The article is published in the April issue of the ISCA Journal.
|The global financial crisis has invited increased scrutiny of the activities companies undertake. It is no surprise therefore that in the past couple of years, much more emphasis has been placed on the presentation of financial statements. Regulators, investors and the wider public are also now more particular about the quality of disclosures in financial statements.
Despite this, boilerplate disclosures are still commonly seen in practice. These often inadequately explain a company’s financial performance and standing.
In this article, we highlight five disclosure areas where improvements can easily be made.
Financial estimates Have sources of estimation uncertainty been adequately disclosed by your company?
Companies are required to disclose major sources of estimation uncertainty that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year. Adequate disclosures should be made in the financial statements so users can see the potential effect of estimations on the financial performance.
For example, a developer has existing unsold development properties in Singapore and assessed that the cumulative effects of the property cooling measures will have an immediate dampening effect on the selling prices of the unsold inventories. After considering all facts and circumstances, the developer concludes that the development’s properties must be written down by a certain percentage. None of the properties are sold after year-end.
In the 2013 financial statements, the developer provides the disclosures required such as the amount of write-down and the circumstances leading to the write-down. During the process, the developer must consider if the estimates it has made are highly uncertain and carry a significant risk of a material adjustment to the carrying amounts of the development properties within the next financial year.
If so, the developer needs to provide the necessary disclosures to comply with the accounting standard. These disclosures include the assumptions used to develop the estimates and how sensitive the carrying amounts are to changes to the assumptions.
Future adoption of new accounting standards What is the impact on your financial position and performance?
We will try to explain this using an illustration. A company – A Limited – is the sponsor of a Singapore publicly-listed real estate investment trust (REIT). Its wholly-owned subsidiaries are the asset and property managers of the REIT who therefore direct key decisions of the REIT. A Limited holds more than 40% unit holdings in the REIT and concluded that it will have to consolidate the REIT due to the adoption of the new consolidation standard.
During the process of finalising the quantitative impact arising from consolidating the REIT, A Limited states in its financial statements that it is in the process of "assessing the impact of the adoption".
The disclosure that A Limited is in the process of “assessing the impact of the adoption” will not provide adequate information on the potential impact arising from the impending accounting changes. For new accounting standards, companies should disclose estimable information that could be helpful in assessing the impact that the application of the new standards will have on the entity’s financial statements.
While A Limited has not finalised the precise quantitative impact, it should disclose the fact that the group will have to consolidate the REIT upon adoption of the new standard and it could also disclose the impact on the financials or an approximation of the potential effect. In addition, A Limited could disclose the assumptions used to determine the estimated effects and add that the group is still finalising the effect of adoption of the standard.
Cash flow statement Have transactions been appropriately reflected in the cash flow statement?
There has been less focus placed on the preparation of the statement of cash flows, compared to other primary statements.
Operating cash flows provide information on the cash generated by the business and are frequently used by analysts. On the other hand, financing cash flows are important for users to predict the claims on future cash flows by long-term capital providers such as lenders and shareholders.
If the cash flows are not properly classified, users might be led to the wrong conclusion on the cash generating abilities of the operating business of the company.
What companies should do is to pay adequate attention to the preparation of the statement of cash flows and carefully evaluate the classification of cash flows. Companies should present the cash flows from operating, investing and financing activities based on the nature of the cash flows.
For example, a company has a long outstanding amount owing to its holding company which initially arose from a trading transaction with the holding company. The company also has some non-trade receivables due from its related companies. If the company chooses to present the movements in these balances as part of changes in working capital in operating cash flows, it might paint a misleading picture of the cash flows from operations.
The operating, investing and financing activities generating the cash flow should be separated based on the nature of the activities. Therefore, it may not always be appropriate for the company in the illustration above to classify inter-company balances as operating activities. This is because the balances could also be financing in nature. If those balances are loans in nature, they should be classified as investing activities in the lender’s books and financing activities in the borrower’s book. They should not be presented as part of operating activities.
Accounting policies Are they customised to your business model and activities?
Accounting policies need to reflect actual practices in order to better communicate information – such as the type of revenue-generating activities and when controls/risks/rewards have been transferred to the customers – to financial statement users.
The information should be customised based on the entity’s business model, activities and operations and for the revenue recognition policy, the specific terms of the sales agreement or the specific shipping terms agreed with the customers should be considered.
For example, a trading company sells its products through a website and states in its revenue accounting policy that it recognises revenue when:
- the risks and rewards of the goods have been transferred, and
- when it is probable that the economic benefits from the transaction will flow to the entity.
While the company’s disclosures are consistent with the accounting standard, it doesn’t provide any meaningful information to the users. How does the company record revenue arising from the business activities undertaken by the company?
The company could enhance the disclosure by explaining when exactly it believes that risks and rewards of ownership have transferred to the customers, for example, when the customer has acknowledged delivery from the company.
New disclosure requirements Have these been integrated with existing disclosures?
In 2013, a number of new disclosure requirements came into effect. Disclosures are typically not on the priority list during the closing process. More often than not, new disclosures are added on to the financial statements without sufficient consideration of how the new information could be integrated with other existing disclosures in the financial statements.
This could cause various problems such as duplication of information or disclosures spread across different sections in the notes. Companies should strive to ensure they have sufficient time at the year-end to collate the information necessary to comply with the new disclosure requirements and to consider how best to integrate the new disclosures with existing disclosures in the financial statements.
The questions we have posted in this article are five areas which companies should focus on to easily improve the quality of their year-end reporting. Good disclosure practices will not only ensure that regulatory requirements are met, but also go a long way towards helping a company establish a stronger relationship with its stakeholders and investors.
Reinhard Klemmer is Partner, and Ryan Tong is Manager, KPMG in Singapore. This article is based on an extended version first published in "Financial Reporting Matters", December 2013, by KPMG and available at kpmg.com.sg. The authors acknowledge the contribution of Chan Yen San and Chua Yun Leng, Senior Managers, KPMG in Singapore.