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Accounting alert 2009/11 - Financial reporting reform

Early Christmas present or missed opportunity?

On Friday 4 December 2009, the Federal Treasury and Australian Accounting Standards Board (AASB) published their respective proposals for substantial reform in financial reporting. The proposals promise a significant change in how and what many entities report – such as the elimination of the reporting entity concept and the removal of parent entity financial statements. The majority of the changes will be welcomed, but the question remains as to whether more could have been achieved.

In this Accounting alert, we explore:

Update July 2010
The changes to the Corporations Act 2001 and associated regulations have been finalised and so are in force. The Corporations Act 2001 amendments were passed by the House of Representatives on 21 June 2010 and the Senate on 24 June 2010, and received Royal Assent on 28 June 2010. Many of the requirements apply from either 28 June 2010 or 30 June 2010.
In addition, The AASB has released AASB 1053 Application of Tiers of Australian Accounting Standards and AASB 2010-2 Amendments to Australian Accounting Standards arising from Reduced Disclosure Requirements to implement its revised differential reporting regime. These Standards were made by the AASB out of session on 30 June 2010 and mandatorily apply to annual financial reporting periods beginning on or after 1 July 2013. Early adoption is permitted to annual reporting periods beginning on or after 1 July 2009 (and so can generally be applied in financial statements at 30 June 2010).
In both cases, the original proposals have been amended in finalising the requirements. More information is available in Accounting alert 2010/08.

An overview of the proposals

High-level summary

The proposals from Treasury and the AASB are best understood when read together. The table below provides a high-level overview of the proposals:

Area Key changes Impact
Reporting framework
  • Removal of reporting entity concept
  • All lodged financial statements considered ‘general purpose’
  • New ‘reduced disclosure regime’ for entities without public accountability (‘publicly accountable’ entities include listed entities, disclosing entities, financial institutions and similar entities)
  • Modified application to not-for-profit and public sector entities
  • Special purpose financial statements no longer permitted where prepared in accordance with Accounting Standards
  • Some reduction in disclosure for reporting entities that do not have ‘public accountability’
Parent entity financial statements
  • Removal of Corporations Act requirement to prepare parent entity financial statements where consolidated financial statements are required
  • Summarised financial information presented in the notes
  • Reduction in the ‘clutter’ in financial statements (two or three columns rather than four or six)
  • Alignment with global best practice
Dividends
  • Introduction of a ‘solvency’ test in lieu of the existing ‘profits’ test for the payment of dividends
  • Dividends permitted to be paid where (a) an entity’s assets exceed liabilities by an amount sufficient to pay the dividend (b) the payment is fair and reasonable and (c) no material prejudice to the ability to pay creditors
  • Greater flexibility in payment of dividends, particularly where ‘non cash’ impairment and similar expenses recognised
  • New approach introduces new subjective ‘fair and reasonable’ and ‘no material prejudice’ tests
Companies limited by guarantee
  • Introduction of three-tiered reporting structure depending on revenue and deductible gift recipient status
  • Review rather than full audit permitted in some cases
  • New requirements for directors reports
  • Prohibition on payment of dividends
  • Many smaller entities will no longer be required to lodge financial statements, or will be able to have financial statements reviewed rather than audited
  • More focussed reporting requirements in financial statements and directors report
  • Elimination of ability to pay dividends will reduce the attractiveness of this structure for commercial activities
Financial years
  • Entities will more easily be able to change their financial year
  • Consequential change of tax year not automatically proposed
  • More flexibility in changing year ends to match the company’s operating cycle or other factors
  • Existing requirements on changes in control will be retained
Other changes
  • Directors’ declaration to include a statement of compliance with IFRS
  • Expansion of listed public company requirements for directors reports to all listed entities
  • Protection of legal professional privilege relating to solicitors representation letters
  • Technical amendments to cancellation of capital, Financial Reporting Council functions and the composition of the Companies Auditors and Liquidators Disciplinary Board
  • Most of these changes are not substantive, but will require changes to the financial reports of some entities
  • Unclear whether the statement of compliance with IFRS will be required by all entities or just those with public accountability
  • Other changes are logical
How long is the comment period?

Treasury has requested comments on the draft Corporations Amendment (Corporate Reporting Reform) Bill 2010 by 3 February 2010.

The AASB Consultation Paper is a ‘first step’ in determining the proposed differential reporting framework for Australia. As such, it contains an analysis of possible approaches and recommends the ‘reduced disclosure regime’ as the preferred approach. The AASB intends to issue, in stages during the consultation process, a companion exposure draft providing more detail of the proposals. Therefore, at this time, there is no set comment period for the AASB’s proposals.

Note: On Friday 26 February 2010, the AASB released a finalised Exposure Draft, ED 192 'Revised Differential Reporting Framework', and formally released its Consultation Paper 'Differential Financial Reporting – Reducing Disclosure Requirements'.  More information on the final proposals can be found in Accounting alert 2010/02 and our Comment letter on ED 192.

When are the new requirements expected to apply?

The stated intention is that the new requirements will be finalised by June 2010.

It is proposed that the majority of the amendments to the Corporations Act 2001 will apply on enactment (such as the dividend test) or from 30 June 2010. The key exception is the expansion of the additional directors report requirements in s.299A to listed registered schemes and disclosing entities, which is intended to apply from 30 June 2011, presumably to permit these entities sufficient time to prepare for the expanded requirements.

Political considerations

The draft legislation confirms a fast-tracking of the red-tape reduction reforms by 30 June 2010. The reforms will impact a vast array of entities and careful planning for the June reporting seasons is needed.

In an uncertain political environment as a result of the Federal Government’s Carbon Pollution Reduction Scheme (CPRS) legislation, the passage of the proposed Corporations Act reforms cannot be taken for granted. The CPRS and other reforms may be given priority over the financial reporting reforms and the possibility of an early election cannot be completely discounted.

Accordingly, entities face a dilemma – do they plan to take advantage of the reforms or do they assume retention of the status quo? For example, simple changes such as the elimination of the parent entity columns from financial statements can require long lead times for publication time frames in bookings, formats and so on.

The proposed differential reporting regime, if implemented as proposed, is intended to be available for early adoption at June 2010 but otherwise the proposed commencement date is unknown until a further Exposure Draft is released by the AASB.

Given the increased disclosure burden for a number of entities, it is unlikely the new differential reporting regime will be mandatory before 2012, to allow affected entities to prepare for implementation. Notwithstanding this, early adoption will be attractive to a number of entities, particularly those reporting entities that are not ‘publicly accountable’.

The proposed differential reporting framework

Summary of AASB’s proposals

Note: On Friday 26 February 2010, the AASB released a finalised Exposure Draft, ED 192 'Revised Differential Reporting Framework', and formally released its Consultation Paper 'Differential Financial Reporting – Reducing Disclosure Requirements'.  More information on the final proposals can be found in Accounting alert 2010/02

The AASB’s Consultation Paper is a proposal for a ‘reduced disclosure regime’ that would be applied by:

  • Non-publicly accountable for-profit private sector entities
  • All not-for-profit private sector entities, unless the relevant regulator requires IFRS
  • Public sector entities other than the Federal, State and Territory Governments, local governments and universities, unless the relevant regulator requires IFRS. The AASB is also to considering which further public sector entities should be required to apply IFRSs.

The table below summarises the ‘two tiered’ reporting framework proposed:

Sector Tier 1
(full IFRS)
Tier 2
(reduced disclosure regime)
For-profit private entities Publicly accountable entities Non-publicly accountable entities
Not-for-profit private entities Only if entity elects, or is directed by a regulator, to apply IFRS All other entities
Public sector entities Federal, State and Territory Governments, Local Governments and Universities All other entities, unless directed to apply IFRS

Source: AASB Consultation Paper, Deloitte analysis.

Under the ‘reduced disclosure regime’, the recognition and measurement requirements of all Accounting Standards would be applied by all entities required to comply with Accounting Standards. The AASB considers this to be consistent with its ‘transaction neutral’ approach to accounting standard setting where the same transaction is accounted for in the same way across all sectors and entities.
Which entities are ‘publicly accountable’?

The AASB is proposing to adopt the IASB’s definition of ‘publicly accountable’ as is contained in the IFRS for SMEs.

Essentially, an entity is considered to have public accountability if its debt or equity instruments are publicly traded, or if it is a financial institution or other entity that, as part of its primary business, holds and manages financial resources entrusted to it by clients.

In addition, the AASB is proposing to provide ‘additional examples’ of entities considered to have ‘publicly accountability’ in the Australian context, specifically managed investment schemes.

Not-for-profit and public sector entities are effectively all considered to be ‘publicly accountable’. As a result, the AASB has decided not to apply this criterion in relation to these entities and developed alternative differentiators as noted above.

Which entities will be required to comply with ‘full IFRS’?

The proposals would see the following entities being required to apply IFRS in full:

  • All entities listed on the Australian Securities Exchange, National Stock Exchange and similar exchanges
  • All banks, credit unions, insurance companies, securities brokers/dealers, mutual funds, investment banks and managed investment schemes
  • All levels of government
  • Universities
  • Any entity required to apply full IFRS under its reporting mandate (legislation, ministerial directive, etc).
What will the ‘reduced disclosure regime’ look like?

The AASB has not yet finally determined the exact nature of the disclosures that would be required under the ‘reduced disclosure regime’. Instead, an Exposure Draft will be issued outlining the proposed disclosures.

The disclosures will be determined by reference to the general purpose nature of all financial statements and so may not offer as much relief as some may be expecting. The IFRS for SMEs will be followed as a guideline to the type and form of disclosures required and will form a benchmark as the minimum disclosure required in a general purpose financial report.

The AASB has included an Appendix to the Consultation Paper providing illustrative examples of the disclosure that might be required for a number of ‘example standards’. These examples are quite instructive. The table below provides a summary of the disclosures that might apply under the example standards. Not all disclosures required are included, but key disclosures included and excluded are highlighted to provide a guide to the level of disclosure likely to be required.

Standard Disclosures retained Disclosures removed
AASB 112 Income Taxes

Major components of tax expense or income

Amounts charged to equity or other comprehensive income

Reconciliation from accounting profit to tax expense

Unrecognised deferred tax assets

Reconciliation of deferred tax assets and liabilities

Taxes related to discontinued operations and business combinations

Evidence supporting recognition of deferred tax assets

Unrecognised deferred taxes in respect of investments in subsidiaries, branches, associates and joint ventures

Tax-related contingent liabilities and contingent assets

AASB 117 Leases

Reconciliation of future lease payments in time bands

General description of leasing arrangements

Contingent rentals (lessees only)

Subleases

AASB 124 Related Party Disclosures

Details of related parties

Compensation of key management personnel

Details of related party transactions by category of related party

General disclosures in relation to government-related entities where the recently introduced exemption is applied

 

The above examples illustrate the amount of disclosure relief may not be as ‘substantial’ as many expected. Many of the exempt disclosures would often not be provided by reporting entities likely to be able to adopt the ‘reduced disclosure regime’.

The biggest impact of these changes will be for entities currently preparing special purpose financial statements. Many of these entities currently prepare ‘bare bone’ financial reports including only the mandatory financial statements and notes. The AASB’s proposals would represent a substantial increase in disclosure for these entities.

The IFRS for SMEs sets a relative high hurdle for compliance due to its focus on ‘general purpose financial statements. This hurdle may potentially be too high for some smaller entities. Interestingly, the United Kingdom is considering retaining its own SME standard for smaller entities as a way to reduce the compliance burden of the IFRS for SMEs (or similar) for these entities. Should Australia also consider the retention of the ‘reporting entity’ concept (perhaps based on a size or other test) in some form as a means of addressing this issue, or introduce a 3rd Tier of financial reporting?

Should Australia adopt the IFRS for SMEs instead?

The Consultation Paper discusses various alternatives to the ‘reduced disclosure regime’, including the possibility of adopting the IFRS for SMEs in Australia. The paper concludes against adopting the IFRS for SMEs for many reasons, including:

  • Australia having already incurred the cost of adopting IFRS recognition and measurement requirements for all entities
  • Loss of comparability between entities in Australia
  • The removal of accounting policy options favoured by Australian entities
  • The staggered update process for IFRS for SMEs
  • A potential detrimental impact on wholly-owned subsidiaries who might be required to apply the IFRS for SMEs even though the consolidated financial statements of the group are prepared under IFRS
  • The lack of substantial economies from adopting the IFRS for SMEs in the Australian context.

Although the Consultation Paper recommends against the IFRS for SMEs, it does request constituent comment on this decision. In addition, the Paper leaves the door slightly ajar for the potential adoption of the IFRS for SMEs in the future, depending upon how widespread adoption is on a global basis and other factors.

The AASB also acknowledges the potential need of Australian subsidiaries where their foreign parent applies IFRS for SMEs and suggests a specific application standard, ASIC class order, or other regulation to permit such subsidiaries the choice of applying IFRS for SMEs. However, an outcome to this issue would appear to be a medium term project without substantial development at this stage.

The approach of effectively adopting at least the recognition and measurement requirements of IFRS for all entities in Australia from 2005 has meant that a lot of the 'pain' of adopting IFRS has already been incurred in the Australian context. Compared with IFRS, the IFRS for SMEs does not result in a substantial reduction in complexity in the recognition and measurement requirements - and in fact many 'simplifications' may be more onerous in practice (e.g. introduction of 'uncertain tax position' accounting for income taxes), be counterintuitive (e.g. mandatory amortisation of goodwill over a 10 year period) or may ultimately be adopted in 'IFRS proper' (e.g. rewrite of financial instruments requirements). Furthermore, there are as yet no widely accepted interpretations of contentious issues under the IFRS for SMEs, a position similar to the original IFRS transition in 2005, with all the uncertainty this brought on transition.

Taken in this context, the AASB's tentative decision not to adopt the IFRS for SMEs can be seen as a logical step. The future paths of IFRS and IFRS for SMEs may diverge over time, particularly in light of the significant projects being undertaken by the IASB. Accordingly, it is equally reasonable to not completely shut the door on IFRS for SMEs just yet.

The elimination of parent entity financial statements

The Treasury proposals include proposals to amend s.295 of the Corporations Act 2001 to eliminate the need for entities to present both consolidated and parent entity financial statements. Instead, where consolidated financial statements are required by accounting standards (predominantly AASB 127 Consolidated and Separate Financial Statements), only those consolidated financial statements would be required.

Even though ‘company’ (parent) columns would effectively be removed from the financial statements, limited financial information about the parent entity would be required to be disclosed in the notes to the financial statements by way of a regulation. The draft regulations propose the following parent entity information be disclosed in both annual and half-year financial reports (including comparative information):

  • Current and total assets and liabilities
  • Shareholder’s equity, split between issued capital and reserves
  • Profit or loss
  • Details of guarantees given in relation to subsidiaries
  • Contingent liabilities
  • Contractual commitments for the acquisition of property, plant or equipment.

Whilst the proposed removal of full parent only information in financial statements is a welcome move, we have a number of reservations about the way in which it is being implemented.

The requirement to include summarised information in the financial statements will require such information to be prepared and audited, substantially reducing any potential cost savings for entities. In fact, the proposed extension of the requirement to half-year financial reports will actually increase the work required by both preparers and auditors in half-year financial statements as parent information is not currently required in half-year reports.

Furthermore, the half-year disclosures, in addition to increasing the costs of preparing and auditing half-year reports, are not proposed to be included on a basis consistent with AASB 134 Interim Financial Reporting. AASB 134 establishes the principle of an ‘update’ to the most recent annual report, including in relation to items such as contingent liabilities and commitments. The proposed regulation would create a requirement to provide all information, not just an update. Therefore, the proposed disclosures may potentially confuse users as the consolidated and parent information would be prepared on different bases.

The rationale for the actual information proposed is difficult to determine. For instance, why is profit or loss the only performance measure required – why not also total comprehensive income? Why is capital expenditure of the parent particularly relevant when entities can effectively choose which entity in the group acquires plant and equipment?

Finally, it is unclear how the proposed exemption is to apply where an entity may choose to prepare consolidated financial statements even though an exemption may apply under Accounting Standards. Because these entities are not ‘required’ to prepare financial statements, will they be able to avail themselves of the relief?

The removal of the parent entity requirement from the Corporations Act 2001 would eliminate a long-standing practice in the Australian context. Many entities not reporting under the Corporations Act also routinely include parent company information, even though it may not be explicitly required by the reporting mandate. We expect this change may therefore ultimately change the ‘convention’ of providing parent only information in financial statements across all sectors.

An initial commentary on the proposals

A positive ‘first step’

The proposed measures certainly represent a substantial reform in financial reporting, implementing long overdue reforms such as the removal parent entity financial statements, aligning the payment of dividends to commercial reality in light of IFRS and statutory protection for solicitor’s representation letters. These should be welcomed by constituents.

Is the elimination of the reporting entity concept the wrong decision?

The differential reporting reforms are a mixed bag. The reduced disclosure regime will be welcomed by reporting entities without ‘public accountability’, offering the promise of a somewhat reduced disclosure burden. However, entities currently preparing special purpose financial statements should brace for substantially more disclosure than is currently required.

In effect, the AASB has decided not to interfere with the 'reporting mandate', i.e. which entities have to prepare financial statements. All financial statements prepared and lodged using Accounting Standards would be considered ‘general purpose’. In this regard, the AASB is using the key concepts under IFRS to determine the recognition and measurement requirements, and IFRS for SMEs to determine the limited disclosure requirements for non-publicly accountable entities required to prepare a financial report in accordance with accounting standards.

Therefore, the AASB is effectively ‘washing their hands’ of the reporting mandate question, leaving this to be a policy decision for legislators and regulators, rather than the AASB. This effectively ‘passes the buck’ on these issues to the legislators. Further complications arise in relation to other classes of entities, such as trusts, where reporting is governed by other documents, such as the trust deed – if these documents refer to ‘Accounting standards’ will general purpose financial reports be required? At least the ‘reporting entity’ concept had the effect of dealing with these issues in the past.

Should the AASB potentially develop a ‘third tier’ or should the AASB remain true to its principle and leave it to regulators to reduce reporting burdens? Another alternative could be for the small proprietary company thresholds to be raised or indexed in some way to remove the formal reporting burden from more companies.

The opportunity for more expansive reform may have been missed

There are many positive and welcomed reforms in the Treasury proposals, however on reflection it might be asked whether the proposals go far enough. We wonder whether the opportunity for true reform might have been missed.

The two glaringly obvious potential reforms are:

  • International Financial Reporting Standards for listed entities and financial institutions – requiring listed entities and regulated financial institutions to directly apply IFRS standards would completely avoid any confusion with Australia’s compliance with IFRS, maximising the ability of Australia’s largest companies to compete for funds in the global arena. Concerns about ‘accounting sovereignty’ could be readily addressed by requiring AASB endorsement of IFRS standards, as currently occurs in Europe
  • Removal of a reporting mandate for wholly owned subsidiaries – the preparation of financial statements for wholly owned subsidiaries of entities preparing consolidated financial statements is an anachronism in light of modern corporate law and commercial realities. Removal of this requirement altogether, rather than relying on a complex ASIC Class Order regime, would significantly reduce red tape in financial reporting.

In addition, there are a large number of comparatively minor reforms that could be implemented in the Corporations Act, including a clearer demarcation between the reporting mandate (who has to report) and Accounting Standards (what reporting looks like) – replacing obsolete accounting terminology by references to Accounting Standards to eliminate confusion and improve consistency and a ‘plain English’ rewrite and simplification of what has become quite a bloated piece of legislation.

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