In recent years ASIC’s surveillance has focused more and more on material disclosures of information useful to investors and others using financial reports, such as:
- assumptions supporting accounting estimates;
- significant accounting policy choices; and
- the impact of new reporting requirements.
This outlines the following top 8 focus areas:
- Impairment Testing and Asset Values;
- Amortisation of Intangible Assets;
- Off-balance Sheet Arrangements and New Australian Accounting Standards;
- Revenue Recognition;
- Expenses Deferral;
- Tax Accounting;
- Estimates and Accounting Policy Judgements; and
- Impact of New revenue Standard.
1. Impairment Testing and Asset Values
The potential impairment of assets such as goodwill, other intangibles and property, plant and equipment continues to be an important area of focus.
AASB 136 Impairment of Assets requires that entities assess at the end of each reporting period whether there is any indication of impairment. If any such indication of impairment exists, the entity shall estimate the recoverable amount of the asset.
In our experience, the following are common pitfalls in respect of impairment calculations:
- The use of unrealistic cash flows and assumptions;
- unrealistic forecasts that have not been met over several reporting periods; and
- material mismatches between the cash flows used and the assets being tested for impairment.
ASIC has placed particular emphasis on :
- the evaluation of values of assets of companies in the extractive industries (or providing support services to extractive industries);
- values of assets that may be affected by the risk of digital disruption; and
- the evaluation of financial instruments, particularly where values are not based on quoted prices or observable market data. ASIC indicated that this includes the valuation of financial instruments by financial institutions.
2. Amortisation of Intangible Assets
AASB 138 Intangible Assets requires that after initial recognition, an intangible asset be carried at its cost or revalued amount, less any accumulated amortisation and any accumulated impairment losses. AASB 138 paragraph 88 states that an entity shall assess whether the useful life of an intangible asset is finite or indefinite and, if finite, the length of, or number of production or similar units constituting, that useful life. It is important to note that an intangible asset shall be regarded by the entity as having an indefinite useful life when, based on an analysis of all of the relevant factors, there is no foreseeable limit to the period over which the asset is expected to generate net cash inflows for the entity.
ASIC has indicated that auditors should challenge and document the basis for any assertion that intangible assets have an indefinite life. Indefinite life intangible assets are not amortised, but are instead subjected to an annual impairment test.
3. Off-balance Sheet Arrangements and New Standards
AASB 12 Disclosure of Interests in Other Entities requires that an entity disclose, for example, significant judgements and assumptions made in determining that:
- it does not control another entity even though it holds more than half of the voting rights of the other entity;
- it controls another entity even though it holds less than half of the voting rights of the other entity;
- it is an agent or a principal;
- it does not have significant influence even though it holds 20 per cent or more of the voting rights of another entity; and
- it has significant influence even though it holds less than 20 per cent of the voting rights of another entity.
It is important for directors and auditors to carefully review the treatment of off-balance sheet arrangements, the accounting for joint arrangements, as well as disclosures relating to structured entities.
4. Revenue Recognition
The primary issue in accounting for revenue is determining when to recognise revenue. It is very important that entities disclose their revenue recognition policy in relation to each revenue stream. The revenue recognition policies should comply with the requirements of AASB 118 Revenue. AASB 18 provides revenue recognition principles in relation to:
- The sale of goods;
- Rendering of services;
- Royalties; and
ASIC has specifically highlighted that the timing of revenue recognition needs careful consideration in industries with complex sale and licensing arrangements that may include continuing obligations, such as software providers.
5. Expense Deferral
Costs incurred by an entity can only be deferred (that is, recognised as an asset) if it meets the definition and recognition criteria of an asset as outlined in the Framework for the Preparation and Presentation of Financial Statements or a specific Australian Accounting Standard.
In particular, the recognition of intangible assets, instead of expensing the costs incurred, can be problematic. AASB 138 paragraph 57 states that an intangible asset arising from development (or from the development phase of an internal project) shall be recognised if, and only if, an entity can demonstrate all of the following:
(a) the technical feasibility of completing the intangible asset so that it will be available for use or sale;
(b) its intention to complete the intangible asset and use or sell it;
(c) its ability to use or sell the intangible asset;
(d) how the intangible asset will generate probable future economic benefits. Among other things, the entity can demonstrate the existence of a market for the output of the intangible asset or the intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset;
(e) the availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset; and
(f) its ability to measure reliably the expenditure attributable to the intangible asset during its development.
AASB 138 paragraph 69 also provides other examples of costs that are recognised as expenses when it is incurred, namely:
(a) expenditure on start-up activities (i.e. start-up costs);
(b) expenditure on training activities;
(c) expenditure on advertising and promotional activities (including mail order catalogues);
(d) expenditure on relocating or reorganising part or all of an entity.
6. Tax Accounting
Tax effect accounting as outlined in AASB 112 Income Taxes can be complex and preparers of financial reports should ensure that they have a proper understanding of both the tax and accounting treatments, and how differences between the two affect tax assets, liabilities and expenses.
Special consideration should be given to the recognition of deferred tax assets and liabilities. A deferred tax liability shall be recognised for all taxable temporary differences. However, a deferred tax asset shall be recognised for all deductible temporary differences to the extent that it is probable that taxable profit will be available in future against which the deductible temporary difference can be utilised.
7. Estimates and Accounting Policy Judgements
Note 2 to the financial statements usually outlines critical accounting estimates and judgements. These disclosures are important to allow users of the financial report to assess the reported financial position and performance of an entity. The disclosure of key assumptions and a sensitivity analysis enable users of the financial report to make their own assessments about the carrying values of the entity’s assets and risk of impairment given the estimation uncertainty associated with many asset valuations.
8. Impact of New Revenue Standard
The IASB has issued a new revenue recognition standard, IFRS 15 Revenue from Contracts with Customers. However, the AASB has not issued the equivalent AASB 15 yet. Currently, revenue recognition is addressed in AASB 118 Revenue and outlines a ‘risk and rewards model’ in relation to the recognition of revenue.
The core principle of the new IFRS 15 is as follows: Recognise revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The following 5 steps represent the application of this core principle:
AASB 108 Accounting Policies, Changes in Accounting Estimates and Errors requires financial reports to disclose the impact of new Australian Accounting Standards on future financial position and results.