Submission to the Ministry of Economic Development. The Statutory Framework for Financial Reporting

Transcription

1 Submission to the Ministry of Economic Development The Statutory Framework for Financial Reporting 2 February 2010

2 THE STATUTORY FRAMEWORK FOR FINANCIAL REPORTING Introduction 1. This submission responds to the request for submissions in the MED s Discussion Document. 2. I am a chartered accountant and have been practicing as a specialist forensic accountant for 12 years. Prior to establishing my forensic accounting practice, I worked for three of the big four international Chartered Accounting practices in NZ and Australia, followed by twelve years of commercial experience as a Chief Financial Officer with private and public companies in New Zealand. 3. My work typically involves expert evidence in relation to a wide range of accounting and financial matters relating to business management and governance; causation and damages issues relating to business failure and breach of contract; and valuation opinion. I have acted for the Insolvency & Trustee Service, Commerce Commission, Crown Law Office, Auckland District Law Society and have acted as advisor to two Commissions of Inquiry. General Comments On the Issues Raised in the Discussion Document 4. It appears that one of the drivers of the Discussion Document is compliance costs. In my opinion this is overstated. Despite a profusion of new accounting standards over the last 10 years and the introduction of IFRS, we still had a global financial crisis driven as much by inadequate disclosure as poor morals. The accounting profession has favoured complication over simplicity and this has created a significant burden on those with obligations to prepare financial statements. As an example a small NZ professional engineering firm recently adopted IFRS. The number of pages in the annual report increased from 13 to 25, the company paid a one-off cost to their accountants of $15,000 for the work to introduce NZIFRS and their annual audit bill has increased by $3,000. All for no discernable improvement in transparency about their business. The solution is not to waive the production of financial statements but provide a way for most small entities to meet minimum standards of disclosure with minimal external support from accounting professionals. 2

3 5. The cost of preparing financial statements is raised as an issue on several occasions. Most small entities already incur accounting costs associated with GST and tax reporting that is undertaken by an external accountant. The additional cost of moving from the GST/Tax work to completing a set of financial statements is not large between $800 and $1,500, making them one of the smallest expenses that businesses incur. It would be wrong to suggest that some economic benefit might result if a business or charitable entity were able to save $800 or $1,500 on the cost of preparing financial statements. There is no economic advantage in sustaining entities that cannot maintain the basic systems and disciplines involved in preparing a summary of the years activity at least once a year,. 6. The preparation of financial statements involves a commitment to a discipline that underpins general principles of good management. All for-profit entities and many not-for-profit entities go through a process to finalise one year s transactions and start the next. The preparation of financial statements is only a small step further. It is a useful discipline for management, Directors or Trustees to have to draw a line in the sand, prepare a statement setting out what it has done against which the actions of Directors and trustees can be measured. Some examples: a) I do a substantial amount of work on relationship property matters, commonly acting for wives who are typically trying to establish what assets were held by trusts or companies and what changes took place in financial performance or financial position. It is true that such work could be conducted from source records but at a significantly higher cost. And the ability to question the reason for changes in performance, and financial position is lost when the management/directors/shareholders were not required to make any statement about the financial position at any point of time. b) I work on matters involving trusts and trustee-beneficiary disputes. The trustee-beneficiary disputes commonly arise many years after the events complained of. I see no reason why the trustees should be excused of an obligation to account for the assets in their trusteeship and I see no reason that evidence of trusteeship should become a trial balance. 3

4 c) I work for a number of insurance companies that offer Income Protection policies. Those policies typically rely on the insured having the ability to show (at the time of claim) what their structure, financial position and earnings were in any of the 3 years prior to claim. Most of these are owners of small businesses operating through trading trusts and companies with links to family trusts. Disputes can arise several years after a claim was made. There is a significant advantage to both insured and insurer in preparing financial statements. I cannot speak on behalf of the insurance industry but my advice to them currently is to insist on the production of financial statements and that would not change with any of the proposals aimed at eliminating them. d) I work on corporate governance issues involving solvency, reckless trading, phoenix companies together shareholder disputes and matters impacting creditors, liquidations and receiverships. All these issues rest to some degree on the availability of financial statements. It is appropriate that at the end of every year the directors, management and shareholders adopt financial statements setting out the financial position and the financial performance. It is a useful internal discipline and it becomes a benchmark against which subsequent conduct can be measured. I do not agree with any move that removes or further restricts the current obligation to prepare financial reports. 7. Whilst the Discussion Document sees a trial balance as an equivalent to a set of financial statements in my experience the trial balance is an unreliable and contestable document. Trial balances tend to be work in progress one version may sit with the company and another may sit with the external accountant. It is always difficult to establish which version was the basis for financial statements and I see no reason why users of financial statements should be put to the task of establishing the matter when the production of financial statements does it cleanly. 8. For these reasons I am generally not supportive of the proposals in the Discussion Document to remove the requirement for entities to prepare financial statements. And if they are concerned about the integrity of the tax base, the IRD should not be supportive either. 4

5 9. I respond as follows to the questions raised in the Discussion Document. Institutions and statutory responsibilities (Part 3) I have no comments on Part 3 Financial reporting principles and indicators (Part 4) General Comments Q3 What comments do you have on the Primary Principle and the Indicators of financial reporting? Should any other principles and/or indicators be considered? In my opinion the Primary Principle is too narrow and ignores important other users. It is an academic construction to suggest that financial statements are produced for external users who are unable to demand them. The major users of financial reports in small companies & trusts are the people directly involved in them as management, shareholders and directors, trustees and beneficiaries. The Discussion Document (Part 5) concludes that 98% of companies would be eliminated by the application of 2 indicators. But all this provides evidence of is the importance of small companies to the fabric of New Zealand. Those 98% of companies (I assume this also captures trading trusts) employ a substantial proportion of the workforce, pay a considerable amount of tax and represent the financial wealth of a significant proportion of New Zealanders. The primary indicators need to be amended so as to be more representative of NZ s SME sector. Q4 What comments do you have on our broad conclusions in relation to preparation, publication and distribution; and assurance? I agree with the proposal Issuers and public sector non-profit entities should be required to prepare and publish GPFR I agree with the proposal 5

6 I agree with the proposal where small (Expenses < $20,000) should not be require to prepare financial statements I agree with the proposal. Unincorporated private non-profit entities which have charitable purposes are not required currently to prepare financial statements and there is little to be gained by a change I do not agree with the opt-out provisions for entities with a significant degree of separation between management/owners. Those to gain from the preparation of financial statements are often minority shareholders or users whose need is not immediately apparent I do not agree with the absence of reporting requirements for all other entities. I have already set out my reasons. The application of the indicators to for-profit entities (Part 5) Q5 What comments do you have on the tests (annual income, total assets and employee numbers) for determining whether a for-profit entity is economically significant? What comments do you have on the two-out-of-three test or the alternative revenue plus one other approach outlined in Section 5.3.1? What comments do you have on the current thresholds of $20m revenue, $10m assets and 50 FTE employees? I have no comments on these proposals as I disagree that such basic indicators can eliminate financial reporting requirements from 98% of NZ companies. Q6 What comments do you have on the proposal to make no changes to the filing requirements for companies with 25% or more overseas ownership? I agree that no changes should be made in these filing requirements Q7 What comments do you have on the proposal to remove filing requirements for overseas-incorporated companies whose New Zealand businesses are not large? 6

7 I do not agree with the proposal to introduce a size indicator and remove the requirement for overseas companies to file financial statements. In my opinion all overseas owned companies should file financial statements. The obligation is not excessive the time and costs of filing are not significant. Companies invest here because of the economic benefits that attach to their investment and a filing requirement is a small cost. Those that advocate non-filing see a benefit in secrecy, not costs. The filing requirement gives a small measure of public accountability which is a fair trade-off for a very liberal overseas investment regime. Q8 & Q9 The opt-in/opt-out and non preparation/opt-in proposals. I do not agree with the proposals that allow entities to opt out of preparing financial statements for the reasons already set out. Q10 What comments do you have on the proposal to remove the requirement for medium and small companies to prepare GPFR? What are the compliance cost implications? I do not agree with the proposals to remove the requirement for medium and small companies to prepare GPFR for the reasons already set out. Q11 & Q12 - the grandfathering provisions, exempting existing large companies at the time of the law change, from lodging financial statements with ASIC? I do not agree with the grandfathering requirement. The financial statements will have been prepared and all that is being asked that they be filed. The fact that such companies have not been required to file in the past, is not a reason to continue that practice. If we have decided that it is appropriate to file, then filing should be required. 7

8 The application of the indicators to public sector entities (Part 6) I have no comments on Part 6 other than agreeing with the requirement that public sector entities continue to publish GPFR. The application of the indicators to private non-profit entities (Part 7) Q15 What comments do you have on the proposal to use annual operating expenditure as the means for determining whether a private non-profit entity is small, medium or large? I agree that operating expenditure is an appropriate way to identify small non-profit entities. Q16 What comments do you have on the proposals to use annual operating expenditure of $20,000 and $20 million as the cut off points between small and medium, and medium and large respectively? If you consider that other criteria should be used, what are those criteria and what cut-off points should be used? I agree with the application of $20,000 and $20m as cut-off points Q 17 What comments do you have on the proposal that financial reporting obligations outlined in this Part would not apply to gaming machine societies? In my experience the line between private benefit and public purpose is not always clear. I am aware that other legislation covers this sector but I see no reason why an exception be made for gaming machine entities that would allow them to be excluded from whatever regime is adopted for other entities. If we want the new regime to apply to all entities, why create an exception for a particular industry? Q18 What are your views on the preparation, distribution, publication and assurance proposals appearing in Part 7.6 and the Appendix insofar as it relates to private non-profit entities? 8

9 I generally concur with the proposals with the exception that I do not think that gaming machine societies be excluded. The application of the indicators to Maori asset governance entities (Part 8) Q19 What are your views on the proposal to make no changes in relation to Maori trust boards? I agree that no change should be made Q20 What are your views on the proposals appearing in Part in relation to Maori incorporations as summarised in Part 8.4? I disagree with the proposals. There is currently a requirement to prepare financial statements. I would have thought that shareholders in the incorporations would continue to expect good governance and to have some evidence of it, by way of financial statements. Q21 What are your views on the proposal to make no changes in relation to Maori reservations? I agree with the proposals Q22 What are your views on the proposal for the Maori Land Court to continue to have the responsibility for setting financial record keeping and reporting obligations for Maori land trusts? I disagree that requirements for record keeping and reporting issues be left to any Court. Maori will have a sense of the importance of good governance, the good disciplines that come with record keeping and the disciplines and protections that come with the requirements to prepare financial statements. The obligations of trusteeship are no less than those burdens on any trustee and in my opinion the Discussion Document should have been prepared to set those boundaries. Courts should have to involve themselves with matters of legal principle, not administration. 9

10 Q23 What are the advantages and disadvantages of requiring economically significant Maori land trusts to publish GPFR? I have no comments Consequential issues (Part 9.1) Q24 What are your views on the advantages and disadvantages of giving assurance standards the force of law? I have no current audit experience, but I see the results of poor audit work, where the auditors suspended professional judgment to assist a longstanding client. I support giving standards the force of law. Q25 What are your views on the proposal to make it an offence to unduly influence, coerce, manipulate or mislead an auditor? I am not sure that there is any evidence that auditors are being unduly influenced, coerced or manipulated or that any financial failures have been caused or assisted by any influence, coercion or manipulation. But there is little downside from creating the offence. It would be reasonable to make it an offence to mislead an auditor, but I would not expect that this would then become a defence for the auditor who had failed to conduct a proper process. Q26 What are your views on the proposal to make it an offence to recklessly or knowingly include false or deceptive matters in an audit report? I am not aware of any evidence that audit reports contain false or deceptive matters. If they are wrong, then they are generally wrong at their core and gave assurance when none was justified. But there is little downside from creating the offence. Q27 What are your views on the proposal to introduce a requirement to change statutory monetary thresholds within a certain time period? What are your views on the ten year proposal? 10

11 The 10 year timeframe appears appropriate Q28 What are your views on the proposals appearing in Part concerning the three exemption powers? I agree with the proposals Q29 What are your views on the proposed change to the solvency test? I disagree with the proposals and recommend that the solvency test not be changed. The solvency test supports a discipline that is useful for both management, Directors and their financial advisers. The trial balance is not a substitute for financial statements and it is absurd to suggest that a trial balance provides important information about whether the company is solvent. The financial statements provide clear statements about working capital, debt and equity against which it is possible to assess Director s actions. The solvency test has been operating for a considerable period of time and I have not heard any complaints about the financial statements needed to support it. Why change something that is not broken? Other issues (Part 9.2) Q30 Do you consider that the parent company preparation and filing requirements should be retained, modified or removed? What are the compliance cost implications? In my own work (and as a financial accountant working in the private sector) I use parent company financial statements and find them a useful source of information. Q31 Assuming the parent company requirements were to be modified, what modifications should be made? Is there a problem that requires change? The parent company will have prepared financial statements and I do not see that the filing obligation 11

12 is onerous and what they should not be filed. They provide valuable information. Q32 What are your views on the proposal to require contributory mortgage brokers and the broker s nominee company to make GPFR available to investors? I agree with the proposal. Q33 Do you consider that the filing deadline for entities with publication requirements should be reduced? What are your views on the IMF suggestion of four months? I have no comments on the proposals Q34 What are your views on the issues relating to remuneration disclosures for key management personnel? I support the Australian approach. Investors will be provided with more useful information about senior management rather than the snapshot of the entire organisation that is presently provided for. New Zealand-Australia Single Economic Market (Part 11) Q35 Do you have any comments on the proposals appearing in this document from Single Economic Market perspective? I have no comments on the proposals. MED s proposals for each class of entity (Appendix) Q36 Do you have any comments on the proposals in the table in the Appendix? I have already set out my comments where appropriate. 12