Consistent application is a must!

The European Securities and Market Authority (ESMA) has published two reports recently which are important to the process of enforcement of application of financial information and reporting requirements by European issuers.

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The first, the Report of IFRS Enforcement Activities in Europe in 2012, comments that the conclusions of enforcement activities show that overall the quality of IFRS financial statements continued to improve as a result of the significant experience gained by preparers with IFRS application since 2005, but noted that there is still room for improvement.

The second, a Consultation Paper on the ESMA Guidelines on enforcement of financial information, expresses the view that in order to achieve a proper and rigorous enforcement regime to underpin investor’s confidence in financial markets, there is a need for a common European approach to the requirements in the Transparency Directive.

Divergent enforcement practices could undermine not only the integrity, efficiency and orderly functioning of markets but also have an impact on financial stability.

ESMA - Its function

ESMA, in its fostering of supervisory convergence in Europe, is responsible to promote the effective and consistent application of the European Securities and Markets legislation with respect to financial reporting.

ESMA has put in place the European Enforcers Coordination Sessions (EECS), a forum of 37 European enforcers from the EEA States who have responsibilities in the area of supervision and enforcement of financial information for the more than 6,000 listed issuers publishing IFRS financial statements on the European regulated markets. European enforcers reviewed more than 2,000 interim or annual IFRS financial statements in 2012, and took more than 500 enforcement actions.

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Priority issues – 2012 reporting

In order to promote consistent application of IFRS, ESMA together with the national enforcers, identified common enforcement priorities in advance of publication of issuers’ 2012 IFRS financial statements and will report later this year in relation to those topics based on feedback received from each jurisdiction. The priority topics identified were:

  • Financial instruments and, in particular, the need for relevant disclosures on financial instruments subject to risk, sovereign debt exposures and impairment of financial assets
  • Recognition, measurement and disclosure of non-financial assets, and in particular, goodwill
  • Measurement of defined benefit obligations, with a focus on the determination of the discount rate and the new provisions of IAS19; and
  • Recognition of provisions for non-financial liabilities.

Earlier this year ESMA reported on reporting practices in relation to impairment of goodwill or other intangible assets with indefinite useful lives. The report is based on a review of more than 200 listed issuers with total goodwill amounting to around €800 billion as of 31 December 2011. The report illustrated that goodwill impairment losses recognised in 2011 were limited to a handful of issuers and concentrated in a very limited number of industries (mainly telecom and financial services).

The report also highlights that, in many cases, the market value of a company based on its share price is considerably lower than its net asset position on balance sheet, raising questions about whether impairment losses have been adequately recognised.

Activity report 2012

The ESMA Activity Report 2012 draws on the overview gained from EECS and related activities in identifying emerging issues. These reflect on those matters that feature more commonly in decisions brought to EECS for discussion and where a relatively higher level of infringements were detected and required corrective action. The examples commented on are:

  • Presentation of Financial Statements – Going Concern: the focus being on the assessment of at which point in time it might be considered that there is no realistic alternative to liquidation, and when the financial statements should be prepared on an alternative basis.
  • Non-current assets for sale and discontinued operations – incorrect application of the requirements in IFRS 5 – inappropriate classification of assets held for sale beyond the initial period of twelve months, inappropriate allocation of impairment losses and provisions in activities to be divested.
  • Determination of discount rate for the calculation of defined benefits obligations – questions arise as to which categories of corporate bonds can be deemed ‘high quality’ when debt markets are stressed.
  • Distinction between a change in accounting estimate and a change in accounting policy – with the different impact resulting from prospective or retrospective application of the respective changes, and how a change in accounting policy is justified on the basis of providing more relevant information.
  • Disclosures on risks and uncertainties – the generally unfavourable economic climate increases the importance of disclosures about risks and uncertainties together with judgements and estimates, and the need for entity –specific information.

IAASA focus

At a national level, the Irish Auditing and Accounting Supervisory Authority (IAASA) published its Annual Report 2012 recently. Chapter 3 of the report is a summary of its findings on examination of issuers’ financial statements. Some of the matters highlighted by IAASA as areas where there is scope for improvement include:

  • Provisions – discounting, disaggregation, presentation of recognition and release
  • Financial instruments – fair value – disclosure of valuation techniques
  • Financial instruments disclosures – disclosures on other price risk
  • Related party disclosures - presentation of key management compensation, on which IAASA has issued a separate report

    IAASA has also published a separate report on the use of Alternative Performance Measures (APMs) with a number of recommendations on how these are presented in annuals reports.

Enforcement guidance

Achieving consistent application of IFRS throughout the EEA is fundamental to underpinning investor confidence in financial markets and their protection. The avoidance of regulatory arbitrage is hugely important insofar as circumstances should be avoided where an issuer’s choice of the market on which to list its securities may be influenced by different approaches to how enforcement is being applied in different European jurisdictions.

The proposed guidance recently published by ESMA reflects on the experience gained since 2005 when CESR, ESMA’s predecessor, first introduced enforcement guidelines. The new guidelines are based on the same principles; however they have been reformulated throughout and have been combined into one document. The scope has been extended to include both IFRS and the national GAAP’s from the EU jurisdictions and third countries’ accounting standards which have been declared equivalent to IFRS.

The Guidelines aim to strengthen and promote supervisory convergence in existing enforcement practices amongst EU national authorities, thereby ensuring the proper and rigorous enforcement of financial information disclosure practices in the EU. The Guidelines establish the principles to be followed in the endorsement process by clearly defining:

  • Enforcement and its scope
  • Expected characteristics of the enforcer
  • Accepted selection techniques and other aspects of enforcement methodology
  • The types of enforcement actions that may be available to enforcers, and
  • How enforcement activities are coordinated with ESMA

The guidelines also propose that the coordination of European enforcers by ESMA should include the development of coordinated views on accounting matters prior to national enforcement actions, the identification of common enforcement priorities and common responses to the accounting standard setter to ensure consistent application of the financial reporting framework.

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