Financial statements are coming under increased scrutiny with the advent of the Accounting and Corporate Regulatory Authority’s Financial Reporting Surveillance Programme (FRSP). It should therefore come as no surprise that more emphasis is being placed on the quality of financial reporting. Regulators, investors and the wider public are also becoming more particular about the appropriateness of accounting practices and sufficiency of the disclosures in the financial statements. As we approach the annual reporting season, we highlight the top five issues you should consider this year-end.
- Declining oil prices may cause impairment and liquidity issues
Oil prices have declined substantially over the past months. Companies that have engaged in speculative investments in oil and gas infrastructure, such as rigs and support vessels, and companies supporting the industry, may be exposed to cash flow problems.
Are there going concern and liquidity risks?
Companies that are negatively affected by falling oil prices may face impairment issues when declining cash flow projections result in lower valuations. They may also face liquidity issues as financing from banks and financial institutions may be restricted.
Heightened liquidity risks mean that greater attention must be paid to key assumptions used to derive cash flow forecasts for going concern or asset valuation assessments. In some cases, companies will need to consider whether there are material uncertainties that would cast significant doubts on a company’s ability to continue carrying on a business as a going concern. Such companies will also need to adequately disclose their liquidity risks and the sources of funding and uncertainties that are
- Development properties may need to be written down due to declining property prices
The property cooling measures in Singapore appear to have taken their toll on the Singapore property market. The property price indices for 3Q2014, published by the Urban Redevelopment Authority, show at least three quarters of consecutive decline.
Is the level of provisioning adequate?
Given the prevailing market sentiment and the signals reflected in the declining property price indices, property developers with significant unsold inventories in Singapore should carefully assess the extent of provisions required to reflect current expectations. A provision is required if the cost is higher than the estimated selling price less costs to complete and sell. Some questions to consider include:
- Are market activities expected to decline further as a result of the cooling measures?
- What is the most recent selling market price of the property or other similar properties within the same locality?
- If the demand in the property market declines substantially, can the developer secure adequate financing?
The assessment is generally carried out on a unit-by-unit basis and not for the development project as a whole as units are marketed individually. However, property developers can group units together for the purpose of the assessment, if the outcome does not differ materially if a unit-by-unit basis approach of determining the amount of provision is adopted.
Based on our experience, the estimation of future selling prices is extremely subjective and highly judgemental. Unless the property is sold after year-end, there is often a wide range of reasonably possible outcomes. Given the significance of the matter, adequate disclosures over the estimates and how they have been derived need to be ensured. Management will have to make a reasonable judgement on the extent of provision required after considering all the facts and circumstances.
- More than half of Singapore-listed companies are trading below book value. Are their assets over-valued?
A very simple indicator for potential impairment is the comparison of net asset value per share with the share price. Recent global economic indicators suggest that there continue to be an increased risk of impairment of goodwill and other non-financial assets.
The relevant accounting standard, FRS 36, requires that non-financial assets such as machinery, patents and goodwill should not be carried in the balance sheet at more than their recoverable amount. Recoverable amount is the higher of the cash flows receivable from (a) selling the asset or (b) earning net profits through the use of the asset (known as “value in use”).
The following are key areas that should be considered when performing an impairment assessment:
- Assumptions and judgements in respect of expected future cash flows should be realistic and take proper account of the current economic conditions and outlook and/or higher levels of uncertainty;
- Companies whose market value has fallen below their book value need to perform an impairment assessment;
- Key assumptions used and sensitivities to reasonably possible changes in those assumptions should be disclosed. These disclosures should not be too high level and aggregated. Sufficient details should be provided;
- Events and circumstances that led to the recognition/reversal of each material impairment loss and the basis for determining the recoverable amounts should be disclosed.
The value placed on the shares of businesses by the “market” is below the most recent carrying value of equity. Are the non-financial assets (machinery, patents and goodwill) impaired?
Where the market value of a company has fallen below its book value, such situations are typically considered to represent an indication of impairment under the accounting standard, and therefore requires an impairment assessment.
An analysis of the price-to-book ratios of publicly-traded companies in Singapore shows that more than half of the companies trade at price-to-book (P/B) ratios below one. This implies that the value placed on the shares of such businesses by the “market” is below the most recent carrying value of equity (or net assets) in their financial statements.
The above data emphasises the need for companies to pay attention to impairment of non-financial assets and to take particular care in assessing the reasonableness of the estimates of recoverable amounts in impairment testing. The involvement of an expert such as a valuation specialist may often provide greater assurance about the recoverable amount estimated, and at the same time, enhances the process used by management to develop their judgements.
- Changing accounting standards: Don’t forget the disclosures
In this financial year, numerous new or revised accounting standards become effective for the first time. The most significant change that is expected to affect many companies is the adoption of the new consolidation suite of standards (FRS 110, 111 and 112).
The new consolidation suite requires companies to reassess their consolidation conclusion. It also provides new guidance on the accounting for joint arrangements and adds new disclosures on interests in subsidiaries, associates, joint arrangements and interests in unconsolidated structured entities.
If the adoption of the new consolidation suite and other new or revised standards result in material effects to the financial statements, adequate disclosures (for example, material effects of changes on respective financial statement line items) should be made to explain the financial effects. Companies should also ensure that adequate time is allocated to prepare the additional disclosures set out in FRS 112.
At the same time, the Accounting Standards Council has also issued numerous new or revised accounting standards (for example, FRS 115 and FRS 109) that are not yet effective for the 31 December 2014 financial statements. Companies are encouraged to consider the implications arising from these impending accounting standards and make the necessary disclosures on the impact of adoption of these new standards in their 2014 financial statements. Any known or reasonably estimable information relevant to assessing the possible impact on the company’s financial statements in the period of initial application should be disclosed so as to inform stakeholders about the upcoming changes.
- Common financial statements presentation and disclosures mistakes to avoid
Last but not least, whether you are a preparer or a reviewer, remember to look out for the following when finalising the 2014 financial statements:
(a) Avoid internal inconsistencies with other disclosures.
(b) Consolidated cash flow statements should not solely be derived from consolidated balance sheet and profit or loss accounts, when significant foreign operations’ functional currencies are not the group’s presentation currency because unrealised foreign exchange changes are not cash flows.
(c) Financial guarantee contracts issued (for example, intra-group financial guarantees provided to banks) that are accounted for under FRS 39 should be included in the maturity (liquidity risk) analysis table at the maximum amount of the guarantee.
(d) Disclose amounts of unremitted earnings from foreign operations for which deferred tax liabilities have not been provided for in the financial statements.
(e) Accounting policies and notes need to reflect actual practices in order to better communicate information to financial statement users. Boilerplate disclosures should be avoided.
(f) Significant judgements on accounting treatments with material effects need to be disclosed.
(g) Only significant estimation uncertainties (for example, goodwill impairment, going concern) with material effects in the next financial year need to be disclosed.
(h) Key management personnel compensation should always be disclosed regardless of quantum.
The article is contributed by Reinhard Klemmer, Partner, Professional Practice at KPMG in Singapore and Chan Yen San, Senior Manager, Professional Practice at KPMG in Singapore. The views expressed are their own.