The new accounting standard "Statement of Financial Performance" (AASB 1018) has changed the way all companies must present their financial results.
To check on how directors were dealing with this change, ASIC recently reviewed how 80 listed companies, whose year ended on 30 June 2001, had complied. This article reports our findings and highlights practices which directors should avoid.
Overall reporting of financial performance
In interpreting accounting standards, the ASIC Act 2001 requires companies to construe the accounting standards in a way that promotes the purpose or object of the standard even if it is not expressly stated. Many companies made genuine attempts to comply with the spirit as well as the letter of the new standard. However ASIC identified a range of practices that went against the spirit, and, in many cases, the letter of the standard. Some companies interpreted the standard in unusual ways, even contrary to common sense, so that they could give the most favourable impression of their results, rather than what would be most useful to investors, analysts and other readers. Based on this survey, ASIC will be suggesting some improvements to AASB 1018 to the Australian Accounting Standards Board to clarify and reinforce the spirit of the new standard. We will also consider enforcement action against particular companies.
A blacklist of sub-standard practices
Highlighting abnormal items
Some companies persisted in singling out items, variously described as 'abnormal' or 'unusual', on the face of the Statement of Financial Performance, including:
• separately showing significant items,
• classifying all revenue and expense line items as "usual" and "unusual", and
• showing particular expenses separately from the nature or functional classifications to which they relate.
Presenting 'alternative' statements
The standard expressly prohibits providing an alternative statement of financial performance in addition to the statement required by the standard itself. ASIC found that some companies nonetheless presented 'alternative statements' and excluded certain write-downs or significant expenses. Highlighting totals other than the bottom line The statutory profit is the legally recognised bottom line. Giving equal or greater prominence to a non-statutory "profit" figure compared to the statutory profit tends to confuse investors and undermine comparability.
We found that the non-statutory "profit" may have excluded items such as depreciation, amortisation, asset sales and/or significant items. We also found some companies disclosed a confusing number of "profit" subtotals. Some companies gave undue prominence to a non-statutory profit in market announcements, which may mislead investors and breach the Corporations Act 2001. Revenues and expenses We identified a range of unlawful or undesirable practices, such as:
• Disclosing a "margin" for each different activity but showing particular items such as salaries in aggregate for all activities.
• Showing certain revenues net of expenses, without showing gross figures.
• Confusing revenues and expenses by reporting some according to their function and others according to their nature. For example, a number of companies reported expenses according to 'production' and 'selling and administration', but then excluded depreciation and amortisation from these functional totals.
• Failing to disclose borrowing costs separately on the face of the Statement.
• Showing large amounts for "Other expenses" or "Other revenue", that should have been broken down into smaller items, or defining functions too broadly and disclosing few line items.
• Showing only the net profit/loss from asset sales on the face of the Statement, rather than separately showing proceeds of sale as revenue and the carrying amount of the assets.
• Failing to reveal movements in reserves and other changes in equity not resulting from transactions with owners as owners at the bottom of the Statement.
• Investment trusts and companies failing to include investment revenue in their revenue from operating activities.
Movements in retained profits
Some companies failed to include a note showing movements in retained profits/accumulated losses as required by AASB 1040 "Statement of Financial Position". Misuse of extraordinary items We found examples where companies treated items as extraordinary that appeared to be of a recurring nature, or showed extraordinary items after deducting outside equity interests from the operating profit after tax.
Flexibility versus comparability
Leaving aside the blacklisted practices mentioned above, AASB 1018 has allowed companies within the one industry to adopt substantially different presentations. For example, some may provide information by nature and others by function, some may show margins when others show total revenues and total expenses, and some may separate out particular items when others do not. While a particular entity or industry benefits from presenting information in the form most appropriate for their needs, users of financial reports need to compare results between companies. To overcome the current lack of consistency, companies operating in similar industries could develop common practices to help investors and analysts compare performance.
Inventories and cost of sales
ASIC also performed a limited review of the procedures that some large listed companies and their auditors adopted in relation to the existence and valuation of inventories and the determination of cost of sales. While the companies' procedures generally appeared to be appropriate, we identified some inconsistencies in the measurement of the cost of inventories and cost of sales. These included:
• Excluding costs of materials extracted from the company's own land from the cost of its inventories.
• Inconsistent treatment of rebates, some including settlement/credit-worthiness discounts in cost of inventories and others excluding volume/purchasing discounts.
• Excluding normal expenses associated with bringing inventories to their present location and condition.
Because the new accounting standard applies to all companies preparing financial reports, our recent review offers important findings for all directors. Directors need to eliminate a range of sub-standard practices to ensure that their financial disclosures meet the requirements of the new accounting standard and comply with the law.
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