ASIC warns of hard line on financial reports

The corporate watchdog has warned companies and auditors that they must raise red flags where a company is in danger of breaching its loan covenants or facing solvency problems, amidst concerns that the credit squeeze is still buffeting many businesses.

The Australian Securities and Investment Commission says it will scrutinise the accounts of 350 companies – including 250 listed companies and 100 large unlisted companies – as part of its 2010-11 compliance program.

At the top of its list will be scrutiny of “going concern” statements signed off by a company’s auditors.

Where there are any issues with a company’s ability to survive for the next 12 months, ASIC wants auditors to make those concerns clear.

“Drawing attention to uncertainties concerning the ability of entities to continue as a going concern, the appropriateness of the going concern assumption in the preparation of financial reports continues to be an important area of focus,” ASIC said in a statement.

“Uncertainty remains over the future economic climate in which many Australian entities operate. There are indications that credit may still be tight for some entities, and entities should continue to focus on the ability to refinance debt within the next 12 months and beyond.”

Another key focus is what is known as non-statutory profit reporting, whereby a company seeks to “sugar coat” its financial results by reporting a non-standard profit figure, such as “underlying profit before one-off items” or “pro-forma profit”.

“Non-statutory profit measures should not be presented in a misleading manner or detract from disclosure of statutory profit. The operating and financial review should be used to explain the statutory result in a meaningful and unbiased manner.”

Other key areas of focus for ASIC include:

• Ensuring asset impairment models are realistic and transparent.
• Ensuring assets are valued at fair market value in balance sheets.
• Ensuring transparency around assets and liabilities that are kept off a company’s balance sheet.
• Ensuring transparency around employee share-plan loans.
• Ensuring assets and liabilities are correctly classified as current (to be used within 12 months) or non-current (to be used over a longer period).

“The current economic conditions continue to affect different Australian entities in different ways, having regard to factors such as their funding models, geographical locations, industries and the countries in which major customers and suppliers are located. We encourage companies and their auditors to continue to focus on issues such as going concern, asset impairment and fair value determination,” ASIC Commissioner Michael Dwyer said.

One possible drawback from the increased focus on flagging “going-concern” issue is the potential impact on companies’ ability to access finance.

Some commentators have argued that greater pressure on auditors to raise red flags may scare lenders away from strong companies.