Annual reporting season - what changes can we expect?
For many leading companies that are calendar year end reporters the annual reporting season will commence shortly. Investors and other stakeholders will have to cope with the challenge of digesting and trying to make sense of annual reports which each year are becoming more voluminous. After a period of calm in the couple of years up to 2009, those involved in the preparation of the 2009 financial statements will have had to grapple with a raft of change - one new standard, amendments to nine standards, together with a large number of what are termed 'minor' amendments and four interpretations. There are also a number of new and amended standards and interpretations available for early adoption.
In addition to dealing with changes to standards, companies will also need to take on board comments made by regulators and others regarding areas of financial reporting in previous years where there is scope for improvement.
What has changed?
Change has taken place in a wide number of areas and while some changes may have fairly limited application, there are a number which will impact on the vast majority of all companies. The list includes:
- Presentation of financial statements
- Operating segments
- Borrowing costs
- Share-based payment :
- Vesting conditions and cancellations
- Financial instruments:
- Disclosures about fair value and liquidity risk
- Puttable financial instruments
- Assessment of embedded derivatives
- Hedges of a net investment in a foreign operation
In addition, new interpretations include those on customer loyalty programmes, agreements for the construction of real estate and transfers of assets from customers.
The following paragraphs comment on some of the more significant changes to standards which are mandatory for 2009 and which are likely to be of relevance to a majority of IFRS adopters.
Presentation of financial statements
A number of amendments have been made to IAS 1, including recommended but non-mandatory changes in terminology such as statement of financial position for balance sheet and presentation/content changes e.g. one statement or two statement approach to statement of comprehensive income. Possibly the most significant change is to include a balance sheet at the beginning of the earliest comparative period whenever an entity retrospectively applies an accounting policy, or makes a retrospective restatement of items in its financial statements, or when it reclassifies items in its financial statements. Given the rate of change in accounting standards and consequent accounting policy changes, many companies may be presenting a third balance sheet in their 2009 financial statements.
IFRS 8 introduces new requirements for segment analysis and reporting, with the objective being to use the 'management approach' and to report on the same basis that information is made available to the entity's chief operating decision-maker for evaluation in deciding how to allocate resources and in assessing performance. Upon adoption of IFRS 8, the identification of an entity's segments may or may not change, depending on how the predecessor standard IAS 14 has been applied in the past.
The U.K. Financial Reporting Review Panel (FRRP) issued a press release in early January questioning the application of IFRS 8 by companies and highlighting some common themes in the questions raised by the FRRP with early adopters and based on half-yearly reporting, as follows:
- Only one operating segment is reported, but the group appears to be diverse with different businesses or with significant operations in different countries
- The operating analysis set out in the narrative report differs from the operating segments in the financial statements
- The titles and responsibilities of the directors or executive management team imply an organisational structure which is not reflected in the operating segments
- The commentary in the narrative report focuses on non-IFRS measures, whereas the segmental disclosures are based on IFRS amounts
The FRRP urges management to ask themselves whether the reported segments appear consistent with their internal reporting and, if not, why not. It encourages directors to test their initial conclusions about segments and suggests eight questions that may help with the process.
Reporting of operating segments promises to be an area of interest during the upcoming reporting season.
Disclosures: fair value and liquidity risk
The standard on financial instruments disclosures has been amended in respect of both introducing a three-level fair value hierarchy for disclosure purposes and clarifying the scope of the items to be included in the maturity analysis to include only those liabilities that are settled by delivering cash or another financial asset.
The fair value hierarchy is based on how fair value is determined ranging from level 1, quoted prices in active markets, to level 3, where fair values are derived at least partly from inputs not based on observable market data e.g. unquoted securities. Additional disclosures to be provided are:
- The level of each financial instrument in the hierarchy in which fair value measurements are recognised
- Reasons for significant transfers between level 1 and level 2
- A reconciliation from beginning to closing balances for level 3
- If changes to any of the assumptions applied for level 3 measurements will have a significant effect on the fair value, the nature and extent thereof
The additional clarity the fair value hierarchy provides should be of assistance to readers particularly with regard to level 3.
IAS 23 has been amended to require that where borrowing costs relate to the acquisition, construction or production of a qualifying asset commencing on or after 1 January 2009 those costs must be capitalised. The option of expensing those costs has been removed.
IFRS 2 has been amended in respect of both vesting conditions and cancellations. In current conditions there may well be a number of schemes that are modified to reflect economic circumstances. The clarity of accounting for such modifications is important: if a modification represents a cancellation it will lead to an acceleration of any remaining charges on a scheme into the current period.
New company law requirements
In addition to the changes referred to above, company law has also been changed by virtue of Statutory Instrument (SI) 450 which implements further European Directive requirements. For all companies reporting under the Companies Acts framework, there are additional disclosure requirements with regard to related party transactions and off-balance sheet arrangements, which could be interpreted as including operating leases, outsourcing agreements, long term supply agreements, employment contracts, defined contribution pension schemes and others. For Irish entities with a listing on a regulated EU market, SI 450 brings a requirement for an annual corporate governance statement which, among other matters, includes a description of the main features of internal control and risk management systems in relation to the financial reporting process with additional responsibilities for the auditor to report on this description in the statutory audit report.
SI 450 was passed into law in November 2009 and is considered effective from that date, albeit that relevant parties are in ongoing discussions to reach a final determination regarding implementation and transition processes.
Companies will have to grapple with the changing requirements while at the same time revisiting those areas which regulators and others have drawn attention to as areas where improvement could be made.
Recently the Irish Auditing and Accounting Supervisory Authority (IAASA) has published 'Observations on Selected Financial Reporting Issues 2009'. The IAASA report comments that against a background of ongoing market uncertainty, reduced access to credit, weak economic activity and potentially impaired asset values, the increased risk and uncertainty places an increased focus on the critical importance of estimates and judgements in preparing financial reports and on the importance of the role played by Boards and Audit Committees in considering and approving periodic financial reports.
The IAASA observations bring attention to a wide range of areas, some of which were also commented on in its January 2009 report, including:
- Valuation and impairment of assets
- Retirement benefits
- Going concern
- Principal risks and uncertainties
- Deferred tax assets
- Earnings per share
Companies need to be aware of the revised Guidance for Directors on Going Concern Assessments and Disclosures published by the UK Financial Reporting Council (FRC). The FRC emphasises the importance of balanced, proportionate and clear disclosures about going concern issues and liquidity and the key assumptions being made in one place in an annual report.
Some of the new areas commented on in IAASA's January 2010 observations are:
- Hedging instruments
- Bank covenants
- Related party transactions
- Government assistance
- Financial instruments - risk disclosures
- Operating profit
- Key performance indicators
- Management reports
IAASA comments that Boards and Audit Committees should critically assess, and, as appropriate, challenge the materiality judgements made by management in the course of the preparation of the financial statements, particularly where it appears that qualitative aspects may not have been sufficiently assessed. In particular, careful consideration is required where management does not propose to correct an identified error.
IAASA also comments that while the approach adopted by a peer entity may be of interest, it should not be considered the most important indicator of the most appropriate accounting treatment, pointing out that the peer's accounting treatment may be based either on its own unique circumstances or even on an incorrect interpretation of the relevant requirements.
With the main reporting season almost here there is much to look forward to and it will be of interest to see how listed entities have dealt with the new requirements and also whether reporting has been enhanced in areas which have been identified by regulators and others as in need of improvement.
First published in Finance Dublin online