Regulation

IAASA’s Observations document highlights key topics management, directors and audit committees should consider when preparing and approving 2018 financial statements.   IAASA published its 2018 Observations document, the eleventh such document, last September. The document aims to assist in the production of high-quality financial reports by emphasising some key financial reporting topics to be considered by management, directors and audit committees when preparing, approving and auditing financial statements. IAASA’s Financial Reporting Quality function examines the annual and half-yearly financial statements of equity issuers, debt issuers and closed-end fund issuers to ensure that they are compliant with the relevant financial reporting framework. IAASA’s financial reporting supervision remit is limited to Irish companies trading on the regulated markets of European stock exchanges (issuers). However, the Observations document may be relevant to a broader range of companies when preparing year-end financial statements. The matters included in IAASA’s Observations document derive from a variety of sources including, but not limited to: The risk rating assessment for individual issuers from IAASA’s risk matrix, which is used to select specific reports for examination; The outcome of overviews performed on preliminary announcements and annual/half-yearly financial reports; Topical issues such as supplier funding arrangements, new IFRS guidance and media commentary; Issues identified at the European Enforcers Co-ordination Sessions (EECS), which is organised by the European Securities and Markets Authority (ESMA). EECS is a forum for European accounting enforcers; Peer issues – matters identified in an entity’s periodic financial report that may be relevant to a wider group of issuers; and Financial reporting issues identified by IAASA’s audit inspection teams. The primary audience for IAASA’s Observations document is the preparers of financial statements. However, it should also help users of those financial statements to understand the significant judgements and estimates made by management in their preparation. Financial reporting environment Entities face unknown economic, political and social threats and uncertainties because of Brexit and heightened protectionist policies, particularly in the USA. The UK is leaving the European Union on 29 March 2019. The details of any Brexit agreement may be clearer by the time entities are finalising their 2018 annual financial reports during the first quarter of 2019. Brexit will affect different entities in different ways and to different extents. Depending on the terms of any Brexit agreement, entities’ ability to conduct business on existing terms may be disrupted (e.g. supply chain, access to the single market, access to the Customs Union, the impact of cross-border and cross-channel trade, and the impact of euro-Sterling exchange rate volatility). Against this ongoing uncertainty, impacted issuers should monitor the likely impact Brexit will have and consider disclosing the financial reporting implications. Some comments on the key topics covered in the Observations document are set out below. Impact of recently issued standards  The quality of disclosures of the impact of new accounting standards effective for the first time in 2018 (IFRS 9 and IFRS 15) in issuers’ 2018 half-yearly reports has been variable. Similarly, the quality of disclosures regarding IFRS 16 (effective 2019) has been mixed. IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors sets out the required disclosures for the initial application of an IFRS [IAS 8.28] and for a new IFRS that is not yet effective [IAS 8.30-31]. The Observations document highlights the requirement to disclose the impact of the initial application of IFRS 9 Financial Instruments. These include the requirements to disclose re-classifications of financial assets and financial liabilities upon initial application of IFRS 9 and a reconciliation of the impairment allowances under IAS 39 Financial Instruments: Recognition and Measurement and under IFRS 9 disaggregated by measurement category [IFRS 7.42I-42S]. IFRS 15 Revenue from Contracts with Customers is effective for accounting periods beginning on or after 1 January 2018. IFRS 15 requires entities to disclose more information about contracts with customers and to disclose disaggregated information about revenue. IAASA indicates that, as the application date of IFRS 16 Leases and IFRS 17 Insurance Contracts nears, entities are required to provide more qualitative and quantitative information about their impact. Significant judgements and sources of estimation uncertainty  IAS 1 Presentation of Financial Statements requires disclosure of significant judgements [IAS 1.122] and sources of estimation uncertainty [IAS 1.125]. IAASA expects entities to: Clearly distinguish these two separate requirements; and Avoid the temptation to provide an extensive list of such items that do not meet the IAS 1 criteria. Complex customer and supplier arrangements and factoring These arrangements can vary greatly from entity to entity, both in terms of their nature and impact. IAASA encourages disclosure of such arrangements and, in particular, the cash flow treatments thereof. Identifiable intangible assets In applying IFRS 3, issuers should consider whether intangible assets should be separately recognised and disclosed on the basis of the separability criterion of IFRS 3 [IFRS 3.B33]. Alternative performance measures Entities’ compliance with ESMA’s Alternative Performance Measures Guidelines has been varied. IAASA reminds entities to endeavour to fully comply with the guidelines and, in particular, to provide explanations where an alternative performance measure is changed or is no longer presented. Consistency of key assumptions IAASA calls on entities to “‘sense check” the consistency between the key assumptions used for the fair value measurement of intangible assets acquired in a business combination with the subsequent intangible asset assumptions used elsewhere in the financial statements. Individual intangible assets Entities with material individual intangible assets should ensure that the disclosure requirements of IAS 38 Intangible Assets, dealing with the disclosure of information about material individual intangible assets, are provided in full [IAS 38.122(b)]. The Observations report can be downloaded at www.iaasa.ie. Maurice Barrett is Senior Financial Reporting Manager in IAASA’s Statutory Reporting Quality Unit.

Dec 03, 2018
Comment

The obligation to report has changed under Companies Act 2014, with the result that the path to prosecution may be more direct. Statutory auditors are required to make a report to the Director of Corporate Enforcement where, in the course of carrying out an audit of the financial statements of a company, the auditors are of the opinion that there are reasonable grounds for believing that a category one or category two offence under Companies Act 2014 has been committed. Where auditors fail to make a notification when required to do so, the auditors themselves are guilty of a category three offence. This obligation to notify is not a new requirement introduced by Companies Act 2014; however, the Act did seek to resolve a difficulty that had arisen under prior Companies Acts relating to similar reporting requirements imposed on auditors under that legislation. Under the prior Companies Acts, the obligation was to report suspected “indictable” offences. However, the determination as to what actually constituted an “indictable” offence was unclear given that offences could be tried either summarily or upon indictment at the election of the prosecuting authorities. Increase in the number of offences to be reported? This change from indictable offences to category one or two offences should result in significantly greater certainty. It is worth noting that the number of category one and two offences under the Act is significantly less than the number of indictable offences under the previous Companies Acts. However, despite this reduction in number, can we expect that, arising out of the greater certainty as to what comprises an offence that requires a report to be made, the number of reports made will actually increase? Wider range of offences to be reported? What is also clearly evident from the statistics relating to reported offences published by the Office of the Director of Corporate Enforcement (ODCE) is that the reports made by auditors under the old regime related to two key areas – offences relating to loans to directors and the offence for failure to keep proper accounting records. Might this also mean that, with the greater clarity brought by Companies Act 2014, a wider range of offences will now be reported? The range of offences that can now be reported under Companies Act 2014 also includes a new reportable offence. This offence occurs where a director or directors of a company are party to the approval of statutory financial statements that do not give a true and fair view, knowing that the financial statements do not give such a view, or being reckless as to whether this is the case. In this regard, where auditors give an opinion other than a clean opinion, and the directors – knowing that the auditors have taken such a view – approve the financial statements, there will naturally be a question as to whether this would cause the auditors to form the opinion that there are reasonable grounds for believing that the director or directors have committed an offence, such that the auditors have a reporting obligation. The implications for directors The duty of directors to ensure that the company of which they are an officer keeps adequate accounting records and that (among other things) the company prepares statutory financial statements in accordance with the requirements of Companies Act 2014 that give a true and fair view of the assets, liabilities, financial position and profit and loss for the financial year are fundamental principles of company law. This has not changed. It is never enough to simply assume that this is being done as where it is not, a director and the company for which it has responsibility could face an ODCE investigation and possible criminal prosecution. The directors of a company must know or be capable of finding out at any time, the company’s financial position. The directors must be in a position to understand the company’s transactions and must take responsibility for the correct presentation to the required standard of the company’s financial affairs for a given period in its statutory financial statements. There were always implications for not doing so; the certainty that Companies Act 2014 now brings in terms of the circumstances where a failure to comply with the accounting requirements of the Act requires statutory auditors to report those possible offences to the ODCE could make the path to prosecution more direct. Claire Lorde is a Corporate Partner and Head of Governance and Compliance at Mason Hayes & Curran.

Dec 03, 2018
Comment

Corporations are being urged to prioritise long-term value over short-term profit, but old ways of thinking must first be tackled. A number of academic papers published out of the University of Chicago in the 1970s and 1980s have had an extraordinary influence on corporate governance. These papers are based on mathematical formulae, which require extremely simplistic assumptions to solve the equations. Company managers are assumed to be motivated solely by self-interest, not by moral obligation (notwithstanding fiduciary duty). It is assumed that it is possible to eliminate self-interest using incentives, so that company managers will look after shareholders’ interests rather than their own self-interest. This perspective only considers two parties: shareholders and managers (otherwise, the mathematics would not work out). This way of thinking led Nobel laureate Milton Friedman to observe that the only responsibility of business is to make a profit. Thus, shareholders and profit maximisation became the imperative of business. Consequently, managers are incentivised to take excessive risks to generate returns at the expense of corporate resilience and long-term sustainable values. The thought police, especially in the US, will not countenance alternative assumptions and ways of thinking. Many top US academic accountancy journals will not publish papers based on alternative theories, with editors of those journals acting as gatekeepers to prevent expression of alternative perspectives. The damage is exacerbated by institutional shareholders, who are not the ultimate beneficiaries of investment returns. Most stock market capital is pensioner monies. Pensioner beneficiaries require long-term sustainable returns. Institutional investors have a short-term focus, exacerbated by end-of-year performance pay incentive systems. Institutional investors cannot be relied on to monitor company management or engage with their investees in a manner that will support long-term value creation. This perspective also ignores the law, specifically the fiduciary duties of directors to look after the company’s (not the shareholders’) interests. These theories have been embraced by regulators. They have therefore impacted corporate governance by requiring separation of chairman and CEO roles; majority independent boards; and acquiescing to incentive systems such as performance pay and stock options, for example. Accounting standards also reflect this perspective, with a heavy focus on providing users with useful information for decision-making purposes. Users are primarily shareholders making buy, hold or sell decisions. However, the tectonic plates are shifting. The Purpose of the Corporation, the Modern Corporation: Corporate Governance for the 21st Century and the Future of the Corporation projects are challenging these embedded notions. These projects argue that corporate governance should align with a socially beneficial corporate purpose. They conclude that corporate entities should aim to create long-term sustainable value for customers and shareholders while also contributing to societal well-being and environmental sustainability – objectives that can be mutually reinforcing. They advocate that company law should require companies to specify their corporate purposes. Companies should adopt structures that ensure they uphold the public good as well as their own private interests. In particular, companies that perform public and social functions such as utilities, banks and companies with significant market power should align their corporate and social purposes. In addition, the regulatory framework should promote an alignment of corporate purposes with social purposes and ensure that companies’ ownership, governance, measurement and incentive systems are appropriate for these objectives. Companies are urged to be more specific about the varied audiences for their corporate governance, customising their reporting for individual stakeholder groups. Methods of engaging stakeholders more effectively in corporate governance are discussed, including through representation and consultation. Alignment of corporate with social purposes will generate increased scrutiny on the social and environmental impact of companies, the design of incentive and control systems and their relationships with corporate strategy, the role of corporate reporting and, finally, the role of investors. These ideas are gaining traction. For example, the British Government recently agreed to introduce laws that will impose on pension schemes a fiduciary duty to protect long-term value by considering the environmental risks of the companies in which they invest. The new rules will push consideration of long-term value and environmental risks down the investment chain to investee firms. Prof. Niamh Brennan is Michael MacCormac Professor of Management at UCD College of Business.

Dec 03, 2018
Comment

When it comes to meetings, the advice of Sir John Harvey-Jones is worth heeding – particularly if a serious dispute is involved. Sir John Harvey-Jones was a renowned UK businessperson in the 1980s and 1990s. A best-selling management book, Making it Happen – Reflections on Leadership, preceded a successful ‘Troubleshooter’ series on BBC television. He became the executive chairperson of an ailing Imperial Chemical Industries (ICI), then the largest company in the UK and Europe; now long split into different entities. I met with Harvey-Jones on a number of occasions. An interesting comment he made was that not long after he took over at ICI, he was talking to a shop floor worker in an ICI paint factory. The worker made a useful observation. Harvey-Jones followed it up, leading to a curiosity as to how many management layers existed between the worker and the executive chairperson. There was 11. Harvey-Jones rescued ICI by reducing the number of layers to six. Internal company meetings Harvey-Jones’ advices were pragmatic and he was a master of using wit to make things happen. Layers of company management created its own bureaucracy of meetings. It also meant turf battles as to who was responsible for what and created a temptation to push a decision up or down the ladder, rather than make a decision at all. His general mantra was that there were too many meetings and/or too many people at them. One of his witticisms was that if you wanted to know the length of a meeting, allow 20 minutes for every person present; and if the chairperson is a ditherer, make that 30 minutes. In the ordinary way, the purpose of internal company meetings is a mix of disseminating information and, more importantly, making decisions. Stating the obvious, management’s job is to manage and a meeting is only necessary when the matter requires the input and/or approval of others. Management time is expensive and meetings are disruptive. The temptation is to set regular meetings. These often become talking shops and, in many cases, repetitive. For example, there is only so much comment that can be made on a routine set of financial figures of one kind or another. An assessment as to the usefulness or otherwise of regular meetings does not go amiss. The rule of three Meetings that are specific to difficult circumstances are different. Here, Harvey-Jones reminded me of the ‘rule of three’. This relates to managing the trajectory of meetings in strained or confrontational circumstances, such as a serious dispute of some kind, a matter gone badly wrong, strong disagreement on policy direction, and so on. Harvey-Jones said to recognise that it will take three meetings to achieve resolution and one should effectively manage the trajectory on that basis. The first meeting is grief all round from the opposing or factional parties. Position-taking, allegations, half-baked facts, egos out of joint and nobody listening except to themselves. The meeting goes nowhere but, most importantly, a smart operator ensures that a further meeting is scheduled before breaking up. The second meeting will likely be the grief expressed all over again but this time, the participants have largely run their course and the repetition has little impact. There will usually be some prepared rebuttals or clarifications following the first meeting. The validity or otherwise of competing positions will likely be better understood. Some tentative steps or overtures, dressed up as trying to understand a rival position or viewpoint, may emerge as everyone knows that the repetitively expressed grief is going nowhere. Again, a smart operator ensures that a further meeting – the third meeting – is scheduled. The third meeting gets there. The facts and positions are known, strengths and weaknesses exposed, all have had their repeated say. People want out of the room. The meeting makes real progress if at least one of the participants, or maybe a mediator or chairperson, circulates written outline proposals. All at the third meeting, probably with a sense of relief, start looking at the proposals paper as an accepted focus. Disagreement on any aspect therein necessitates putting forward an alternative proposal and possible resolution gathers pace. Maintain momentum Harvey-Jones’ point was that if parties break up in disarray, it takes a long time to assemble everybody all over again. Momentum is lost, the underlying difficulties may worsen and individuals become entrenched. Do not leave a contentious meeting without scheduling another. This too can work in resolving legal-related disputes.   Des Peelo FCA is author of The Valuation of Businesses and Shares, 2nd edition, published by Chartered Accountants Ireland.

Dec 03, 2018
Comment

Businesses must engage with education providers to ensure that tomorrow’s game changers are equipped with the right skills. Employers in Northern Ireland anticipate a shortage of highly skilled workers over the next three to five years with 76% of firms not confident that there will be sufficient people available to fill skilled roles, according to the November 2018 CBI/Pearson Education & Skills annual report. Other findings in the study include: Aptitude and readiness for work is a high priority for employers when recruiting school, college and university leavers; Employers view the promotion of STEM subjects, awareness of career options, and IT and digital skills as the top three priority areas for action in secondary schools; 92% of employers want to play a greater role in supporting schools and colleges; and 65% of employers are experiencing, or are anticipating, difficulty recruiting individuals for apprenticeships. Gone are the days of safe bet ‘lifers’. No sector will escape the transformation of the workplace environment. Come 2035, the oldest working generation will cease to be the largest and after that, things will change. Millennials have a fresh outlook on life and don’t particularly like outdated corporate cultures. The dominant viewpoint of the workforce is increasingly becoming ‘why should I choose to work for you? What can you offer that is better than your many competitors?’ And because the skilled are in demand, they have the luxury of naming their price. That said, it is up to the employer to ensure that they are fostering a culture and brand that will attract and retain the brightest and best. Given the hiring difficulties that businesses are experiencing, it makes sense for employers to optimise their ability to retain existing team members. Providing positive leadership, a strong brand, a good working environment, a culture of respect, investing in training and development and empowering employees to fulfil their potential all have an important role to play in this regard. Where businesses are losing employees, exit interviews can be a useful way to gain insight into aspects of the organisation and culture that may need to be improved. While performance reviews provide the opportunity to seek formal feedback from employees on how they feel about their current role and how they would like to see their career progressing, regular informal chats and ongoing communication with employees are just as important to ensure that we, as employers, have our finger on the pulse so timely corrective action can be taken. Brand attractors For many millennials, personal development ranks ahead of professional development. Keep in mind that coaching, mentoring, continuing education, career progression and volunteering opportunities are highly valued by millennial workers whereas salary and/or flexibility may be more sought after by other workers. The ability to balance work and home responsibilities allows some individuals to continue working when they might otherwise not be able to. Flexible working was one of the issues highlighted by UK Business Secretary, Greg Clark, recently when he announced a series of new measures as part of the Government’s Industrial Strategy. While many companies are embracing flexible working and the benefits it brings, some employees face barriers in raising this issue with their employers. The Government may create a duty for employers to consider whether a job can be done flexibly, and oblige them to make that clear when advertising. With Brexit-related uncertainties including future trading relations and what shape the UK migration system might take, along with major changes in global technologies (artificial intelligence, robotics etc.), our priorities as employers and business influencers must include working closely with education providers to harness the power of business to ensure that today’s education and skills training equips tomorrow’s game changers.   Teresa Campbell FCA is Director of People & Culture at PKF-FPM Accountants Ltd.

Dec 03, 2018
Comment

As talk of another property bubble abounds, it’s time to assess whether house prices reflect fundamentals or froth. Are Irish property prices overvalued? Since they hit bottom in March 2013, residential property prices have risen by 82.8% to September of this year, according to data from the Central Statistics Office. Since bottoming in February 2012, residential prices have risen by 96.1% in Dublin. According to a recent edition of The Economist, Dublin’s house prices are overvalued by 25%. To gauge whether house prices reflect fundamentals or froth, The Economist compared them with rents and household incomes. It used the average ratio over the past 20 years as “fair value”. But does it make sense to expect house prices to hold a constant relationship to rents and incomes? I don’t think that it does, for such an analysis ignores two key developments that should cause us to expect higher house prices relative to incomes and rents. Interest rates All other things being equal, house prices would rise relative to incomes and rent levels as a result of a fall in interest rates. The very first element in the Capital Asset Pricing Model formula for cost of equity is the risk-free rate of interest. If the risk-free rate falls, we would expect the cost of equity to fall. If the cost of equity and the cost of debt both fall as a result of reduced interest rates, we would expect the cost of capital to fall. If the cost of capital falls, we would expect a given stream of expected cash flows to attract a higher capital value independent of whatever might be happening to income and/or rents levels. Consider the eurozone’s benchmark risk-free rate, the average yield on 10-year German government bonds. Twenty years ago, it was 4.2%. A decade ago, it was 3.9%. Today German 10-year government bonds yield less than 0.4%. Consider also the prospect that this big fall in interest rates is unlikely to be reversed any time soon. Instead, it is likely that we face a lengthy period before we see interest rates back at 2008 or 1998 levels. Population The other big factor influencing residential property prices is our population. At the height of our economic boom, in 2007, the population of Ireland was 4.34 million. Last year, in 2017, our population reached 4.78 million, an increase of around 440,000 compared to a decade earlier. I should say that these are official estimates of our population. When the census was last carried out, in 2016, it was reported that there were 9,575 Chinese nationals staying here on Census night. I reckon that this figure is a very considerable understatement of the actual number of Chinese resident here. I would therefore guess that Ireland’s actual population growth has been even stronger than official statistics indicate. Strong population growth and strong economic growth together with low levels of construction of new dwellings explains why Daft.ie’s latest quarterly report indicates that rent levels are now 30% higher than in 2007.  Discounted cash flow model The best way to get a handle on residential property prices is to analyse them using a discounted cash flow model. This takes into account interest rate variations and changes in rent levels. Such models are subject to very considerable uncertainty because of the difficulty in accurately estimating key input variables. My model of Irish residential house prices does not suggest any significant deviation from fundamental value. That’s not to say that a recession mightn’t cause prices to dip, but it doesn’t support notions that residential property prices have returned to bubble levels – especially not with mortgage credit levels down 40% compared to a decade ago. Cormac Lucey FCA is an economic commentator and lecturer at Chartered Accountants Ireland.

Dec 03, 2018