FINANCIAL REPORTING DOSSIER

On 19th November, 2020, the US Securities and Exchange Commission (SEC) adopted amendments to certain financial disclosure requirements in Regulation S-K (Items 301, 302 and 303). The amendments, inter alia, (a) replace the current requirement for quarterly tabular disclosure with a principles-based requirement for material retrospective changes; (b) add a new item, Objective, to state the principal objectives of MD&A; (c) enhance disclosure requirements for liquidity and capital resources and results of operations; and (d) replace current item Off-balance sheet arrangements, with an instruction to discuss such obligations in the broader context of MD&A.

FRC: Research Supports Introduction of Standards for Audit Committees

On 2nd December, 2020, the UK Financial Reporting Council (FRC) reported that its newly-commissioned research has shown that the developments of standards for audit committees would support a more consistent approach to promoting audit quality. The research also reveals that the key attributes audit committee chairs value in auditors are a good understanding of the business and its sector, the ability to identify key risk areas, good communication skills, along with a focus on timeliness in raising issues and completing work.

IAASB: Quality Management Standards

On 17th December, 2020, the International Auditing and Assurance Standards Board (IAASB) released three Quality Management Standards: (a) International Standard on Quality Management (ISQM) 1, Quality Management for Firms that Perform Audits or Reviews of Financial Statements, or Other Assurance or Related Services Engagements; (b) ISQM 2, Engagement Quality Reviews; and (c) ISA 220 (Revised), Quality Management for an Audit of Financial Statements. The standards become effective on 15th December, 2022 and are aimed at promoting a robust, proactive, scalable and effective approach to quality management.

IFAC: New International Standard Support Resources

On 21st December, 2020, the International Federation of Accountants (IFAC) released updates to two international standard support resources: (a) Agreed-Upon Procedures (AUP) Engagements: A Growth and Value Opportunity that describes AUP engagements, when they are appropriate and identifies key client benefits; it provides six short case studies with example procedures that might be applied; and (b) Choosing the Right Service: Comparing Audit, Review, Compilation and Agreed-Upon Procedures Services that explains and differentiates the range of audit, review, compilation and agreed-upon procedures services which practitioners can provide in accordance with relevant international standards.

IFRS Foundation: Educational Material on Going Concern Application

On 13th January, 2021, the IFRS Foundation published an educational material Going Concern – A Focus on Disclosure aimed at supporting consistent application of IFRS standards. The educational material brings together the requirements in IFRS standards relevant for going concern assessments as deciding whether financial statements should be prepared on a going concern basis involves a greater degree of judgement than usual in the current stressed economic environment arising from the Covid-19 pandemic.

 

FRC and IESBA: Government-backed Covid-19 Business Support Schemes

And on 26th January, 2021, the UK FRC and the International Ethics Standards Board for Accountants (IESBA) jointly released a Staff Guidance publication, Ethical and Auditing Implications Arising from Government-Backed Covid-19 Business Support Schemes that inter alia includes guidance for those who prepare related financial information and disclosures, as well as for those who independently audit or provide assurance services regarding such information.

2. Research – Revaluation Model for PPE

Setting the Context

Items of property, plant and equipment (PPE) upon initial recognition (Day 1) are measured at cost. The subsequent measurement requirement (Day 2), in general across prominent GAAPs, is to allocate the capitalised cost to the periods (and manner) in which the benefits embodied in the asset will be consumed by way of a depreciation charge. Additionally, the assets will also be subject to impairment testing. Accordingly, PPE are carried in the balance sheet at their historical cost.

The IFRS framework permits the use of an alternate accounting model for Day 2 measurement of PPE, viz., the Revaluation Model. USGAAP, on the other hand, prohibits the use of the revaluation model for PPE.

In the following sections, an overview of the revaluation model under IFRS is provided and an attempt is made to address the following questions: What have been the historical developments and rationale adopted by global standard-setters, and what is the current position under prominent GAAPs?

The Position under Prominent GAAPs

USGAAP

The Accounting Principles Board’s Opinion No. 6 (APB Opinion No. 6) issued in October, 1965 (that amended Accounting Research Bulletin No. 43) specifically prohibited the use of current values in subsequent measurement of items of PPE except under specified situations. The relevant extract is provided herein below:

Chapter 9B – Depreciation on Appreciation: The Board is of the opinion that property, plant and equipment should not be written up by an entity to reflect appraisal, market or current values which are above cost to the entity. This statement is not intended to change accounting practices followed in connection with quasi-organisations or reorganisations.

Extant USGAAP does not permit the use of the revaluation model for subsequent measurement of PPE. ASC 360, Property, Plant and Equipment requires items of PPE to be measured subsequent to initial measurement by accounting for depreciation (on cost) and for any impairment losses. [ASC 360-10-35]

IFRS

Current Position

Under IFRS, in measuring PPE subsequent to initial recognition, an entity can choose either the cost model or the revaluation model as its accounting policy. The measurement basis is therefore a function of the policy choice.

The IFRS Conceptual Framework defines a measurement basis as an identified feature of an item being measured in the financial statements. With respect to assets, a historical cost measure provides monetary information using information derived, at least in part, from the price of the transaction or other event that gave rise to them. In contrast with current value measures, historical cost does not reflect changes in values, except to the extent that those changes relate to impairment. On the other hand, current value measures (e.g., fair value) provide monetary information about assets using information updated to reflect conditions at the measurement date.

Information provided by measuring assets at fair value is perceived to have predictive value since it reflects the market participants’ current expectations about the amount, timing and uncertainty of future cash flows.

 

The conditions specified by IAS 16 that need to be complied with by an entity that opts to use the revaluation model are:

* If an entity elects to use the revaluation model, it needs to apply the same for an entire class (grouping of assets with similar nature and use) of PPE,

* The model can be used only for items for which fair value can be measured reliably,

* Revaluations should be made with sufficient regularity to keep the values of PPE current in the balance sheet, and

* If an item of PPE is re-valued, the entire class of PPE to which the asset belongs should be re-valued.

Revaluation gains being unrealised in nature are recognised in other comprehensive income and are never recycled to the income statement. The IFRS Conceptual Framework states: The accounting process of revaluation of PPE gives rise to increases or decreases that in effect meet the definition of income and expenses. However, they are not included in the Statement of Profit and Loss under certain concepts of capital maintenance and instead, are included in equity as capital maintenance adjustments (revaluation reserves). [IFRS Conceptual Framework 8.10]

The revaluation surplus included in equity is permitted to be transferred directly to retained earnings when the asset is derecognised. This may involve transferring the whole of the surplus when the asset is retired or disposed of and some of the surplus may be transferred as the asset is used (the amount of the surplus transferred would be the difference between depreciation based on the re-valued carrying amount and depreciation based on the asset’s original cost).

 

Historical Developments

Under the International Accounting Standards framework (now IFRS), IAS 16 Accounting for Property, Plant and Equipment was issued in 1982. The standard permitted the use of re-valued amounts as a substitute for historical cost. However, these amounts were not necessarily based on fair value, a measurement base that had yet to gain traction in the accounting arena. The re-valued amounts could be on any valuation basis subject to the cap that they could not breach the recoverable amount.

The standard underwent a re-haul in 1993 (with an effective date of 1st January, 1995) where fair valuation was introduced in connection with revaluation accounting. Fair value as defined then was based on arm’s length pricing in an exchange transaction. It may be noted that the fair value concept under IFRS has since developed and now has a new definition courtesy IFRS 13 that is based on the notion of an exit price. Recoupment of additional depreciation (on account of revaluation) through the profit and loss account was not permitted.

In 2003, IAS 16 was amended whereby a condition was attached: an entity could opt for the revaluation model only for items of PPE whose fair value could be measured reliably. Under the previous version of the standard, the use of re-valued amounts did not depend on whether fair values could be reliably measured.

Ind AS

Indian Accounting Standards (Ind AS 16, Property, Plant and Equipment) is aligned with its IFRS counterpart IAS 16 in the area of revaluation accounting.

 

AS

AS 10 – Accounting for Fixed Assets issued in 1985 permitted the usage of revaluation amounts that were in substitute of historical cost. Relevant extracts from that standard are provided herein below:

* A commonly accepted and preferred method of restating fixed assets is by appraisal, normally undertaken by competent valuers. Other methods sometimes used are indexation and reference to current prices which when applied are cross-checked periodically by appraisal method.

* It is not appropriate for the revaluation of a class of assets to result in the net book value of that class being greater than the recoverable amount of the assets of that class.

* An increase in net book value arising on revaluation of fixed assets is normally credited directly to owner’s interests under the heading of revaluation reserves and is regarded as not available for distribution. A decrease in net book value arising on revaluation of fixed assets is charged to profit and loss statement.

The standard was revised in 2016 and AS 10, Property, Plant and Equipment was notified on 30th March, 2016 and is similar to Ind AS in many aspects but with some conceptual differences, viz.,

1)  Fair value under the AS Framework is the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm’s length transaction unlike Ind AS where it is based on the notion of an exit price (Ind AS 113, Fair Value Measurement), and

2)  In the absence of the concept of OCI, revaluation surpluses are directly credited to shareholder’s funds without routing them through total comprehensive income.

IFRS for SMEs

Section 17, Property, Plant and Equipment of extant IFRS for SMEs states that ‘An entity shall choose either the cost model or the revaluation model as its accounting policy’. [Section 17.15]

The IFRS for SMEs Framework issued by the IASB required the cost model to be used for subsequent measurement of PPE until 2017. The IASB, in 2015, made amendments that introduced the accounting policy option to use the revaluation model in acknowledgement of the fact that not allowing the revaluation model was the single biggest impediment to adoption of the accounting framework in some jurisdictions. This amendment was made effective from 1st January, 2017.

 

US FRF for SMEs

The Financial Reporting Framework for Small- and Medium-Sized Entities (FRF for SMEs), a self-contained financial reporting framework not based on USGAAP issued by the AICPA, does not permit the use of the revaluation model for Day 2 measurement of PPE.

Chapter 14, Property, Plant and Equipment of the Framework states that it does not deal with special circumstances in which it may be appropriate to undertake a comprehensive revaluation of assets and liabilities of an entity [i.e., New Basis (Push-Down) Accounting].

In Conclusion

The attribution of current values to items of fixed assets (PPE) continues to be a contentious issue in the accounting world. There is a lack of consensus among prominent GAAPs. While some accounting frameworks have permitted revaluation as an option focusing more on the relevance characteristic of items in the financial statements, other frameworks that do not permit such revaluations continue with their unwavering focus on the reliability aspect.

Compared to USGAAP, there is greater flexibility to incorporate current values for PPE under IFRS.

3. Global Annual Report Extracts: ‘Reporting on External Audit Process Effectiveness’

Background

The UK Corporate Governance Code issued by the FRC requires Audit Committees to report on the effectiveness of the external audit process in the Annual Report. This reporting obligation is contained in Section 4, Principle N, Provision 26 of the Code (extracted below):

Section 4 – Audit, Risk and Internal Control

Principle N – The board should establish formal and transparent policies and procedures to ensure the independence and effectiveness of internal and external audit functions and satisfy itself on the integrity of financial and narrative statements.

Provision 26 – The annual report should describe the work of the audit committee, including:

* an explanation of how it has assessed the independence and effectiveness of the external audit process…

Extracts from an Annual Report

Company: BODYCOTE plc. (FTSE 250 Constituent, 2019 Revenues – GBP 720 million)

Extracts from the Report of the Audit Committee

 

External Audit – Assessment of Effectiveness

The Committee has adopted a formal framework for the review of the effectiveness of the external audit process and audit quality which includes the following aspects:

* assessment of the engagement partner, other partners and the audit team,

* audit approach and scope, including identification of risk areas,

* execution of the audit,

* interaction with management,

* communication with and support to the Audit Committee,

*insights, management letter points, added value and reports, and

* independence, objectivity and scepticism.

An assessment questionnaire is completed by each member of the Committee, the Group Chief Executive and Group Chief Financial Officer and other senior finance executives. The feedback from the process is considered by the Audit Committee and provided to the external auditor and management. The full formal questionnaire is completed every three years with key areas being completed every year.

The Committee considered the FRC Audit Quality Review report on PWC dated July, 2019. If the audit is selected for quality review, the Committee understands that any resulting reports will be sent to the Committee by the FRC. After considering the above matters, the Committee felt that the external audit had been effective.

4. COMPLIANCE: Presentation of Other Comprehensive Income

Background

Under the Ind AS framework, other comprehensive income (OCI) comprises items of income and expense that are not recognised in the Statement of P&L as required or permitted by other Ind AS’s. Examples of OCI include PPE revaluation surplus, re-measurement of employee-defined benefit plans and gains / losses arising from translating the financial statements of a foreign operation.

An entity needs to take into consideration relevant requirements of Ind AS1, Presentation of Financial Statements in complying with the related disclosure and presentation requirements.

The same is summarised in Table A (on the following page):

Table A: Presentation and Disclosure Requirements (OCI)

¹ Amounts
previously recognised in other comprehensive income that are reclassified to
P&L in the current reporting period

5.  INTEGRATED REPORTING

a) Key Recent Updates

IIRC: Revisions to the International <IR> Framework

On 19th January, 2021, the International Integrated Reporting Council (IIRC) published revisions to the International <IR> Framework that: (a) focuses on simplification of the required statement of responsibility for the Integrated Report; (b) provides improved insight into the quality and integrity of the underlying reporting process; (c) makes a clearer distinction between outputs and outcomes; and (d) lays greater emphasis on the balanced reporting of outcomes and value preservation and erosion scenarios.

 

GRI: Three New and Updated Standards Effective 2021

Companies disclosing their impacts through sustainability reporting standards are required to adhere to three new and updated GRI standards for reports they publish effective 1st January, 2021, viz., (1) GRI 207: Tax 2019 – A new standard that enables organisations to better communicate information about their tax practices with a focus on transparency on the tax contribution they make to the economies in which they operate; (2) GRI 403: Occupational Health and Safety 2018 – An updated standard that represents global best practice on reporting about occupational health and safety management systems, prevention of harm and promotion of health at work; and (3) GRI 303: Water and Effluents 2018 – An updated standard that provides a holistic perspective on the impact organisations have on water resources and considers how water is managed, inclusive of impact on local communities, and provides a full picture of water usage, from withdrawal to consumption and discharge.

b) Reporting Organisational Strategy and Drivers of Value Creation

Background

The primary purpose of an Integrated Report is to explain to providers of financial capital how an organisation creates value over time. One of the Guiding Principles of the International <IR> Framework is Strategic Focus and Future Orientation: An integrated report should provide insight into the organisation’s strategy and how it relates to the organisation’s ability to create value in the short, medium and long term and to its use of and effects on the capitals. [Para 3.3, Part II]

Extracts from Integrated Report of CAPGEMINI SE [Listed: Euronext Paris]

Our Group is built on five strategic pillars:

1.  Be the Preferred Partner for our client’s transformation and growth challenges.

2.  Invest in our employees, who are our most valuable assets.

3.  Roll out a balanced portfolio of innovative offerings.

4.  Innovate by mobilising an ecosystem of strategic partners.

5.  Strengthen our impact as a responsible company.

Our Value Creation: Using our operational excellence, innovative assets and added-value partnerships, we link technology, business and society to deliver sustainable value to all stakeholders.

Our Drivers of Value Creation:

Passionate and committed talents:

* Seven core values.

* A continuous entrepreneurial spirit.

* Ethical conduct at all times.

* CSR stakes at the heart of our decisions.

Motivating development paths:

* The recruitment of the best talents.

* Recognised knowhow in particular in the design and management of complex technological programmes addressing business challenges.

* The development of tomorrow’s skills.

* Regular training courses adapted to each employee.

A global ecosystem of research and innovation:

* A global technology and innovation network, including 15 Applied Innovation Exchanges (AIE) to co-innovate with our clients.

* Euro 160m cash invested in digital and innovation acquisitions.

An agile organisation:

* Global delivery model.

* Proven expertise in the allocation of talents and skillsets.

* Global Quality Management System.

* A hub of more than 110,000 employees in India.

 

6. FROM THE PAST – ‘The Theory of Why Strong Mandatory Disclosures Drive Capital Formation is Straightforward’

Extracts from a speech by Luis A. Aguilar (then Commissioner, US SEC) at the Annual Conference of the Consumer Federation of America in December, 2013 is reproduced below.

‘It is investors who are the real “job creators” in our economy. As such, it is in the country’s best interest that we ensure that there is an investment environment that works for investors, particularly the retail investors that live and work on Main Street.

Facilitating true capital formation means making sure that investors have the information needed to make informed decisions. The goal is for issuers to provide potential investors with appropriate and sufficient information so that investors can assess the risks and potential rewards of investing their capital. True capital formation is about ensuring that the companies with the best ideas, even if those ideas are risky, can get the financing they need to make those ideas a reality.

For that goal to be reached, the research makes it clear that we need strong and effective securities regulation that fosters appropriate disclosures.

The theory of why strong mandatory disclosures drive capital formation is straightforward. Disclosures improve the accuracy of share prices and help to determine which business ventures should receive society’s limited capital.’