial statements, reducing four columns to two throughout the accounts.
  • Companies limited by guarantee. Currently, all 11,000 have to prepare accounts and have an audit. While there will be no change for the approximately 32 per cent attracting over $1,000,000 in revenue, of the nearly 50 per cent with revenues below $250,000, and where those companies that don’t have deductible gift-recipient status, they will no longer have to do either. The remaining companies will still have to prepare and lodge accounts but can reduce costs by choosing a review rather than an audit.

Companies limited by guarantee are, for the large part, not-for-profit (NFP) organisations and Jim Service AO FAICD is concerned that the Australian Accounting Standards Board (AASB) has an active project looking to include performance measures in with the accounting standards.

“Many would wonder how social issues fall within their remit,” he says.

Thomas Girgensohn FAICD, a director of the Make-A-Wish Foundation and Moneyswitch, as well as chairman of Stemcor Australia, also believes it’s wrong to force NFPs to be vanguard organisations in terms of environmental matters.

“NFPs are quite different from commercial organisations in that there is no requirement to be transparent to shareholders at large,” he says. “The range of organisations is incredibly wide and it is extremely difficult to say what each one should report on. I think the market sorts this out – if an NFP wants to appeal to a particular group, it will have to report on what interests that group.”

Most small to medium-sized enterprises (SMEs) can also look forward to simpler reporting – although not simple enough, according to Keith Reilly, national head of professional standards at Grant Thornton.

“The International Financial Reporting Standards (IFRS) were designed by the International Accounting Standard Board (IASB) primarily for listed companies; the AASB simply endorses them,” explains Reilly. “Finally, the IASB has agreed that IFRS is far too complicated once you’re outside the listed market and has released a much more simplified accounting standard called IFRS for SMEs. However, the AASB is not convinced this is the right answer; instead, it plans to reduce the number of disclosures companies have to make under full IFRS. It also plans to make companies currently doing simplified accounting comply with full IFRS – sheer madness is the term I regularly use.”

“It really is quite extraordinary,” says Service. “After years of promoting international standards, the AASB is now considering a special SME standard for Australia and ignoring the proposed international one.”

Broad-based business reporting

Now that the GFC is behind us, shareholders are starting to pay more attention to broad-based business reporting of issues such as climate change.

“While climate change is political, there are already reporting requirements for the large companies,” says Reilly. “Either way, shareholders want to know how directors are handling this.”

While they’re generally known as “non-financial”, these broad-based measurements are not without financial implications.

As the ICA points out in its supplementary paper, Broad BasedBusiness Reporting in Practice, carbon emissions are likely to have a financial effect under an emissions trading scheme, while high staff turnover will lead to increased recruitment and training costs as well as damage to customer relationships. The difficulty lies in establishing these values.

ICA has also identified a number of the perceived barriers to the transparent and balanced reporting of non-financial measures, such as problems with establishing a longer-term focus and identifying the right measures for a particular business, as well as the time and cost involved in collecting information. However, Erik Mather MAICD, managing director of Regnan Governance and Research, believes directors have no choice but to find ways of breaking through these barriers.

“Australian institutional investors are leading the world with their commitment to responsible investing via the UN Principles for Responsible Investment (UNPRI),” he says. “Along with their global peers, these investors are now walking the talk of UNPRI commitment. That means demanding broad-based business reporting and investing based on these broader understandings.”

Things to bear in mind

Continuing rigour: “Last year, the GFC meant there was a lot more rigour around accounts and that was a good lesson,” says Kerry Hicks. “There’s growing community expectation that directors should be on top of the accounts. Also, some of the ASIC cases we’ve seen in the past 12 months have made it clear this must continue.”

Careful thought: “Don’t leave anything till the last minute,” says Michael Coleman. “A lot more care and attention is needed to ensure reports are simple, effective and understandable.”

Talk to your auditors: Thomas Girgensohn recommends that directors spend more time with their auditors. “There’s often a sense that the quicker you get the auditors out the better, but I think they provide an important opportunity for directors to get an outsider’s perspective on the organisation.”

Legal obligation: “Too many boards still forget they have two legal obligations in relation to the accounts,” says Jim Service. “They must comply with accounting standards but they must also be true and fair. If the standards compromise truth or fairness, the directors must say so and explain why. If they fail to do that, they risk the very unpleasant and expensive experience of defending themselves in court.”

And, finally, just in case… “Take responsibility for your directors’ and officers’ (D&O) insurance policy,” says Martin Kriewaldt. “It affects you personally so check it personally – and remember that the level of cover needs to be very high given the costs that will be incurred if the worst happens, or if ASIC thinks the worst might have happened. The Australian In