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Article:

Accounting Records and Documentation

22 April 2021

Background

Preparers of financial statements may have recently noticed an increase in the frequency of certain terminology being used in the financial reporting lexicon – including that used in our more recent Cheat Sheets.

Terms such as “...accounting records…”, “… documentation…”, and “…audit evidence…”, particularly in the context of preparers of financial statements being requested to provide such items.

While none of these items are new (nor requests to produce and provide these items) certain current events are placing the microscope squarely in the vicinity of an entity’s internal record keeping and documentation.

However, “what” these items are and “what” they need to represent is often misunderstood, as too are the origins as to “why” these items are required.

This Cheat Sheet has been produced to provide a high-level overview of this area of financial reporting, as well as examples of the types of transactions and events most applicable with respect to an entity needing to prepare “accounting records”, “documentation”, and/or “audit evidence”.

Need assistance?

BDO IFRS Advisory is a dedicated service line available to assist entities in understanding and addressing their financial reporting obligations. Further details are provided on the following page for your information.


What is covered in this Cheat Sheet

In order to navigate through these areas of accounting, this Cheat Sheet is broken down into the following sections:

What are “accounting records”, “documentation”, and “audit evidence”?

For companies1 in New Zealand the best place to start is the Companies Act 1993 (the “Act”)2, in particular Section 194 - Accounting Records must be kept.

The Act does not define “accounting records” per se, however Section 194 makes it clear as to what is being referred to (extract below):

            194 Accounting records must be kept

  • (1) The board of a company must ensure that there are kept at all times accounting records that:
    • correctly record the transactions of the company; and
    • will enable the company to ensure that the financial statements or group financial statements of the company comply with generally accepted accounting practice (if the company is required to prepare such statements under this Act or any other enactment); and
    • will enable the financial statements or group financial statements of the company to be readily and properly audited (if those statements are required to be audited).

From the wording of Section 194, it should be apparent that “accounting records” are not simply limited to an entity’s general ledger, and any supporting (mathematical) reconciliations.

Preparers of NZ IFRS financial statements will be all too aware that the application of NZ IFRS to various transactions and events requires not only significant analysis, but also the use of areas of significant management judgement and estimation.

In such cases, it is highly unlikely that (a), (b), and/or (c) above would be satisfied merely with an entity producing its general ledger and/or any supporting (mathematical) reconciliations.

Instead, it is likely that additional and complementary documentation will be necessarily, that takes a more narrative and explanatory form as to bridge the “understanding gap” between the transaction or event, and how it has been accounted for, and why.

As such, this additional and complementary documentation, would clearly and transparently:

  • Describe the background and nature of the transaction or event.
  • Denote which accounting standards (NZ IFRS’) are (and/or are not) applicable, and why.
  • Describe how the entity has approached the assessment and analysis of the transaction against the accounting standards requirements.
  • Displays the outcomes, conclusions, and/or determinations of the entity’s assessment and analysis.
  • Describes how the transaction or event has been accounted for (i.e. asset/liability/revenue/expense recognition, and values thereof).

The goal of this documentation should be that a reader (including the entity’s Auditor), with no previous knowledge or understanding of the transaction or event, should be able to review the documentation (whether in the present day, or at some far point in the future) and be able to:

  • Understand the nature of the transaction or event,
  • Understand how management addressed and approached the analysis of the transaction or event it, and
  • Be comfortable that Management’s assessment and analysis of the transaction or event against the requirements of the applicable accounting standards was thorough, complete, and accurate.

*1    Note that while not all entities will be companies subject to the Act, those non-company entities will likely be subject to other legislation and/or founding documents that will require and make reference to “accounting records” (or similar).
*2    Section 11, Sub-part I – Accounting Records

Why the current (re) focus on this area?

There are various factors causing a (re)focus on “accounting records”, “documentation”, and “audit evidence”.

(a) The current economic environment (i.e. COVID-19)

The unfortunate reality is that it is likely that a more than an insignificant number of entities will ultimately succumb to the current and ongoing economic turmoil that has been brought about by COVID-19 (i.e. insolvencies and the like are on the horizon to some degree).

As was the case with the Global Financial Crisis in the late 2000’s through to early 2010’s, when times go bad… people go into “protection mode”, particularly with respect to foreshadowing the subsequent scrutiny that may be placed on an entity by shareholders, financers, in in the worst-case scenario, receivers, liquidators, and/or the Inland Revenue Department.

One of the first areas to get picked over in this process is looking into how the Directors and Management have been running the business, and were they complying with all laws and regulations as they should have been, including their LEGAL requirement to keep complete and accurate accounting records.

Not having adequate accounting records is “low-hanging-fruit” in any case against Directors and Management, and accordingly the current environment is reminding people of the very real need to make sure that their house is in order.

(b) Expectations on Directors

One of the key responsibilities of Directors is to ensure that their entity is complying with all applicable laws and regulations, including those related to financial reporting and the preparation of financial statements.

In this respect, Directors are responsible that:

  • The financial statements fairly represent their business and comply with the applicable financial reporting and accounting standards, and
  • The financial statements must be supported by appropriate accounting records that correctly record the transactions of the entity (and where applicable, enable the financial statements to be Audited).

The Financial Markets Authority (FMA) in New Zealand has released various publications and guidance to assist Directors in understanding and executing their roles and responsibilities.

While the FMA is predominately concerned with only FMC reporting entities, their publications and guidance related to the roles and responsibilities of Directors are equally applicable to Directors of all entities.

In the FMA’s most recent Audit Quality Director Guide (Nov 2020) (click here), the FMA expands on what (in their opinion) “accounting records” include, noting that:

This includes, for example, papers that set out the accounting treatments chosen by the entity and any assumptions and judgements made by directors.

We also recommend that directors document instances where they determined disclosure not to be material.

Accordingly, such explicit public comments from regulators such as the FMA have Directors sitting up and taking notice to ensure that their entity’s Accounting and Finance Teams are preparing thorough, complete, and accurate as is expected of them.

(c) Auditor requirements

Auditor requirements are obviously not mutually exclusive from the current economic environment discussed above.

It should be no surprise that when the economic environment is challenging:

  • Certain judgmental areas of accounting are “triggered” or exacerbated, resulting in
  • Higher audit risk and associated Auditor scrutiny.

Naturally, this will lead to further lines of Auditor enquiry as well as increased requests for documented analysis from an entity to support various accounting treatments, as well and Management’s judgements and estimates.

However, in addition to this, there are a couple of audit-industry-specific factors that are driving the push for increased documentation to be provided by entities:

  • 1) The ongoing industry expectation for greater Auditor independence

In response to ongoing industry pressure, Audit firms are drawing definitive lines-in-the-sand around the support that they can and cannot provide to their audit clients in order to demonstrate clear Auditor independence and reduced potential for conflicts of interest.

Accordingly, areas that an Auditor may have previously documented internally themselves for their own audit file purposes are instead now being pushed back onto the entity to be produced directly by the entity themselves in the first instance.

  • 2) Revision to Audit Standard ISA (NZ) 540 Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures

In the same way that entities have accounting standards that they must comply with, Auditors too have their own audit standards that they must comply with.

One of these audit standards (ISA (NZ) 540) addresses an Auditor’s requirements when auditing areas that involve accounting estimates.

Recently, ISA (NZ) 540 was updated and revised (effective for year-ends 31 December 2020 and beyond), with the key change being a greater level of professional scepticism being required to be applied by Auditors, with terminology such as “challenge”, “question”, “reconsider”, and “stand back” being spread throughout the revised requirements.

Practicably, this translates to a greater documentation burden being pushed on to entities by their Auditors, to ensure that the revised requirements of ISA (NZ) 540 are complied with.

Failure to obtain sufficient audit evidence documentation may lead to Auditors being required to issue qualified (or even disclaimed) audit opinions with respect to a limitation of scope (i.e. lack of support and evidence).

What types of transactions and events should an entity be looking to document?

The types of transactions and events that any entity should be looking to document have these same common features:

  • They require detailed analysis of applicable NZ IFRS’ in order to determine the correct accounting treatment, and
  • In determining the correct accounting treatment, significant judgements are required and/or estimates provided.

While there are likely dozens of potential transactions that would contain these features, a short list of the “repeat offenders” that we in IFRS Advisory typically see in practice include (but are not limited to):

   
A The initial adoption of NZ IFRS for the first time (NZ IFRS 1)
B Share-based payments (including Employee Share Option Schemes (ESOPs)) (NZ IFRS 2)
C Business combinations (whether via share purchases or the purchase of select trade-and-net-assets) (NZ IFRS 3)
D Convertible loans (i.e. loans with options for the loan to be converted into shares)

(NZ IAS 32)
(NZ IFRS 9)

E Revenue recognition (all entities, in all industries) (NZ IFRS 15)
F Leases as lessee (i.e. bringing leases on-balance sheet) (NZ IFRS 16)
G Financial asset impairment (i.e. identifying and quantifying forward-looking impairment factors) (NZ IFRS 9)
H Non-financial asset impairment testing (i.e. Goodwill, cash-generating units (CGUs), discounted cash flow modelling etc.) (NZ IAS 36)
I Whether and entity “controls” an investee (i.e. is a Subsidiary) (NZ IFRS 10)
J Whether and entity “jointly controls” an investee (i.e. is a Joint Arrangement) (NZ IFRS 11)
K Whether a Joint Arrangement is classified as a Joint Venture or Joint Operation (NZ IFRS 11)
L Whether and entity has “significant influence” over an investee (i.e. is an Associate) (NZ IAS 28)
M Whether Development costs meet the criteria to be capitalised as an intangible asset (NZ IAS 38)
N Whether non-current assets meet the criteria to be held-for-sale (NZ IFRS 5)
O The identification of an entity’s Operating Segments (including in determining and entity’s CGUs for the purposes of impairment testing) (NZ IFRS 8)

Your go-forward requirements

Step 1 – determine the “lay of the land”

For those entities subject to external audit, your first step should be to engage with your Auditors as early as possible to confirm expectations and requirements around:

  • What transactions and events they will be requiring new and/or enhanced documentation, and
  • In what form will the documentation be required (i.e. will an internal Memo/Report from management suffice, or, is the transaction or event in question significantly complex and/or judgemental such that the Auditor will ultimately be requiring a formal Accounting Opinion from an IFRS expert advisor).

For those entities are do not have external audit, Management should be confirming the two points above with the appropriate governance body within the entity (i.e. whether this is the Board, the Audit and Risk Committee, the Chief Financial Officer etc.) – or if in doubt, discuss with an IFRS expert advisor.

Step 2 – determine the plan of attack

The simple question here is “Who is best placed to undertake the analysis and documentation?”, with the choice being:

  • Management (i.e. internally)
  • External IFRS expert advisors engaged by Management, or
  • A combined effort of Management and their external IFRS expert advisor (lead by Management, or the external IFRS expert advisor)

Step 3 – execute and deliver

Once the plan is in place, parties involved undertake their respective roles and responsibilities with the end goal being the production of documentation that is thorough, complete, and accurate.


BDO IFRS Advisory

Members of BDO’s IFRS Advisory department come ready with real life experience in applying IFRS and are therefore well placed to provide entities with the expertise and assistance they require as their external IFRS expert advisors..

For more information as to how BDO Accounting Advisory Services might assist with your entity in navigating this and other areas of IFRS application, please contact James Lindsay at BDO Accounting Advisory Services ([email protected], ph +64 9 366 8041), and visit our webpage.

Also, visit our dedicated Adopting NZ IFRS 16 webpage for more information and resources on all things related to lease accounting.

 

 

This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact your respective BDO member firm to discuss these matters in the context of your particular circumstances.

 

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