Financial reporting surveillance programme. Review of financial reporting by issuers cycle 14 [2011] NZSecCom 7 (15 April 2011)

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EXECUTIVE SUMMARY ............................................................................................................ 1

INTRODUCTION .......................................................................................................................... 4

Scope and issuer selection ............................................................................................. 5

FINDINGS ...................................................................................................................................... 5

COMPARATIVE FINDINGS ....................................................................................................... 6

Comments specific to Cycle 14...................................................................................... 9

Financial instruments............................................................................................................. 9

Goodwill impairment testing................................................................................................. 12

Disclosure of fees paid to auditors ....................................................................................... 12

Separate fund financial statements ...................................................................................... 13

Alternative performance measures....................................................................................... 13

Property, plant and equipment ............................................................................................. 14

Market Matters ............................................................................................................ 15

Provision of non-audit services by external auditors .......................................................... 15

ANALYSIS OF NZ IFRS MATTERS RAISED 2007 – 2010..................................................... 16

Overall analysis ..................................................................................................................... 16

NZ IAS 1 Presentation of Financial Statements ................................................................. 17

NZ IFRS 7 Financial Instruments: Disclosures ................................................................. 18

NZ IAS 24 Related Party Disclosures .................................................................................. 18

CONCLUSION ............................................................................................................................. 19

LOOKING AHEAD ..................................................................................................................... 19

APPENDIX 1: FURTHER ANALYSIS OF NZ IFRS MATTERS RAISED 2007 - 2010 ......... 1

Financial institutions ........................................................................................................ 1

Other issuers..................................................................................................................... 3

APPENDIX 2: BACKGROUND TO THE SECURITIES COMMISSION’S FINANCIAL REPORTING SURVEILLANCE PROGRAMME..................................................................... 1

The Commission’s Financial Reporting Surveillance Programme ........................... 1

New Zealand Generally Accepted Accounting Practice ............................................. 2

Selecting issuers.............................................................................................................. 2

Identifying matters and taking action .......................................................................... 3

This report presents the findings of Cycle 14 of the New Zealand Securities Commission’s Financial Reporting Surveillance Programme (FRSP), which sampled 25 issuers’ financial reports dated between 31 March 2010 and 31 July 2010.

Findings highlight the need for issuers to keep up to date with developments in financial reporting. A number of matters raised with issuers in this cycle relate to recent amendments to financial reporting standards, particularly changes in financial instruments reporting.

Financial reporting is a dynamic process. The importance of particular disclosures changes, and standards continue to evolve. Issuers must stay on top of developments and tailor disclosures to ensure they disclose their business activities coherently and transparently.

This is the Securities Commission’s last FRSP report. We therefore comment on what the FRSP has achieved since its inception in 2005. We also include an analysis of our main findings since issuers began reporting under New Zealand Equivalents to International Financial Reporting Standards¹(NZ IFRS).

We wrote to 17 of the 25 sampled issuers on matters that included: (a) financial instruments –

(iii) non-disclosure of the liquidity risk information used by management; (b) goodwill impairment testing – testing performed using inappropriate business

(d) alternative performance measures – measures reported were not reconciled to financial statement measures;

(e) separate fund financial statements – failure to provide separate financial statements for segregated funds within a scheme; and

(i) uncertainty as to whether revaluations were regular enough to ensure assets were valued correctly;

(ii) changes to accounting policies to measure certain previously revalued assets at cost.

We are still discussing two matters with an issuer. Of those concluded, none have warranted enforcement action against an issuer or referrals to other regulators or disciplinary bodies.

¹NZ IFRS was available for voluntary adoption by issuers for financial reporting periods beginning on or after 1

January 2005. NZ IFRS became mandatory for issuers for financial reporting periods beginning on or after 1

The FRSP is designed to encourage high-quality financial reporting. This enhances the credibility of the financial information that issuers provide, thus strengthening investor confidence in the New Zealand securities market.

Since 2005, the FRSP has used persuasion and education to improve financial reporting quality. This was particularly important during the NZ IFRS adoption phase, when issuers had to deal with a completely new suite of financial reporting standards.

We believe the programme has achieved good results. It enabled the Commission to regularly interact with issuers and auditors. Correspondence with issuers and auditors, and public surveillance programme reports, allowed us to highlight areas in which reporting was deficient and could be improved.

The FRSP has given issuers valuable information, and we have had much positive feedback from issuers and auditors on the programme and matters raised. The Commission reached agreement on eighty-eight percent of matters raised with issuers²; recent follow-up reviews show that 79%³of issuers who agreed to make changes in subsequent reports did so.

In addition, matters raised with issuers in recent reviews have tended to relate to new requirements and amendments to standards rather than to basic financial reporting or existing requirements. This indicates that most issuers have taken account of matters raised with them and are keen to improve the quality of their reporting. Matters that warranted more serious action were removed from the FRSP and referred to appropriate bodies.

General compliance has improved, however there is still considerable scope for improving financial reporting. As well as being compliant, issuers need to keep refining financial reporting so that it is coherent, consistent, clear and concise in order to be transparent. We emphasise that:

“Transparency is not just a buzz word or a cliché. It is a fundamental and absolutely essential attribute of sound financial markets. Relevant, trustworthy and timely information is the oxygen of financial markets. Depriving markets of such information – or polluting the information – can have very adverse consequences.”⁴

²Either by issuers providing further information that explained the queried treatment and/or agreeing to provide further information in subsequent financial statements.

³The review of matters raised with issuers was limited to Cycles 8 to 10 as not all subsequent financial statements of the issuers in the later cycles are currently available. In determining the percentage of issuers who

did make subsequent changes to their financial statements we have excluded the matters raised that relate to issuers that are either in moratorium or receivership. These issuers represented 7% of all matters raised in

⁴Hertz, R.H. (2009) “History Doesn’t Repeat Itself, People Repeat History – Front-line Thoughts and

Although this is the last FRSP report from the Securities Commission, new standards continue to be issued and existing standards improved. As such the surveillance of issuers’ reporting will remain relevant for the New Zealand market that will be regulated under the Financial Markets Authority (FMA).

Under the Financial Markets Authority Act 2011, FMA is responsible for monitoring issuers’ compliance with the Financial Reporting Act 1993. The body will have wider responsibilities and greater enforcement powers than the Commission that will allow it to enhance its surveillance programmes.

1. This report sets out findings from Cycle 14 of the Commission’s FRSP. In Cycle 14 the Commission reviewed the annual reports of 25 issuers whose financial years ended between 31 March 2010 and 31 July 2010.

2. This report includes comments on what the FRSP has achieved since its inception in

3. Appendix 2 sets out the programme’s background, including how the Commission selects issuers for review and deals with any issues it identifies.

4. The report is intended to inform directors, chief financial officers and other financial statement preparers, auditors and financial analysts on financial reporting areas the Commission considers could and should be improved.

5. Although the FRSP focuses on encouraging financial reporting improvements, it can lead to enforcement action. Where that is warranted, the issuer is removed from the FRSP and the issue immediately becomes an enforcement matter.

6. We are still discussing with an issuer two matters raised in Cycle 14. However, no other matters warranted Commission enforcement or referral to another body.

⁵NZ IFRS was available for voluntary adoption by issuers for financial reporting periods beginning on or after

1 January 2005. NZ IFRS became mandatory for issuers for financial reporting periods beginning on or after

(i) inadequate disclosure of assumptions used in valuing investments and derivatives;

(iii) non-disclosure of the liquidity risk information used by management; (h) goodwill impairment testing – testing performed using inappropriate business

(j) alternative performance measures – measures reported were not reconciled to financial statement measures;

(k) separate fund financial statements – failure to provide separate financial statements for segregated funds within a scheme; and

(i) uncertainty as to whether revaluations were regular enough to ensure assets were valued correctly;

(ii) changes to accounting policies to measure certain previously revalued assets at cost.

(2) Point taken/change agreed: the issuer acknowledged the point and/or agreed to make changes in subsequent financial statements.

(3) Second letter sent: reiterating the points made and closing the matter. (4) Other follow-up action: e.g. a written request for answers to further

11. Table 2 compares Cycle 14 results with those of previous cycles. Under NZ IFRS, the Commission has written to more issuers and raised, on average, more issues per issuer than under previous New Zealand Generally Accepted Accounting Practice (NZ GAAP)⁷. Of the many factors contributing to this, the most significant is the more complicated and detailed nature of NZ IFRS requirements compared to previous NZ GAAP.

12. Notwithstanding that “matters per issuer written to” remained steady over the NZ IFRS period, matters raised with issuers in recent cycles relate mainly to new requirements and amendments to standards rather than to basic financial reporting or existing requirements. This, coupled with the high percentage of matters raised in each cycle where we reached agreement, indicates that issuers have taken into account matters raised with them and are keen to improve the quality of their financial reporting.

⁶Matters raised exclude instances where the Commission wrote directly to audit firms and/or directors of issuers.

⁷Previous NZ GAAP is the financial reporting regime that existed in NZ prior to the implementation of

NZ IFRS. NZ IFRS was available for voluntary adoption by issuers for financial reporting periods beginning on or after 1 January 2005. NZ IFRS became mandatory for issuers for financial reporting periods beginning on or after 1 January 2007.

Cycle #	Financial periods included in sample	NZ GAAP	Number of issuers reviewed	Number of issuers we wrote to	Issuers written to %	Matters raised	Matters per issuer written to
1	31 March 2004 – 31 July 2004	Previous NZ GAAP	40	15	38%	22	1.5
2	31 December 2004 – 31 March 2005	Previous NZ GAAP	46	19	41%	24	1.3
3	31 March 2005 – 30 September 2005	Previous NZ GAAP	45	19	42%	27	1.4
4	30 June 2005 – 31 March 2006	Previous NZ GAAP	40	17	43%	27	1.6
5	31 March 2006 – 30 September 2006	Previous NZ GAAP	40	16	40%	29	1.8
6	30 June 2006 – 30 April 2007	Previous NZ GAAP	30	20	67%	37	1.9
7	31 December 2006 – 30 September 2007	Previous NZ GAAP/ NZ IFRS	44	17	39%	29	1.7
8	30 September 2007 – 30 June 2008	NZ IFRS	40	35	88%	96	2.7
9	30 June 2008 – 31 December 2008	NZ IFRS	24	17	71%	31	1.8
10	31 January 2009 – 31 March 2009	NZ IFRS	20	17	85%	48	2.4
11	31 March 2009 – 30 June 2009	NZ IFRS	24	20	83%	34	1.7
12	30 June 2009 – 31 January 2010	NZ IFRS	21	17	81%	39	2.3
13	31 March 2010	NZ IFRS	20	16	80%	31	1.9
14	31 March 2010 – 31 July 2010	NZ IFRS	25	17	68%	32	1.9

Notes	Outcome	Matters raised ⁸	%
(1)	Resolved	152
(2)	Point taken/change agreed	294
	*Agreement reached*	*446*	88%
(3)	Second letter sent	31
(4)	Other follow-up action	29
		60	12%
	Total matters raised	506	100%

(2) Point taken/change agreed: the issuer acknowledged the point and/or agreed to make changes in subsequent financial statements.

(4) Other follow-up action: e.g. a written request for answers to further questions, or referral to another body, such as the National Enforcement Unit of the Companies Office, to consider enforcement action.

13. The above table is based on statistics in our public reports. As at the date of this report only two of 29 matters raised included in other follow-up action remain outstanding.

14. The Commission reviews subsequent financial reports of issuers who agree to make changes in their next set of statements. Our most recent follow-up reviews for reporting under NZ IFRS indicate that 79% of matters raised are reflected in issuers’ later statements.⁹

15. The Commission will write to issuers who have not made the agreed change where the matter is material to their financial statements.

⁸Matters raised exclude market matters, and have been updated for the resolution of matters that were outstanding at the time previous public reports were published.

⁹The most recent review has covered issuers written to in Cycles 8 to 10 of the FRSP. The review of matters raised with issuers was limited to Cycles 8 to 10 as not all subsequent financial statements of the issuers in the later cycles are currently

available. In determining the percentage of issuers who did make subsequent changes to their financial statements we have excluded the matters raised that relate to issuers that are either in moratorium or receivership. These issuers represented 7%

16. Figure 1 shows matters most frequently raised with issuers. A number of matters raised in Cycle 14 relate to recent NZ IFRS amendments, particularly those relating to financial instruments. However, we also raised matters relating to established requirements that issuers should have been well aware of. Subsequent paragraphs detail matters the Commission wants to highlight.

17. Financial instruments include financial assets and financial liabilities. Financial assets include cash, shares in other entities, trade receivables and derivatives that are “in the money”. Financial liabilities include trade payables, bonds and debentures issued, bank loans received and derivatives that are “out of the money”. NZ IFRS 7 Financial Instruments: Disclosures and NZ IAS 32 Financial Instruments: Presentation sets out disclosure and presentation requirements for financial instruments.

(a) the extent and complexity of an entity’s involvement in financial instruments and how these have been valued;

(a) fair-value disclosures: information on how issuers determined the fair value of their investments and derivatives; and

(b) liquidity risk disclosures: quantitative information on exposures to liquidity risk reviewed by key management personnel.

20. In response to the global financial crisis, the International Accounting Standards Board (IASB) amended IFRS 7.¹⁰This included a requirement that entities classify and disclose according to a fair-value hierarchy any financial instruments measured at fair value.

21. The hierarchy informs users about the relative reliability of inputs to fair-value measurements. It has the following levels:

(a) level 1: fair values are based on quoted prices (unadjusted) for identical assets or liabilities in an active market;

(b) level 2: fair values are based on inputs other than level 1 quoted prices that are observable for the asset or liability, either directly (ie as prices) or indirectly (ie derived from prices); and

(c) level 3: fair values are based on inputs for the asset or liability that are not based on observable market data (unobservable inputs).

22. We wrote to two issuers where it was unclear whether their investments in unitised funds were correctly classified as level 1. We remind issuers that hierarchical classification is determined by the inputs to fair-value measurement of the security held, rather than by those of any underlying investments. For example, units held in a fund that only invests in level 1 financial assets may be a level 2 financial asset if there are insufficient transactions to constitute an active market for those units. Conversely, a unit in a fund that invests in level 2 or level 3 financial assets could constitute a level 1 financial asset were those units to be traded at arm’s length in an active market.

... the methods and, when a valuation technique is used, the assumptions applied in determining fair values of each class of financial assets or financial liabilities. For example, if applicable, an entity discloses information about the assumptions relating to prepayment rates, rates of estimated credit losses, and interest rates or discount rates.

24. The fair value of level 2 and level 3 assets or liabilities are determined using a valuation technique. Therefore, entities holding material balances of such financial assets or financial liabilities must disclose the actual underlying inputs and assumptions used in the valuation techniques.

¹⁰See Improving Disclosures about Financial Instruments (Amendments to IFRS 7).

25. We continue to see many issuers with significant involvement in level 2¹¹derivatives failing to disclose the actual assumptions applied in their valuation techniques. Instead, they disclose only general information, such as “market rates were applied”. Where applicable, actual information, such as details of forward price curves and discount rates, must be disclosed.

26. Some entities may need to consider whether aggregation of such information or disclosure of ranges of assumptions is appropriate.

27. We also wrote to one issuer with material level 3 financial assets and liabilities. The issuer disclosed information on the valuation technique used but not details of actual underlying assumptions. The issuer agreed to make further disclosures of key variables used, including information on actual discount rates, credit spreads and liquidity premiums, in its next set of financial statements.

28. Issuers often engage third parties to help value their level 2 and level 3 financial instruments. Here, issuers need to ensure they have enough information on techniques used and assumptions applied to meet their financial reporting requirements.

29. As a result of the global financial crisis, the IASB also changed the IFRS 7 application guidance. This included re-iterating that entities must disclose summary quantitative data about their exposure to liquidity risk that is based on information given internally to key management personnel.¹²This requirement was part of the original NZ IFRS 7. Entities must explain how summary quantitative data is determined.¹³

30. Usually, we raise non-disclosure of such liquidity risk data with financial institutions.

This issue is discussed in more detail in Cycle 8 and 9 reports. In Cycle 14 we wrote to three issuers about it.¹⁴Typically, such issuers disclose their procedures for monitoring liquidity risk but fail to disclose the relevant quantitative information. Yet investors need this quantitative information for a complete picture of how the issuer is managing the liquidity risk associated with its financial instruments.

31. The Commission wrote to an issuer that had recognised one of its equity investments at cost and well over its quoted price. We emphasise that:

(a) Under NZ IAS 39 Financial Instruments: Measurement and Recognition, equity investments can only be measured at cost when they do not have a quoted price in an active market and their fair value cannot be reliably determined. This exception is for rare circumstances, and will not be available

¹¹For example, interest rate derivatives, short-term electricity price hedges, forward foreign exchange derivatives.

under NZ IFRS 9 Financial Instruments.¹⁵Equity investments quoted on an exchange and regularly traded at arm’s length within a narrow price range cannot be measured at cost.

(b) The best indication of fair value is a quoted price in an active market. A financial instrument is regarded as quoted in an active market if quoted prices are readily and regularly available from an exchange, dealer, broker, industry group, pricing service or regulatory agency, and if those prices represent actual and regularly occurring market transactions conducted at arm’s length.¹⁶

(c) The fair value of a portfolio of financial instruments is the product of the number of units of the instrument and its quoted market price. If an entity holds a large block of a particular instrument and the only available market exit prices come from transactions involving small blocks, then no adjustment should be made for the expected effect of selling the large block in a single transaction.¹⁷

32. In Cycle 14 we wrote to three issuers on four matters raised in relation to goodwill impairment testing and/or disclosures. We remind issuers that, for the purposes of impairment testing, goodwill cannot be allocated to a cash-generating-unit that is larger than an operating segment as defined by NZ IFRS 8 Operating Segments before aggregation.¹⁹Therefore, where issuers have changed their operating segments as a result of adopting NZ IFRS 8, they will need to consider the impact on their impairment testing.

33. We wrote to three issuers about disclosure of the value and nature of non-audit services from their auditors, as required by NZ IAS 1 Presentation of Financial Statements.²⁰

34. Issuers should check, as part of their review procedures, that the types of services and fees disclosed in their financial statements are consistent with the services disclosed in the audit report. If an audit firm provides services at no cost to the issuer, we recommend that financial statements disclose this.

35. Issuers should disclose where a third party incurs and re-charges services from the issuer’s auditor on the issuer’s behalf, and what those services cost.

¹⁵NZ IFRS 9 is the replacement standard for the NZ IAS 39 and has an effective date of 1 January 2013 and requires all equity investments, within its scope, to be measured at fair value.

¹⁸See article in the December 2009 issue of the New Zealand Institute of Chartered Accountants’ Journal by

36. Separate financial reporting of funds within a scheme allows investors to evaluate the performance and risks associated with their investments. This is particularly important when the assets in one fund are unavailable to meet the liabilities of other funds within the scheme.

37. Section 9A(1) and 9A(2) of the Financial Reporting Act 1993 (FRA) requires schemes, including unit trusts, superannuation schemes and other managed funds (schemes), to prepare and register:

(a) the scheme’s financial statements if the liabilities of the issuer/trustee and the scheme are not limited to a particular group of assets (‘separate fund’); or

(b) both the scheme and the fund’s financial statements if the liabilities of the issuer/trustee or the scheme are limited to a separate fund.

(a) one issuer had failed to provide separate financial statements for each of its separate funds, despite the funds’ assets being unavailable to meet the liabilities of any of the other funds. The issuer agreed to update its next financial statements; and

(b) one issuer failed to make it clear in its financial statements or its prospectus whether the assets in its individual fund were available to meet the liabilities of any other funds within the scheme. This information is likely to be material to investors and should be clearly disclosed.

39. A number of listed issuers disclosed alternative performance measures in the commentary accompanying the financial statements. Such measures varied significantly and had labels such as “underlying earnings after tax” and “net earnings after tax before unusual items.”

40. We recognise that such measures can be helpful to users but issuers must ensure they are not misleading. Measures should:

(b) be understandable and clearly reconciled with measures in the financial statements;

282AD+ASICs+review+of+30+June+2010+financial+reports+and+focuses+for+31+December+2010?openDoc ument#1 for further guidance. ASIC has also recently issued Consultation Paper 150 Disclosing Financial information other than in accordance with accounting standards which issuers may also find of use. This is available online at: http://www.asic.gov.au/asic/pdflib.nsf/LookupByFileName/cp150.pdf/$file/cp150.pdf

41. In Cycle 14, alternative performance measures typically reflected adjustments for the removal of tax depreciation on certain buildings and related deferred tax effects, impairments of assets, restructuring costs, and fair-value movements in derivatives.

42. In most cases, the issuer gave clear reasons for their adjustments and provided reconciliations of the alternative measures to relevant financial statement information. However, two issuers did not provide such reconciliations; we raised the matter with them and they agreed to do so in future.

43. Under NZ IAS 16 Property, Plant and Equipment, entities may choose to revalue particular classes of assets to fair value. However, all relevant assets in that class must be revalued with ‘sufficient regularity to ensure that the carrying amount does not differ materially from what would be fair value at the end of the reporting period.’²²

44. We wrote to one issuer about these requirements. It was the first time the issuer had revalued that particular class of property, plant and equipment in three years, and it had resulted in increases in the asset class, total assets and equity of about 15 to 20%.

45. Issuers should annually review the carrying amount of revalued assets, and, when there is evidence that the fair value may be materially different, obtain a new valuation. During volatile economic conditions, the value of assets may change significantly. Determining key assumptions and performing sensitivity analysis for reasonably possible changes in them helps issuers determine the appropriate frequency of revaluations.

46. We wrote to one issuer that had changed its accounting policy from recognising property, plant and equipment at fair value to historical cost.

47. NZ IFRS only permits a voluntary change in an accounting policy if it results in financial statements providing both more reliable and more relevant information on the effects on the entity’s financial position, financial performance or cash flows²³of transactions, other events or conditions. Given that fair value better represents an asset’s ability to generate future cash flows, we suggest issuers ensure any change in accounting policy from measuring assets at fair value to cost meet both criteria.

48. The Commission wrote to three audit firms about their provision of internal audit services, assistance with financial statement compilation and/or financial reporting advice to issuers we reviewed in Cycle 14.

49. Professional standards consider such services to be a threat to the perceived and actual auditor independence.²⁴In these three cases, the auditors confirmed the existence of safeguards that ensured their independence was uncompromised.

²⁴For example see the New Zealand Institute of Chartered Accountants’ Code of Ethics: Independence in

50. This section analyses NZ IFRS matters raised from Cycles 8 to 14 of the FRSP. It gives an overview of the kinds of matters most commonly raised with issuers under NZ IFRS. It also indicates pitfalls for issuers to avoid when preparing financial statements.

51. Cycles 8 to 14 covered 174 reviews of issuers’ financial reports with balance dates between 30 September 2007 and 31 July 2010. Two hundred and fifty-five matters were raised with 126 issuers, of which 27 are financial institutions. The analysis excludes matters raised in relation to market matters, such as disclosure of directors’ share dealings and substantial security holder disclosures.

52. As a result of our increased focus on reviewing financial institutions’ financial reports we have analysed matters raised with financial institutions²⁵separately from those raised with other entities. This analysis appears in Appendix 1. We recommend issuers review their financial statements against this information as a further check on their transparency.

²⁵We have used the definition of financial institutions included in NZ IFRS 7 Appendix E for this purpose.

54. Below, we comment briefly on each of these. We note that the proportion of matters raised in relation to basic presentation of financial statements and related party disclosures has decreased, whereas the proportion of matters raised under financial instruments has gone up. This suggests that, after the initial adoption process, issuers took into account many of the basic financial reporting issues that NZ IAS 1 and NZ IAS 24 require that were highlighted to them. Matters raised under NZ IFRS 7 have increased over the period mainly because it is a relatively new standard and it has frequently been amended.

55. NZ IAS 1 is a foundation standard under NZ IFRS. It sets out overall requirements for presenting financial statements, guidelines for their structure and minimum requirements for their content. NZ IAS 1 matters are, at 29%, the most common type of matters raised with issuers. However, on a cycle-by-cycle basis, these matters have decreased substantially.

56. Our reviews of financial statements up until March 2009 identified three common issues covered by IAS 1: ²⁶

(a) failure to provide an unreserved statement of compliance with IFRS; (b) material levels of unexplained expenses or ‘other expenses’; and

57. Issuers have significant scope to determine what they disclose about management’s judgements in applying accounting policies and sources of estimation uncertainty. Issuers could still be more transparent about this. The Commission expects these disclosures to include a description of key judgements and estimates, and a cross- reference to relevant financial statement notes.

58. Issuers’ failure to disclose details of non-audit services provided by their auditors either by value or nature is an ongoing concern. We are usually alerted to such omissions through a cross-check of information in the audit report against that in the financial statements. Previous financial reporting standards did not require disclosure of a description of non-audit services, and that might be why many issuers seemed to omit the information.

59. Financial instrument disclosures are the second most common type (17%) of all

matters raised with issuers. This, when coupled with matters raised under NZ IAS 39

Financial Instruments: Recognition and Measurement, represents 22% of all matters raised, and reflects the changing nature of financial instrument standards.

60. Matters raised in respect of issuers’ accounting for, and disclosures relating to, financial instruments represent nearly half (49%) of all matters raised with financial institutions. However, these are only 12% of matters raised with other issuers.

61. Inadequate liquidity risk disclosures were a significant issue in our reviews of the

2008–2009 financial statements of finance companies and other financial institutions. We found several issuers were only disclosing contractual maturity information on their financial assets and liabilities, when they managed liquidity risk on a different basis. While we have seen some improvement in this area, there are still ongoing liquidity risk disclosure issues, as discussed in our Cycle 14 findings.

62. Another issue pertaining to many finance companies was the non-disclosure of concentrations of credit risk by security type, especially for providers of second mortgages or other subordinated lending. Users need such disclosures in order to gauge the potential losses issuers could incur should their borrowers’ financial situation deteriorate. This is also an area where disclosure has improved.

63. More recent matters raised have concerned how fair values of financial instruments have been determined and disclosure of the assumptions used in the valuation of these instruments.

64. Related party disclosures were the third most common type of matters raised with issuers (16%).

65. However, like matters raised in relation to NZ IAS 1, related party disclosure matters raised have decreased over the period. This is primarily due to a fall in the number of matters raised in relation to key management personnel compensation disclosures. The main issue with these disclosures was the omission of share-based payments and directors’ fees: these are now better disclosed.

66. Other matters raised typically relate to non-disclosure of the value, terms and conditions of transactions with related parties, and outstanding balances. Issuers should not assert that all transactions with related parties are conducted at arm’s length basis when this is not so. Even when this is the case, disclosure of the value of such transactions is still required.

67. The Commission’s review of selected issuers in Cycle 14 highlighted various aspects where issuers need to improve when preparing financial statements. These included matters that arise from recent amendments to financial reporting standards, particularly financial instruments standards.

68. This report also analysed NZ IFRS matters raised from the FRSP’s Cycles 8 to 14. It gives an overview of the types of matters most commonly raised with issuers under NZ IFRS. It also indicates pitfalls issuers should avoid when preparing their financial statements.

69. Overall, fewer basic matters are being raised with issuers: in relation to statements of compliance with IFRS (NZ IAS 1 requirement), and key management personnel compensation disclosures (NZ IAS 24 requirement).

70. NZ IFRS has been mandatory since 2007 and issuers should be familiar with its requirements. We consider issuers are well-placed to tailor their financial statements to add value for users. Financial reporting is a dynamic process. The importance of particular disclosures can change over time. It is imperative that issuers keep up to date with financial reporting standard developments and ensure their business activities are disclosed in a coherent and transparent manner.

71. This is the Securities Commission’s last FRSP report. FMA is, however, responsible, under the Financial Markets Authority Act 2011, for monitoring issuers’ compliance with the Financial Reporting Act 1993. FMA will have wider responsibilities than the Securities Commission and be able to use its greater enforcement powers to enhance surveillance programmes.

²⁷NZ IFRS 7 paragraphs 34(a) and (c), E20, 27; NZ IAS 1 paragraphs NZ105.1, 122, 125, 97, 16; NZ IAS 39 paragraphs 63 – 65 and AG87 - AG91; NZ IAS 24 paragraphs 17-19.

73. The matters commonly raised with issuers other than financial institutions included:

o the specific fair-value assumptions applied when measuring financial instruments using valuation techniques;

o borrowing facilities and other funding arrangements, including collateral pledged and details of any covenant breaches during the period;

²⁸NZ IAS 1 paragraphs NZ105.1, 122, 125, 97, 16; NZ IAS 24 paragraphs 17-19.NZ IFRS 7 paragraphs 14, 18,

27, 27A, 36; NZ IAS 36 paragraphs 80(b), 134; NZ IAS 16 paragraphs 77(c), 74(a); NZ IAS 40 paragraphs

75(d) and (g); NZ IAS 8 paragraphs 28 and 49; NZ IFRS 8 paragraphs 11-19, NZ IAS 7 paragraphs 14 – 17; NZ IAS 38 paragraphs 51-67.

• whether cash-generating-units for goodwill impairment testing are appropriate eg no larger than operating segments;

• non-disclosure and appropriateness of assumptions underlying the valuation of each cash-generating unit for impairment testing of intangible assets and goodwill.

• non-disclosure of assumptions for the revaluation of property, plant and equipment;

• non-disclosure of the existence and amounts of restrictions on title, and property, plant and equipment pledged as security for liabilities;

• the appropriateness of classifying land or buildings as property, plant and equipment rather than investment property.

• non-disclosure of specific assumptions for the revaluation of investment properties;

• non-disclosure of the existence and amounts of restrictions on the realisability of investment properties.

APPENDIX 2: BACKGROUND TO THE SECURITIES COMMISSION’S FINANCIAL REPORTING SURVEILLANCE PROGRAMME

1. The Securities Commission is the main regulator of the New Zealand securities market. Our purpose is to strengthen investor confidence and foster capital investment in New Zealand by promoting the efficiency, integrity and cost-effective regulation of our securities markets.

2. The Commission regards quality financial reporting by issuers²⁹to be fundamental to the fairness, efficiency and transparency of New Zealand’s securities markets.

3. Section 10(c) of the Securities Act 1978 requires the Securities Commission “to keep under review practices relating to securities, and to comment thereon to any appropriate body”.

4. As part of carrying out this function the Commission established the ongoing FRSP in

5. The aim of the FRSP is to encourage New Zealand issuers to improve the quality of their financial reporting so that:

(b) investors can have confidence in the credibility of financial information issuers provide; and

6. The FRSP involves reviewing selected issuers’ financial statements. At the end of each cycle the Commission publicly reports on this surveillance work by providing market participants with a summary of its findings. Copies of reports for all cycles are available on the Commission’s website www.seccom.govt.nz

(a) In relation to an equity security or debt security, or to an advertisement, investment statement, prospectus, or registered prospectus that relates to an equity security or a debt security, or to a trust deed that relates to a debt security, the person on whose behalf any money paid in consideration of the allotment of the security is received:

(b) In relation to a participatory security, or to an advertisement, investment statement, prospectus, or registered prospectus, or to a deed of participation that relates to a participatory security, the manager:

advertisement that relates to such an interest, the contributory mortgage broker:

(d) In relation to a unit in a unit trust, or to an advertisement, investment statement, prospectus or registered prospectus that relates to such a unit, the manager:

(e) In relation to a life insurance policy, or to an advertisement, investment statement, prospectus, or registered

prospectus that relates to a life insurance policy, the life insurance company that is liable under the policy:

(f) In relation to an interest in a superannuation scheme, or to an advertisement, investment statement, prospectus, or registered prospectus that relates to such an interest, the superannuation trustee of the scheme.

7. The Financial Reporting Act 1993 requires issuers to prepare financial statements that comply with New Zealand Generally Accepted Accounting Practice (NZ GAAP) and provide a true and fair view of the matters to which they relate.³⁰

8. The Commission reviews issuers’ financial statements against NZ GAAP. For the purpose of the Financial Reporting Act, financial statements and group financial statements comply with NZ GAAP only if those statements comply with:

(b) in relation to matters for which no provision is made in applicable financial reporting standards and that are not subject to any applicable rule of law, accounting policies that:

9. The Financial Reporting Act defines “applicable financial reporting standard” to mean an approved financial reporting standard that applies to a reporting entity (or group) and to an accounting period (or interim accounting period) in accordance with a determination of the Accounting Standards Review Board (ASRB) for the time being in force or any election made under section 27 of the Financial Reporting Act. All issuers are required to apply NZ IFRS in the preparation of their financial statements for annual accounting periods commencing on or after 1 January 2007.

(a) the level of issuer compliance with NZ GAAP in financial statements prepared under the Financial Reporting Act;

(b) whether any breach of NZ GAAP identified in those financial statements is likely to cause the financial statements to not show a true and fair view, or be materially misleading to users in the context of information disclosed for investment decision-making under the Securities Act, and therefore require enforcement action; and

11. The FRSP aims to review all issuers listed on NZX Limited (NZX) at least once every three to four years.

³⁰Part II of the Financial Reporting Act 1993 (section 11) requires every ‘reporting entity’ to prepare financial statements that comply with generally accepted accounting practice and to provide any additional information required to ensure those statements are a true and fair view of the matters to which they relate.

Part I, Section 2 of the Financial Reporting Act 1993 defines a reporting entity as : (a) An issuer; or

12. Dual- and overseas-listed issuers may also be selected. Overseas-listed issuers are issuers domiciled or incorporated outside New Zealand that have a recognised stock exchange as their home exchange and are also listed on NZX.

13. Dual-listed issuers are those incorporated in Australia, and on the Australian Stock

14. When the Commission selects dual- and overseas-listed issuers, it first writes to the regulator in the overseas jurisdiction to determine whether a review of the financial reporting of the issuer has already been undertaken locally. If it has, the Commission does not review them. If the issuer has not been reviewed by the overseas regulator, the Commission reviews the annual report, NZX announcements and, if applicable, the current prospectus. Where appropriate, findings are communicated to the overseas regulator. If the Commission communicates what it considers to be a significant matter about an issuer to the appropriate overseas regulator and the regulator proposes to take no action, the Commission will write directly to the overseas- or dual-listed issuer on the matter.

15. Issuers trading on the Unlisted³¹exchange and issuers not listed on any exchange may be also included in cycle reviews.

16. Issuers may be selected on the basis of criteria determined by the Commission: on areas of particular risk affecting the issuer; the sector the issuer is in at the time of selection; and/or their balance dates. Issuers can also be reselected for a later review when the nature of issues identified in an earlier cycle raised concerns.

17. The Commission looks at an issuer’s annual report when reviewing its financial statements and, in the case of listed issuers, this includes reviewing any NZX announcements for the period and any relevant prospectuses. While NZX announcements are not comprehensively reviewed, any market matters relating to continuous disclosure, disclosure of relevant interests by directors and officers, and substantial security holder disclosure are followed up where necessary.

18. Matters identified in the review are referred to as matters raised³²or other matters.

19. Matters raised are those that are important or where further clarification or information is needed. The Commission is likely, for example, to write to an issuer where a matter:

³¹Unlisted is an unregistered securities trading facility; it is not a registered stock exchange or authorised securities exchange under the Securities Markets Act 1988. Unlisted provides a facility for trading previously allotted securities.

³²Prior to Cycle 6, the Commission referred to matters raised as significant matters.

20. Financial reporting requires the exercise of professional judgement. The Commission takes this into account when reviewing financial statements and determining which matters to follow up.

21. The Commission writes to an issuer requesting additional information and in some cases asks the issuer to revise or enhance disclosures in future financial statements.

22. When writing to an issuer about matters raised, the Commission may include other matters found in the review in relation to that issuer. Other matters are miscellaneous matters the Commission considers could be better disclosed.

23. The Commission’s policy is to avoid writing to an issuer whose financial statements raise only other matters, unless these are so numerous that it is useful to give the issuer feedback. In this respect, the Commission is mindful of the educative function of the FRSP.

24. In each case where the Commission writes to an issuer, a copy of the letter is also sent to the issuer’s auditor. This practice acknowledges the role of auditors in helping maintain and improve financial reporting standards. It also alerts an auditor to the particular aspects of its client’s financial statements that concern the Commission.

25. Auditors play an important role in encouraging companies to comply, not only with statutory requirements, but also with best practice. The Commission encourages auditors to be vigilant when auditing of financial statements. High-quality external auditing is critical to the integrity of financial reporting and to the efficiency and integrity of the securities markets.

26. Where a matter may have significant market impact, it is removed from the FRSP and considered as a separate enforcement matter.

27. We refer to appropriate bodies matters identified in the FRSP that are considered a likely breach of:

Notes	Outcome	Matters raised ⁶	%
(1)	Resolved	9
(2)	Point taken/change agreed	19
	*Agreement reached*	28	88%
(3)	Second letter sent	2
(4)	Other follow-up action	2
		4	12%
	Total matters raised	32	100%