The complexities of disclosure required in financial reports has created a challenging reporting environment. Here's what directors need to know.
Australian directors are enduring their toughest financial reporting season in decades. Shareholders and stakeholders are seeking clarity, while directors are grappling with the uncertainty created by a global recession and pandemic. Directors may wish to address the following considerations as they approach their reporting and disclosure obligations.
Directors’ role in reporting
Directors should be mindful that approval of the financial statements is a core duty. It is the directors who must make a declaration that the financial statements comply with accounting standards and present a true and fair view. Case law has consistently shown that in discharging that duty it is not sufficient to rely on management, an audit committee or the auditor. Directors must bring their own knowledge to bear and, if in doubt, should ask questions.
Solvency
All entities — whether for-profit or NFP — require directors to sign off on the financial statements and to declare they have reasonable grounds to believe the entity will be able to pay its debts as and when they become due and payable. The government’s decision in response to COVID-19 (to relieve director personal liability for insolvent trading) means there may be many entities that are technically insolvent — or whose solvency is unclear — that will continue trading. This raises novel questions when it comes to making the solvency declaration. Specific guidance is available in this unlikely circumstance and directors potentially affected should download the AICD’s COVID-19 guide for further information.
Going concern
An entity is a going concern unless the directors intend to liquidate the entity or cease trading (or have no realistic alternative but to do so) and intend to continue its operation for at least 12 months. Like the solvency declaration, this judgement is subject to audit. We expect the next 12 months will see many entities considering going concern for the first time. When assessing going concern, directors need to evaluate material business risks, undertake scenario analysis and weigh probabilities. Where there is material uncertainty regarding going concern — or even potentially where there is uncertainty that is less than material — then the assumptions that underly the going concern assessment will need to be disclosed.
Entities will need to have a reasonable basis for those assumptions. The AICD’s COVID-19 guide contains some case studies of hypothetical companies (including a charity) making these assessments and determining what they need to disclose. It also refers to guidance on the topic (bit.ly/3jEp79E) issued by the Australian Accounting Standards Board (AASB) and the Auditing and Assurance Standards Board (AUASB).
Tips for this reporting season
- Test key assumptions and check they are accurate right up to publication date. Consider whether there are reasonable grounds for any disclosures, especially forward-looking statements.
- Monitor for consistency, including across cashflow forecast, impairment calculations and statements in directors’ reports.
- Where solvency and going concern issues arise, study publications from the AICD and regulators/statutory bodies including ASIC, the AASB and AUASB.
Directors’ reports
The directors’ report — as well as the operating and financial review (OFR) for a listed entity — should disclose sufficient information so that any significant changes throughout the year, or likely developments in operations in the future, are clear to users. Where the entity has shareholders, the report should contain sufficient information to allow shareholders to make informed judgements, including on the entity’s future prospects. This means assessing the impact of COVID-19 and disclosing how it has affected the financial year as well as how you expect to be impacted in the future.
Whenever making disclosures in the directors’ report, particularly any forward-looking statements, consideration must be given to whether it is of benefit to users, whether the information is accurate, and whether it is based on demonstrably reasonable grounds. Any forward-looking information not based on reasonable grounds is potentially misleading and should not be disclosed.
The significant uncertainty around COVID-19 might mean an entity feels it is unable to make forward-looking statements about likely developments or future prospects with the requisite degree of confidence. In those cases, it might be reasonable to simply acknowledge and disclose uncertainty about the future. Listed companies should also be mindful of the implications of making forward-looking statements on their continuous disclosure obligations.
Further assistance on directors’ reports is provided in the AICD’s COVID-19 guide. This includes case studies examining disclosure in a hypothetical company as well as non-exhaustive lists that directors might consider when trying to determine what the impact of COVID-19 has been on the entity, steps taken to mitigate, as well as material business risks.
Financial statements
Directors should be alert to the potential effect of COVID-19 on line items and notes in their financial statements. While non-executive directors are not personally preparing the financial statements, they are making a declaration as to their accuracy and must therefore understand the key issues. These include:
- Significant accounting policies — these may need to be reviewed in light of COVID-19.
- Events after reporting period — entities need to monitor events occurring after balance date. The Australian Securities and Investments Commission (ASIC) has indicated this will be a priority for their review and inspection process.
- Leases — including possible impairment for lessors and rent relief for lessees.
- Government assistance — ASIC has indicated it wishes to see amounts of JobKeeper disclosed. Entities may also wish to consider their reliance on JobKeeper for disclosure of future prospects and with respect to their going concern assessment.
- Impairment, including of financial assets.
- Current/non-current changes to both assets and liabilities.
- Expected credit loss.
- Stock provisioning.
- Onerous contract provisioning.
Heightened scrutiny
Directors should be particularly cognisant of the heightened scrutiny that will be applied to financial reporting and disclosure during COVID-19. This should include focusing on appropriate documentation and record keeping to support the assumptions underlying the accounts.
To mitigate (legal) risk, directors should be able to point to adequate evidence that judgements made in this time of uncertainty were on the basis of reasonable and reliable information. Directors should also ensure frequent and consistent internal communication on financial matters — including with fellow board members, management, internal risk and audit staff, and the external auditor. This requirement is particularly acute if there are remote working arrangements.
Uncertain times
Predicting outcomes during the COVID-19 crisis, continuous disclosure and staggering increases in D&O insurance were among the challenges raised during a recent AICD director discussion.
Rising premiums for D&O insurance of up to 300 per cent have reached a crisis point, Sally Pitkin FAICD, chair of Super Retail Group and a director of Link Group and the Star Entertainment Group, told a roundtable hosted by the AICD and AFR Boss in late July. “My three listed boards’ premium increases for the next 12 months are between 120 and 250 per cent,” said Pitkin. “We’re in a situation where at least we can still get it [insurance] and there seems to be no choice but to pay the premium. But this is a crisis point from my perspective as a director. Insurance is a very important element in a risk management program.”
Also speaking at the roundtable were Diane Smith-Gander AO FAICD, a director of Wesfarmers and AGL Energy and chair of Safe Work Australia, Peter Hay FAICD, chair of Melbourne Airport Corporation and Newcrest Mining, Kevin McCann AO FAICDLife, chair of Citadel Group, and Craig Claughton, national practice leader at insurance broker and risk adviser Marsh.
Hay said in one case, his D&O insurance premium had increased 300 per cent and that one consideration was whether to drop securities cover to decrease the cost, given the uncertain times. “We’re reluctant to drop it, but it depends on the cost differential to some extent and we don’t know what it is yet,” he said. “I’m the chair of Melbourne Airport Corporation, it is a non-listed company, but tell me when international flights are going to begin again, then when domestic flights are going to pick up. All one can do is paint a series of scenarios and work from that basis. In the listed space, we’re relying on knowing what the future looks like in order to make investment decisions. The investors have got to put up with uncertainty, too, at the moment, because there is no certainty as to when these pandemic features are going to recede and things get back to normal. It’s not the case for all businesses, but it is the case for a lot of businesses.”
Claughton said that Australia’s continuous disclosure requirements were “quite onerous” on directors. “We are out of step with the rest of the world and some sort of consistency with other countries would be a first step.”
Risk factors
The directors called for securities class actions to be banned during the COVID-19 pandemic. “When you think about what is the foundation something like that stands on, it’s an expectation of a market operating in a particular way,” said Smith-Gander. “You just look at the volatility in the market, and the settings of the market, and that doesn’t exist. So I think when things change, regulatory settings also have to change.”
McCann said directors were “constantly worrying” about forecasts during COVID-19. “Are things happening to our business as a result of COVID-19 that require disclosure to the market?” he said. “We’re careful about opening our offices because we’re worried about the possibility of class actions if we infect our staff or third parties. It’s something that’s constantly on our mind.”
Pitkin warned the uncertainty of the pandemic would continue “for some time”. “We all dealt with that initial crisis phase, companies were pulling every lever they could to manage costs, to protect revenue, to look after people,” she said. “Everyone started feeling hopeful that we could now start looking more to the future. Then the second wave happened, and the realisation that this is just going to go on with this uncertainty.”
Continuous disclosure, said Pitkin, was very important for market integrity and investor protection. “Directors understand the criticality of an informed market for the success and sustainability of our companies,” she said.
“The most important thing is to have a very good line of sight for the investors on the assumptions you’re making, added Smith-Gander. “When those assumptions become unfeasible, that’s the minute you need to make some announcements to the market.”
AICD CEO and MD Angus Armour FAICD said it is in no-one’s interest to protect bad directors. “We had a very forensic look at company culture over the past few years, and boards are being held to account for company culture,” he said. “We need to step back and look at our regulatory culture, our regulatory environment with the same focus and intent. We’re going to have to give people hope and a sense of destination and there is absolutely no incentive in the current setting to provide that hope or that sense of destination because we could be held to account for something later on when circumstances change.”
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