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Technical Findings of the Conduct Committee’s Financial Reporting Review Panel 2013/2014

Technical findings

The areas identified in this presentation are those where we asked most questions of boards in the year.

  • Accounts under review were from December 2012 – September 2013.
  • Other matters reported in last year's Technical findings remain relevant.

Common areas of questioning

  • Business reviews
  • Accounting policies
  • Critical judgements
  • Estimation uncertainties
  • Revenue recognition
  • Cash flow statements
  • Intangible assets
  • Property, plant and equipment
  • Impairment
  • Capital management
  • Income taxes
  • Provisions, contingent liabilities and contingent assets
  • Business combinations
  • Presentation of financial statements
  • Industry issues
  • Other

Business reviews: balanced and comprehensive

We challenged companies where there was no discussion or explanation of significant items featured in the accounts:

  • eg potential financial effect of disputed tax

We questioned the omission of significant explanations on the grounds that they had been previously published in the interims.

We also identified examples of poor discussion of performance

  • eg profit after substantial and/or unexplained adjustments

Business reviews: balanced and comprehensive

We challenged lack of reference to key matters impacting and explaining performance eg

  • amortisation halved on drug licence;
  • figures included in financial review, but not discussed;
  • broad discussion of changes in financial review, without reference to the amounts; and
  • omission of significant explanations of performance previously published in the interim report.

Business reviews: principal risks and uncertainties

We challenged where there was a question whether:

  • all PRUs disclosed were genuinely principal;
  • PRUs were not company-specific; eg, regulatory risk did not explain the most relevant regulations; or
  • all PRUs were disclosed; eg, reliance on a major customer, exposure to pension scheme, operating lease commitments.

Business reviews: key performance indicators

Key performance indicators (KPIs) are required 'to the extent necessary' to provide an understanding of a company's position or operations.

We challenged companies where:

  • KPIs were not clearly identified;
  • indicators could not be recalculated;
    • eg debt/earnings ratio after capitalising leases
  • there was no appropriate level of discussion.

Accounting policies

We questioned:

  • Policy descriptions that summarised the standard;
  • Policy descriptions that did not describe the company's specific application in practice;
    • eg: insurance contract valuation methods.
  • Policy descriptions that used 'standard-speak' rather than plain, understandable English.

Accounting policies

We questioned:

  • Lack of policies for transactions or balances that were material to the business, eg: supplier rebates, shares classified as liabilities, conditional land purchases, vehicle purchases on consignment, bill and hold;
  • Unnecessary repetition of policy descriptions;
  • Descriptions of policies where no other disclosure made;
  • New IFRS requirements with little or no effect on future financial statements.

Critical judgements

We challenged disclosure of critical judgements not sufficiently specific to enable an understanding of where judgement was exercised or its effect

  • eg 'revenue recognition'

We queried lack of disclosure where needed to understand management's decisions

  • eg classification of debt /equity, held for sale assets, lease renewal, intangible or financial instrument classification, non-consolidation of investment subsidiary controlled by regulator.

Estimation uncertainties

We challenged the lack of disclosure of uncertainties around estimation when it was apparent from the accounts that a significant uncertainty existed.

  • eg evidence supporting non-impairment of capitalised exploration/ evaluation expenditure, contingent consideration receivable

The quality of explanation often fell short of what was needed to help users understand judgements made relating to the estimate and uncertainties.

  • eg lack of sensitivities.

Revenue recognition

We queried :

  • lack of explanation of the point at which risks and rewards are transferred to the customer for significant business streams, including stage of completion
  • Lack of specific policy for unusual items:
    • Deferred income on onerous contracts
    • Barter transactions with house-builders
    • Success or incentive fees
  • Failure to disclose revenue by category

Revenue recognition

We challenged disclosure of revenue policies that appeared inconsistent with the business model:

  • Partnerships, concessions, franchises and outsourcing featured in various business models but the policies did not explain how they affected revenue.
  • The company indicated that it acted as agent but this was not supported by the stated policy.
  • The impact of delays in revenue recognition on costs and the timing of release of deferred income were not explained.

Cash flow statements

  • We continued to note a range of minor mistakes indicative of a lack of care
  • Instances of misclassification included:
    • Pension cash flows classified as financing;
    • IPO costs unrelated to new share issue classified as financing; and
    • Amounts to buy or sell rental assets classified as investing rather than operating.

Cash flow statements

  • We challenged instances of inappropriate netting eg:
    • Loan drawdowns/ repayments
    • Excessive aggregation and netting of adjustments from profit to operating cash flows
  • We challenged the disclosure of non cash items in the cash flow statement eg:
    • Conversion of convertible debt
    • Dividend in specie

Intangible assets

  • We challenged:
    • Justification for long amortisation periods
    • Extremes of capitalisation of internally generated intangibles - where all or no development costs were capitalised we asked for nature of costs and queried how capitalisation criteria were applied in practice
    • Failure to disclose R and D expense
  • We reminded boards of the need to disclose any individually significant intangible asset and its remaining amortisation period.

Property, plant and equipment

  • We challenged classes of property, plant and equipment which grouped together assets of dissimilar nature or use.
  • Companies who, in the course of their ordinary activities, routinely sell items of PP&E that they have previously held for rental, should transfer the assets to inventory at their carrying amount and record the proceeds as revenue.
  • Disclosure of assumptions used to calculate FV of revalued property, plant and equipment.

Impairment

  • Discount rate(s) should be pre-tax reflecting current market assessments of time value of money and asset-specific risks.
  • We challenged when a single discount rate was applied to CGUs with apparently different risk profiles and when a range was given for all CGUs.
  • Estimation uncertainties were uninformative.
  • For PP&E, we challenged CGU aggregation and why a market capitalisation indicator was ignored.

Impairment

  • A description is required of each key assumption driving cash flow projection determining value in use. The discount and terminal growth rates were often incorrectly identified as the only key assumptions.
  • A description is also required of the approach to determining the values attributed to assumptions, including how past experience or external sources of information have been used.
  • We challenged unclear and generic sensitivity disclosures.

Capital management

  • Qualitative and quantitative disclosures required in respect of identified capital were at times inconsistent.
  • We challenged failure to identify what is managed as capital.
  • We asked boards to explain their policy for capital management and how it was applied.

Income Taxes

  • We queried the quality of explanations in tax reconciliations, including where the message appeared to differ from the business review, eg prior year items, non taxable income
  • We challenged items that would not be expected in a reconciliation of total tax eg: adjustment to share based payments, adjustments for timing issues, capital allowances.
  • Deferred tax should be measured at the tax rates expected to apply when the asset/liability is realised or settled, based on tax rates enacted or substantively enacted at the period end.

Income Taxes

  • We challenged lack of deferred tax on fair value adjustments to assets acquired in business combinations.
  • The nature of evidence supporting a deferred tax asset is a required disclosure when its use depends on future profits and the company is loss-making.
  • Some companies are still confused about where to recognise current and deferred tax relating to items recognised outside the income statement; if the item is recognised in equity, tax should also be recognised in equity and not OCI.

Provisions, contingent liabilities and contingent assets

  • We challenged poor disclosure of movements in provisions.
  • We challenged the justification for cash outflows being remote where contingent liabilities were not quantified and explained.
  • We challenged the amount recognised for PPI mis-selling and other provisions.

Provisions, contingent liabilities and contingent assets

  • We asked for details of the components of provisions classified in a significant class of 'other' provisions.
  • We challenged aggregation of accruals and provisions.
  • Relevant disclosures are required for each class of provision, contingent liability and contingent asset and include uncertainties relating to amount or timing.

Business combinations: recognition

  • All identifiable assets, subject to qualifying conditions, are to be recognised separately from goodwill.
  • We queried the lack of customer-related intangibles and mineral rights acquired.
  • Identifiable assets acquired and liabilities assumed are to be measured at the acquisition date fair values.

Business combinations: consideration

  • Acquisition-related costs (except debt/equity issuance amounts) are to be expensed in the period.
  • Disclosures should enable users to evaluate the nature and financial effect of business combinations.
  • We challenged the accounting treatment and disclosures around deferred and contingent consideration.

Presentation of financial statements

  • We challenged non-disclosure of proposed dividends.
  • We challenged the aggregation of accruals and deferred income as these liabilities are different in nature and liquidity. Similar challenges were made in respect of prepayments and accrued income.
  • We questioned reclassifications and restatements where no quantified explanation was provided.

Industry issues

Resource companies

  • Unclear disclosure of key policies; eg recognition and impairment of exploration and evaluation assets
  • No definition of industry specific terms; eg 'commercial reserves' and 'successful efforts accounting'
  • Reserves used in impairment and depreciation unclear

House-builders

  • Interest in ensuring transparency in income statement about movements in inventory provisions set up through exceptional items during the financial crisis

Industry issues

Property Development

  • Allowance needs to be made for the developer's profit in valuation of partly constructed buildings.

Investment Trusts

  • Failure to disclose risks and affects of derivatives.

Other

  • Where operating leases represented a significant cost and future commitment, we challenged bland descriptions of the lease terms which did not reflect their impact.
  • We challenged the thresholds at which an unrealised loss on equity investments became significant or prolonged.

Other

  • Where it appeared that there were significant off balance sheet commitments, we challenged the lack of disclosure under the Companies Act (Section 410 A).
  • We challenged the classification of financial assets as level 2 in the hierarchy based solely on the fact that the values had been provided by a pricing agency.

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Name Technical Findings of the Conduct Committee’s Financial Reporting Review Panel 2013/2014
Publication date 27 September 2023
Type Report
Format PDF, 167.1 KB
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