For-profit entities: disclosing the impact of adopting new standards
Tier 1 for-profit entities, which are those entities reporting under New Zealand equivalents to International Financial Reporting Standards (“NZ IFRS”), are required to disclose the likely impact of adoption of NZ IFRSs that are not yet in effect prior to their adoption of those NZ IFRSs. The Financial Markets Authority (“FMA”) has recently:
- Reminded FMC reporting entities of the need to do this in relation to NZ IFRS 9 Financial Instruments, NZ IFRS 15 Revenue from Contracts with Customers and NZ IFRS 16 Leases (“the new standards”)
- Advised that it will review financial statements in relation to these disclosures.
In addition, the FMA suggested that FMC reporting entities examine the Statement on Implementation of New Accounting Standards that was recently released by the International Organization of Securities Commissions (“the IOSCO Statement”).
The IOSCO Statement notes that each of the new standards has the potential to have a substantial impact on the financial statements of those entities that will apply them:
- The new revenue standard has the potential to significantly impact the timing of revenue recognition, and thus could have a substantial impact on the reported revenue of those entities adopting the standard. In addition, revenue is the starting point for other performance measures (such as operating income, net income and earnings per share), for key analytical ratios (such as margins, return on equity and return on assets) and for valuation metrics (such as revenue multiples and price-to-earnings ratios). Consequently, the new revenue standard also has the potential to substantially impact a number of measures of interest to investors.
- The new financial instruments standard has the potential to change the measurement of financial assets, including the impairment recognised in relation to those assets.
- The new leases standard will largely remove the distinction between operating and finance leases for lessees. In most instances this will result in lessees recognising lease assets and liabilities on their balance sheet, which could substantially affect key financial ratios, including ratios related to debt covenants.
The IOSCO Statement notes that the extent to which the new standards could affect financial statements and related processes should not be underestimated and that the new standards may warrant significant system changes and necessitate an entity’s review of its existing contracts with customers, lease agreements and other arrangements.
The IOSCO Statement also notes that those entities that will be impacted by the new standards should ensure that:
- Their adoption process is commenced as early as possible
- Any required changes to financial reporting systems, including those related to disclosure, are identified
- The impact on financial condition requirements (such as loan covenants and regulatory capital requirements), and items such as future tax liabilities, the ability to pay dividends and employee incentive schemes, is determined and communicated as appropriate (for example, to shareholders and the market)
- Appropriate disclosure of the impact of adoption is made in the financial statements before the new standards have been adopted – such disclosure would likely become more detailed and quantified (even if as an estimate) as the date of adoption became closer
- Any significant accounting estimates and judgements arising from the new standards are captured in sufficient detail to allow adequate disclosure in the financial statements when the new standards have been adopted
- Auditors are provided with appropriate information about the process, and consequences, of adopting the new standards.
Many entities that have commenced their adoption of one or more of the new standards have found that there have been substantial adoption impacts. For that reason, early commencement of the adoption process, and early communication of adoption impacts, is required to enable the smoothest possible transition.
For more on the above, please contact your local BDO representative.