FINANCIAL REPORTING DOSSIER

This article
provides (a) key recent updates in the financial reporting global space;
(b) insights into an accounting topic, viz. convenience translation; (c)
compliance aspects of transition disclosure under Ind AS 116 from the
lessee’s perspective; (d) a peek into an international reporting practice in
the Auditor’s report; and concludes with (e) an extract from a
regulator’s speech from the past on MD&A disclosure

KEY RECENT UPDATES

Revised International Standard on Auditing (ISA 315)

On 19^th December, 2019 the IAASB issued ISA 315 (Revised
2019), Identifying and Assessing the Risks of Material Misstatement.
ISA 315 (Revised) sets out enhanced requirements and application material
to support the auditor’s risk assessment process. The revised ISA has enhanced
requirements related to exercise of professional scepticism,
separate focus on understanding the applicable financial reporting
framework, clarifications on which controls need to be identified
for the purposes of evaluating the design of a control, and determining whether
the control has been implemented and also considerations for using automated
tools and techniques incorporated within the application material of the standard.
A new Appendix (Appendix 6) has also been added to provide the auditor with considerations
for understanding general IT controls.

The revised ISA is
effective for audits of financial statements for periods commencing on or after
15^th December, 2021.

SEC Guidance on Reporting KPIs and Metrics in MD&A

On 30^th January, 2020 the US SEC issued a Guidance on
Management Discussion and Analysis (MD&A) related to disclosure of
Key Performance Indicators (KPIs) and metrics. SEC registrants are required to
discuss and analyse statistical data in the MD&A section that in the
company’s judgement enhances a reader’s understanding. Such information could
constitute KPIs and other metrics.

The SEC, based on
the issued guidance, expects the following disclosures to accompany the metric:
(i) a clear definition of the metric and how it is calculated, (ii) a
statement indicating the reasons why the metric provides useful information
to investors, and (iii) a statement indicating how management uses the
metric in managing or monitoring the performance of the business. A company
should also consider whether there are any estimates / assumptions underlying
the metric or its calculation and whether disclosure of such items is necessary
for the metric not to be materially misleading.

It may be noted
that examples of metrics to which the guidance applies include operating
margin, same store sales, sales per square foot, average revenue per user,
active customers, total impressions, traffic growth, employee turnover rate, number
of data breaches, etc.

USGAAP – Simplifying the Accounting for Income Taxes

The FASB issued
Accounting Standards Update (ASU) No. 2019-12 in December, 2019, Simplifying
the Accounting for Income Taxes, amending Topic 740, Income Taxes.
The ASU makes a number of amendments and is part of the FASBs USGAAP
simplification initiative. One such amendment relates to intra-period tax
allocation.

Intra-period tax
allocation is the process of allocating income tax expense (or benefit) to
components of income statement, i.e. continuing and discontinuing operations,
other comprehensive income and equity. Under extant USGAAP, the general
accounting principle is that an entity determines the tax expense / benefit for
continuing operations and then proportionally allocates the remaining tax
expense / benefit to other items. USGAAP made an exception to this general
principle in a situation when there was a loss in continuing operations and a
gain / surplus in OCI / discontinuing operations. The ASU has removed the exception
and the amended position is that ‘the tax effect of pre-tax income or
loss from continuing operations should be determined by a computation that does
not consider the tax effects of items that are not included in continuing
operations’. This has an impact in situations when income from
continuing operations is subject to a tax rate that is different from the tax
rate applicable to chargeable / capital gains on discontinued operations / OCI.

The amendment is
effective for public companies for fiscal years commencing 15^th
December, 2020. It may be noted that IFRS (IAS 12, Income Taxes) does
not explicitly provide guidance on such intra-period tax allocation.

RESEARCH: CONVENIENCE TRANSLATION

Introduction

Convenience
translation is ‘a display of financial statements or selected
portions of financial statements in a currency other than the
presentation currency, as a convenience to some users’.

Setting the
Context

An analysis of a
sample of four companies’ data based on their annual reports filed with the US
Securities Exchange Commission (SEC) is provided below.

It may be noted
that the ‘functional currency’ is the currency of the primary
economic environment in which an entity operates.

The ‘presentation currency’ (or the reporting currency) is the
currency in which the financial statements are presented.

As can be seen from
the above table, Company 1 presents its financial statements in RMB although
its functional currency is US$. It also presents US$ figures for the latest
financial year based on a convenience translation converting all balance sheet
and income statement items at the year-end exchange rate.

Company 3 and 4
are India listed entities whose functional currency is the INR. Company 4 presents
its financial statements in US$ (applying IAS 21) while the other company
presents its financial statements in INR with a convenience translation of only
the current period figures in US$ [based on year-end exchange rate (applying
SEC Regulation S-X)].

In the following
sections an attempt is made to address the following questions:

1.  What is the current position with respect to
convenience translation under prominent GAAPs?

2.  Is there consistency among GAAPs with respect
to convenience translation?

3.  Is there a difference between displaying
financial statements in a presentation currency (that is different from an
entity’s functional currency) and convenience translation of financial
statements?

4.  Is convenience translation an option or mandatory
for a US listed entity?

5.  Why do entities adopt convenience translation
if it is optional?

The position
under prominent GAAPs

US GAAP

USGAAP does not
contain any guidance on convenience translation. Even the SEC
regulations do not permit full-fledged convenience translations for foreign
private issuers (FPIs) with the exception of a ‘limited convenience
translation’.

The Accounting
Standards Codification (ASC 830) that covers the accounting topic Foreign
Currency Matters in USGAAP states that, ‘this topic does not cover
translation of the financial statements of a reporting entity from its
reporting currency into another currency for the convenience of readers
accustomed to that other currency’. (ASC 830-10-15-7).

US-listed
entities that are subject to SEC regulations may
at their option present convenience translation of financial statements.
The salient aspects of the said rule [Regulation S-X, Rule 3-20 (b)] are
summarised below.

a.  An FPI shall state amounts in its
primary financial statements in the currency which it deems appropriate.

b. If the reporting currency is not the US
dollar, dollar-equivalent financial statements or convenience translations
shall not be presented, except a translation may be presented of the
most recent fiscal year and any subsequent interim period presented using
the exchange rate as of the most recent balance sheet, except that a rate
as of the most recent practicable date shall be used if materially different.

IFRS and Ind AS

IAS 21 The
Effects of Changes in Foreign Exchange Rates permits an entity to present
its financial statements in any currency or currencies.

IFRS also does not prohibit an entity from providing, as
supplementary information, ‘a convenience translation’. Such a
‘convenience translation’ may display financial statements (or selected
portion of financial statements) in a currency other than the presentation
currency as a convenience to some users. The ‘convenience translation’ may be
prepared using a translation method other than that required by the
Standard. These types of ‘convenience translations’ should be clearly
identified as supplementary information to distinguish them from information
required by IFRSs and translated in accordance with IAS 21 (para 57 and BC14).

The position under IND
AS 21 The Effects of Changes in Foreign Exchange Rates is the same
as under IAS 21.

AS

AS 11 The
Effects of Changes in Foreign Exchange Rates does not contain any explicit
guidance with respect to ‘convenience translation’. It also does not prohibit use
of a currency other than the currency of country of domicile as the reporting
currency:

Conclusion

At present there is
no consistent principle underlying the preparation and presentation of financial
statements applying convenience translation across GAAPs. USGAAP and AS do not
contain explicit guidance on this topic. IFRS (and Ind AS) does permit
convenience translation, albeit it does not contain the prescriptions
available when financial statements are translated into a presentation currency
(other than the functional currency). The SEC regulations provide the
methodology to be adopted for presenting convenience translation figures that
is very limited in scope.

Presenting
financial statements in a presentation currency (both under IFRS and USGAAP)
requires standard procedures to be adopted (with balance sheet items being
translated at closing rate and income statement figures at average rates and
resultant exchange differences accounted in other comprehensive income).
Convenience translation, on the other hand, under SEC regulations requires all
items in the balance sheet and income statement to be translated at closing
rate (with no comparatives). Some entities that have dual listing status opt for
providing additional information by way of such a translation for the
convenience of their investors. A summary of the case studies is provided in
the table below:

GLOBAL ANNUAL REPORT EXTRACTS: ‘APPLICATION OF
MATERIALITY’ IN
AUDIT REPORT

Background

Unlike SA 701 in
the Indian context, International Standard on Auditing (UK) 701 Communicating
Key Audit Matters in the Independent Auditor’s Report issued by the
Financial Reporting Council (FRC), UK also deals with the auditor’s
responsibility to communicate other audit planning and scoping matters
in the auditor’s report (paragraph 1-1).

As per para 16-1 of
ISA (UK) 701, Communicating other Audit Planning and Scoping Matters,
the auditor’s report is required to provide:

1   An explanation of how the auditor applied
the concept of materiality in planning and performing the audit. Such
explanation shall specify the threshold used by the auditor as
being materiality for the financial statements as a whole

2   An overview of the scope of the audit
including an explanation of how such scope: addressed each Key Audit Matter
relating to one of the most significant risks of material misstatement
disclosed and was influenced by the auditor’s application of the materiality
disclosed

It may be noted
that ISA (UK) 701 that was effective 2016 has undergone a revision in November,
2019 (further updated in January, 2020) and amendments require the auditor’s
report to specify the threshold used by the auditor as being materiality
for financial statement as a whole and performance materiality, and
to also provide an explanation of the significant judgements made by the
auditor in determining materiality and performance materiality. The revised ISA
is effective for audits of financial statements for periods commencing on or
after 15^th December, 2019.

Extracts from an
Independent Auditor’s Report

Company:
Whitbread PLC (2018/19 revenues: GBP 2.05 billion, FTSE 100)

Our Application of Materiality

We define
materiality as the magnitude of misstatement in the financial statements that
makes it probable that the economic decisions of a reasonably knowledgeable
person would be changed or influenced. We use materiality both in planning the
scope of our audit work and in evaluating the results of our work. Based on our
professional judgement, we determined materiality for the financial statements
as a whole as follows (refer to the table below):

We agreed with the Audit Committee that we
would report to the Committee all audit differences in excess of GBP
1.25 m (2018: GBP 1.3 m), as well as differences below that threshold that,
in our view, warranted reporting on qualitative grounds. We also report to the
Audit Committee on disclosure matters that we identified when assessing the
overall presentation of the financial statements.

COMPLIANCE: TRANSITION
DISCLOSURE UNDER IND AS 116

Background:

Ind AS 116 Leases became effective from 1^st April,
2019. The ensuing fiscal year ending 31^st March, 2020 financial statements of Ind AS preparers need to
incorporate disclosures mandated
by Appendix C – Effective Date and Transition of Ind AS
116.

The disclosure requirements from the lessee’s perspective is a
function of the transition option elected and a
ready reference to the same is provided in the table given below: (Disclosures – A Referencer)

FROM THE PAST – ‘DISCLOSURES ARE DRIVEN BY WHAT INVESTORS
WANT TO KNOW’

Extracts from a
speech made by Elisse B. Walter (former Commissioner, US SEC) at the
Stanford Directors’ College meeting in June, 2013 are reproduced below:

‘Regulations
are the floor but not the ceiling. They tell
companies what, at a minimum, should be covered, but it’s up to the company to
make sure the story gets told. That’s where MD&A
(Management’s Discussion and Analysis) becomes a real opportunity for
the company to tell shareholders what’s really going on. No MD&A
should be merely a recitation of the financial statements. Give
investors the when, the where, the why and, perhaps most importantly, the what’s
next. You should address your investors like they are your business
partners, and the MD&A should reflect that perspective. Disclosure isn’t driven
by what the company wants to disclose but by what the investors want to know.
That should be front and centre as you review the MD&A.

Ask yourself, what do I know about the company’s
performance that cannot be reasonably inferred from the financial statements?
You are the investor’s voice and as the company’s stewards, you should also be
their advocate as well. You play such a crucial role in ensuring that the company’s
true story is told, and that’s the story that investors deserve to
hear.’  

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1   Para BC279, IFRS 16