ASIC deputy chief accountant Doug Niven outlines some important issues in ensuring financial reports comply with the Corporations Law.
During the last financial year, the Australian Securities and Investments Commission caused listed companies to make a record $2400 million worth of corrections in their financial statements to better inform their shareholders. This significant outcome is a result of ASIC's action in identifying and addressing financial reporting issues, which included reviewing year end 1999 financial reports of more than 300 listed companies. Such reviews brought to light many areas of improvement, some of which will be discussed here. So whether you are a company director or auditor, read on for ASIC's views on some important issues to be considered in ensuring financial reports comply with Chapter 2M of the Corporations Law. Amortisation of intangibles Intangible assets including trade names, customer databases and licences should be amortised in accordance with AASB 1021 "Depreciation". Where asset values are very large, not amortising can materially overstate company profits.
AASB 1021 requires intangible assets to be amortised over their estimated useful lives, following the pattern of loss or consumption of economic benefits. The Australian Accounting Standards Board confirmed (in Accounting Interpretation AI1 "Amortisation of Identifiable Intangible Assets") that AASB 1021 applies to intangible assets in the same way it applies to physical assets. Companies must:
• Be able to substantiate to ASIC, periods chosen as being reasonable estimates of the useful lives of intangible assets, taking into account factors such as likely technical and commercial obsolescence. It is highly unlikely ASIC will accept that a life is unlimited, or that it should be regarded as unlimited because a precise estimate cannot be made.
• Not rely on revaluations of intangible assets or reassessments of underlying value as a substitute for amortisation.
Companies must comply with both:
- the AASB 1021 amortisation requirement and
- the separate requirement of AASB 1010 "Accounting for the Revaluation of Non-Current Assets" that carrying amounts of non-current assets are not overstated.
• Not revalue residual amounts of an asset unless the carrying amount is also revalued.
• Amortise, even if the asset's value at some future date during its useful life is expected to be higher than its current carrying amount.
• Amortise on a straight-line basis over time if economic benefits embodied in the assets are expected to be lost or consumed on a time basis. In 1999, Australian Pacific Airports Corporation and Brisbane Airport Corporation changed the pattern of amortisation of rights to operate airports to a straight-line basis following discussions with ASIC. This increased amortisation charges in the early years.
• Not include internally-generated or purchased goodwill in the value of intangible assets. Accounting standards prohibit recognition of internally-generated goodwill. Purchased goodwill must be amortised over no more than 20 years. ASIC has already asked some companies to review and revise their approaches to accounting for intangibles.
Companies must not recognise revenue before services are rendered and must detail their revenue recognition policies (see AASB 1004 "Revenue").
Deferred expenditure Expenditure should not be inappropriately capitalised as an asset. The mere fact that expenditure is incurred does not necessarily give rise to an asset and AASB 1013 "Accounting for Goodwill" prohibits recognition of internally-generated goodwill. In April, One.Tel Limited announced a $100 million write-off of deferred expenditure following discussions with ASIC. The expenditure related mainly to advertising and staff costs associated with acquisition of customers, and costs relating to establishing operations in other countries. Expenses cannot be deferred merely to match revenues. To determine whether there is an asset, the definition of "asset" in accounting standards and concepts should be applied.
Lease accounting ASIC is concerned that the accounting used by some companies for complex leasing arrangements are purported to give a result under AASB 1008 "Leases" which differs from the substance of those arrangements. ASIC's view is that an arrangement's overall substance should be considered in determining whether substantially all of the risks and benefits of ownership of assets have been transferred from one party to another. Separate agreements relating to particular assets must be considered together as terms and conditions of one agreement may affect the substance of another agreement.
Acquisition accounting In accounting for acquisitions of assets and businesses:
• Profits of newly controlled entities should not be recorded before the date of obtaining control.
• The substance of transactions should be followed rather than their legal form.
For example, cash doesn't determine the amount of a share issue and an acquisition in back-to-back transactions where the cash consideration is unrealistic. Similarly, a non arm's length transaction between two controlled entities may involve a capital contribution in substance by a common parent to one of the entities.
Debt/equity classifications AASB 1033 "Presentation and Disclosure of Financial Instruments" requires financial instruments issued, or their components, to be classified as liabilities or equity. A liability is a contractual obligation to deliver cash or another financial asset to another entity, or to exchange financial instruments with another entity on potentially unfavourable terms. Equity is the residual interest in a company's assets after deducting its liabilities. For example, a liability will normally exist where an instrument is redeemable at the holder's option, or where interest above market rates pays off the principal component of an instrument. An instrument may appear to be equity because interest is only payable out of profits, but it may not be equity if arrears must be made up before dividends on ordinary shares can be paid and those arrears don't need to be met out of profit. On initially recognising converting financial instruments:
• a liability is recorded to the extent that the holder is not exposed to changes in fair value of the issuer's equity instruments, while
• equity is recorded to the extent that the holder is exposed to such changes.
Directors' and executives' emoluments The directors' reports of listed companies should comply with s.300A of the Law, including disclosure of:
• Value and terms of options granted to directors and officers.
• Emoluments of all directors and all five executive officers receiving the highest emoluments.
• The policy for determining the nature and amount of emoluments, and discussion of the relationship between that policy and company performance.
The amount of all emoluments must be disclosed, including the value of options. All options have some value at time of issue and some have significant value. Any assumptions that may significantly affect disclosed option values and how they affect the values should be disclosed. UIG Abstract 14 "Directors' Remuneration" also indicates that directors' remuneration under AASB 1017 "Related Party Disclosures" includes share options provided under employee share ownership schemes. Directors have fiduciary obligations and should understand the values of options issued. Option values should also be provided to members of public companies when those members are asked to approve financial benefits to be given to directors in the form of options under Part 2E.1 of the Law.
Reserve accounting Revenues and expenses that must be recorded in the profit and loss statement should not be recorded directly in reserves. ASIC is also concerned with the use of certain negative reserves.
Upcoming review ASIC is targeting reporting for financial years ending first half of 2000 by:
• "new economy" companies, focusing on revenue and asset recognition, and lease accounting
• recently privatised former government-owned enterprises. While we will continue to educate, we will also seek explanations from some companies and consider enforcement action to address non-compliances with the Law and accounting standards.
Most matters in this article appear in earlier ASIC media and information releases. For more information, visit the financial reporting pages at www.asic.gov.au
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