Every year ACRA provides guidelines to ensure companies comply with existing financial reporting standards. On 21 Nov 2019, ACRA has released the Financial Reporting Practice Guidance No. 2 of 2019, which highlights three financial reporting areas that directors should pay close attention to before approving the companies’ FY2019 financial statements. One key area is the new and recent accounting standards on leases, tax, revenue and financial instruments. The other areas include impairment assessments and business acquisitions.
The guidance encourages directors to pay close attention to the following areas
Leases, Tax, Revenue and Financial Instruments:
- Implementing the new lease standard: For a lessee, it must generally account for its leases as finance leases, i.e. recognise right-ofuse assets on the balance sheet, with corresponding lease liabilities that may significantly impact the lessee’s financial r: atios and performance metrics.
- Uncertainty over Income Tax Treatments: The new interpretation gives more guidance as to when and how to provide for uncertain tax provisions, which may not be available under the current standard. In particular, when determining the amount to be recorded for uncertain tax provisions, directors must assume that the tax authority has a right to examine, and has full knowledge of all relevant information when making those examinations.
- Revenue from Contracts with Customers: directors must understand the intricacies of the related concepts (such as control, performance obligations, timing of recognition, costs incurred to fulfil a contract) when complying with the new revenue recognition principles
- Financial Instruments: Some companies continued to face challenges in valuing their investments in unquoted equities at fair value. Directors are encouraged to critically assess the assumptions used by management in those valuations.
Impairment assessment and valuation:
Directors of companies in industries with challenging outlook ought to pay close attention to the impairment tests conducted by management. Some Common mistakes in estimating future cash flows:
- when conducting impairment test on property, plant and equipment (PPE), the future cash flows could be incorrectly projected to perpetuity, rather than to the remaining useful life of the PPE.
- future cash flows can be projected to perpetuity when conducting impairment test on goodwill and other intangible assets with indefinite useful life
- when computing the recoverable amount of an asset, the projected future cash flows could be incorrectly discounted using the company’s current borrowing rate, the country’s inflation rate or the government bonds’ interest rate, without any adjustment to reflect the risks specific to the asset(s)
- key assumptions such as revenue, gross margin and growth rate used could be overly optimistic
- where headroom is small and carrying value of the asset is material, sensitivity analysis ought to be disclosed for investors to assess the safety margin
Directors should pay attention to the scope of the valuation service, which should include identifying specific intangible assets, and assessing management’s assumptions used to value them. The failure to separately identify, recognise (and amortise) specific intangible assets may lead to an overstatement of goodwill, and total assets, over time. Directors should also understand the importance of determining the acquisition date. This is the date assets acquired and liabilities assumed are valued, and from when the results of the acquired business are consolidated.
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Date: 26 Nov 2019
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