Soon to be published research conducted for the Australian Accounting Standards Board (AASB) suggests that we may be about to enter a new era for statutory reporting by large private (or proprietary) companies (LPCs). CPA Australia plans an extensive direct engagement with members to help inform our position and we think now is a good time for you to start thinking about possible implications of any change to share with us. By sketching out the “known knowns” this article provides some information that would be helpful to that process. And to do that effectively, the article includes a discussion of some developments that took place in the 1990s which are particularly relevant today.
In 1994, something happened that changed the statutory reporting by Australian private companies. At that time it was thought to be a change forever. The Corporations Law Simplification Taskforce, a committee within the Attorney-General’s Department, produced the First Corporate Law Simplification Bill.
Today, as a result of amendments to the Corporations Law (now Act) from that Bill, only public companies (listed and unlisted), LPCs and some foreign controlled small propriety companies are required to prepare, and have audited, financial statements for lodgement with Australian Securities and Investment Commission (ASIC). Consequently, over 98 per cent of companies are exempted from preparing statutory financial statements.
The 1994 decision has transformed private companies’ financial reporting.
However, the soon to be published AASB research report suggests that we are about to enter a new transformation phase. Pending the final research report, the minutes to the AASB meeting of 10 April 2013 identify some areas of concern to the AASB. So what are the issues that need fixing; how did we get to this situation; and who is responsible for fixing them? The AASB minutes answer the “what” question and are summarised below. Below, a more discursive approach is taken to answering the “how” and “who” questions.
What are the issues identified as needing fixing?
The April 2013 minutes describe the issues that need fixing in this way:
- “In light of the high incidence of [Special Purpose Financial Statements] SPFSs amongst lodged financial statements, there is doubt as to whether the reporting entity concept is being applied as intended by SAC 1 Definition of the Reporting Entity in identifying entities that should prepare [General Purpose Financial Statements] GPFSs.”
- “A proportion of SPFSs lodged with [ASIC] appear not to have applied the recognition and measurement requirements of all applicable Australian Accounting Standards.”
- “The exemption from lodgement of financial statements of grandfathered [LPCs] does not stem from accounting standards, if any changes were made to the lodging requirements applicable to such entities, they would need to arise from legislative change.”
How did we get to this situation?
As part of the changes to the law in 1994, an important distinction was made as to whether a private company had to prepare and lodge financial statements. Parliament adopted a statutory quantitative size test rather than the accounting profession’s qualitative reporting entity test (where reporting entities produce GPFSs which by definition apply all accounting standards and non-reporting entities produced SPFSs which by definition apply Accounting Standards AASBs 101, 107, 108 and 1031 and a “pick and choose” process to applying all other accounting standards).
So since 1994 we have had a system whereby private companies first apply the statutory quantitative size test to determine if they are large. If they are determined to be so, they then apply the profession’s qualitative reporting entity test to determine whether they are required to prepare GPFSs or SPFSs.
Inter alia, the research commissioned by the AASB uses size thresholds and debt data to examine whether LPCs are appropriately applying the profession’s qualitative reporting entity test. The quantitative research asserts that the high incidence of SPFSs (80 per cent) and the low level of GPFSs (20 per cent) indicates that “…the reporting entity concept, as a means of differentiating between the entities that should prepare GPFSs and those that need not, is not being applied as envisaged under SAC 1.”
This assertion is not supported by ASIC. While the findings from the ASIC review of the financial reports of 200 private companies identify a similarly high incidence of SPFSs (75 per cent), its position is somewhat different. ASIC notes that while many of the companies reviewed satisfy quantitative size tests, the critical test for determining what is required when preparing the statutory reports continues to be the profession’s qualitative reporting entity concept: “Preparers of financial reports should have regard to SAC 1…in identifying potential users of financial reports”.
Readers may be surprised by the assertion of the AASB research. Typically, an accountant understands that the reporting entity concept is a qualitative test that focuses on the substance of the entity and not its form. Therefore, a LPC should only prepare financial statements that are GPFSs when its judgement is that it is reasonable to expect the existence of dependent users of GPFSs. Otherwise it will prepare SPFSs. As already mentioned, the distinction is important. SPFSs generally have fewer disclosures than GPFSs, with preparers applying Accounting Standards AASBs 101, 107, 108 and 1031 and determining what if any other disclosures are relevant. Further, some preparers of LPC SPFSs hold the view that in applying professional judgement they can “pick and choose” measurement standards.
The AASB (Agenda paper 9.2 February 2013) maintains that there are indications that the recognition and measurement requirements of applicable accounting standards have not rigorously been followed by LPCs that prepare SPFSs, notwithstanding the requirements of the ASIC Regulatory Guide (RG) 85 Reporting requirements for non-reporting entities (July 2005). RG 85 states that all LPCs should comply with the recognition and measurement requirements of accounting standards, whether or not they are reporting entities. While most people might expect the regulator’s view to be very important, it is not the position specifically stated in the four accounting standards that apply to SPFSs. Therefore, it is the judgement of some preparers of LPC SPFSs that RG 85 can be ignored.
The AASB asserts, based on the preliminary findings, that a substantial minority of LPCs do not clearly state application of recognition and measurement requirements of accounting standards. Following their further analysis of the notes to the financial statements the researchers concluded that the extent to which these LPCs applied these requirements remains an open question. This does not mean they are not following the measurement requirements; it is just not clear from the disclosures made what they do. When a LPC says its SPFSs follow Accounting Standards AASBs 101, 107, 108 and 1031 it is very difficult to work out what measurement standards they have followed – especially when they do not provide a lot of disclosures for the applicable standards. ASIC of course had greater access than the researchers to the LPCs and this might explain why the findings of the ASIC review differ from those of the AASB. ASIC states “We raised questions on the accounting treatments of a number of companies and, in most cases, were satisfied with the information and explanations provided. We did not identify any companies that had deliberately chosen not to comply with the recognition and measurement requirements of the accounting standards”.
Who is responsible for fixing what?
Back in 2010 the AASB proposed to remove from its accounting standards the concept of the reporting entity, but deferred the proposals pending further research. Were the AASB to remove the concept with no compensating changes from the Australian Government we would be left with the situation whereby the financial statements of all LPCs would be GPFSs. This would have the effect of increasing disclosures, even if the Reduced Disclosure Requirements (RDR) were adopted. Based on the AASB research, it would also affect those entities “picking and choosing” measurement standards by ….
The minutes of the April 2013 AASB meeting make explicit the need for AASB staff to liaise with the government through Treasury with a view to coordinating the efforts of the AASB and government in dealing with the issues emerging from the research. The AASB expects to release the final research report in the first half of 2014 along with its own paper setting out its assessment of the policy implications of the research conducted. For example, the AASB might take the opportunity to reconsider the place of IFRS for SMEs in Australia (either in conjunction with its Tier 2 Australian Accounting Standards – RDR or as a replacement for it). In April 2010, CPA Australia’s submission to the AASB on its proposals made in ED 192 Revised Differential Reporting Framework noted the absence of published empirical evidence that the current financial reporting requirements had been damaging to business or the Australian public. Further, we did not consider the AASB had made a substantive case to support a change to the reporting entity concept. The soon to be published research of the AASB will provide new insights. In 2010 we opined that as ‘who is required to reports GPFS’ is a matter of policy for lawmakers, any changes in this area need to be undertaken through normal due process mechanisms by those lawmakers. That the AASB plans to develop an ED based on a redeliberation of ED 192 does not change our opinion.