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  1. 1. Institute of Chartered Accountants of New Zealand May 2005 Request for Comment on Discussion Paper and Exposure Draft ED-103 Prospective Financial Information Issued by the Financial Reporting Standards Board Institute of Chartered Accountants of New Zealand
  2. 2. Request for Comment on ED-103 Prospective Financial Information The Financial Reporting Standards Board (FRSB) of the Institute of Chartered Accountants of New Zealand (the Institute) has issued for comment this Discussion Paper relating to Exposure Draft No. 103: Prospective Financial Information (ED-103). Commenting on the Exposure Draft The FRSB welcomes comment on the exposure draft. To assist the FRSB in summarising the views of commentators, answers provided to the discussion questions would be appreciated. Respondents are strongly encouraged to provide detailed comment on the issues canvassed in the discussion questions and on any other aspects of the exposure draft. Comments should be addressed to: The Director – Accounting Standards Institute of Chartered Accountants of New Zealand PO Box 11342 WELLINGTON E-mail: ASD@icanz.co.nz Comments are due by 16 August 2005 Respondents are requested to indicate on their submission on whose behalf (for example, own behalf, a group of people or an entity) the submission is being made. Contents Discussion Paper ED-103: Prospective Financial Information 2
  3. 3. DISCUSSION PAPER Introduction The purpose of this exposure draft is to establish new reporting requirements in respect of general purpose prospective financial information prepared for external users. Currently such requirements are included in FRS-29: Prospective Financial Information (FRS-29). The proposed Standard specifies information to be included in a set of prospective financial statements and specifies minimum disclosure requirements. The proposed Standard no longer defines or makes any distinction between the terms forecast and projection. Instead it emphasises the disclosure of risks and the degree of uncertainty relating to assumptions in providing useful prospective financial information. Following due consideration of comments, the FRSB intends to submit the finalised financial reporting standard to the Accounting Standards Review Board (ASRB) for approval as a financial reporting standard, in terms of the Financial Reporting Act 1993.1 Background The review of FRS-29 was prompted by:  issues arising from an enquiry by the Securities Commission into Vertex Group Holdings Limited. This enquiry highlighted some uncertainty regarding the distinction between projections and forecasts. As a result of the issues raised in this enquiry the review of FRS-29 considered whether it was appropriate to amend the definitions of projections and forecasts or to remove the distinction; and  concerns raised by the Office of the Auditor-General about the appropriateness of some of the requirements and commentary in FRS-29 for public sector entities – in particular local authorities – preparing forecast financial statements in accordance with new legislative requirements. In addition, the FRSB considered that it was appropriate to review the requirements of FRS-29 following the issue of New Zealand equivalents to International Financial Reporting Standards (IFRSs). The proposed Standard is intended to be applied by entities reporting in accordance with New Zealand equivalents to IFRSs and entities reporting in accordance with Financial Reporting Standards and Statements of Standard Accounting Practice. The proposed Standard carries forward many of the requirements of FRS-29. However there are some important differences. The proposed Standard:  clarifies the application of the Standard to particular types of published prospective financial information;  includes discussion of the qualitative characteristics and the implication of these characteristics for prospective financial information;  removes the distinction between forecasts and projections; and 1 FRS-29 currently has authoritative support (by way of a direction by the Accounting Standards Review Board (ASRB)). Following an amendment to the Financial Reporting Act, the ARSB now has authority to approve standards relating to prospective financial information. 3
  4. 4.  has a greater focus on disclosure of the level of uncertainty associated with prospective financial information. The following sections address key issues considered in the development of the proposed Standard. In developing the proposed Standard the FRSB considered a range of international pronouncements. A list of these pronouncements is included in the Basis for Conclusions. Scope The scope of the proposed Standard captures general purpose prospective financial information:  required to be published by public sector entities;  published by other entities in accordance with securities legislation and regulations, and any prospective financial information published in conjunction with such information; and  published in a prospectus, investment statement, advertisement for an offer of securities or other similar documents. The Standard is not intended to apply to: (a) verbal prospective financial information disclosures or earnings guidance published by a New Zealand Exchange Limited listed issuer; (b) individual items of prospective financial information such as sales forecasts published in other reports such as an annual report; or (c) historical pro-forma statements. [Refer ED-103 paragraphs 2 to 8, the Basis for Conclusions paragraphs BC7 to BC-14 and Question 1] Prospective non-financial information The FRSB noted that prospective non-financial information was outside the scope of FRS-29 and considered whether any of the requirements in the proposed Standard should apply to prospective non-financial information. The FRSB noted that long- term council community plans are required to include a significant amount of information which is not financial but needs to be consistent with, and provides the basis on which, financial information is prepared. The FRSB decided not to extend the scope of the proposed Standard to prospective non-financial information. However, application of the proposed Standard to prospective non-financial information is encouraged (paragraph 5). The proposed Standard (paragraph 20) also requires that “Prospective financial information and any accompanying general, narrative or non-financial information shall be consistent with any current planned courses of action and strategies published elsewhere by the entity.” [Refer ED-103 paragraphs 5 and 20] 4
  5. 5. Qualitative characteristics The proposed Standard states that prospective financial information is expected to meet the four qualitative characteristics of understandability, relevance, reliability and comparability. This requirement was prompted by a review of international guidance, in particular Prospective Financial Information Guidance for UK Directors issued by the Institute of Chartered Accountants in England and Wales (2003) (PFI UK). The disclosure requirements of the proposed Standard are intended to ensure that prospective financial information produced in accordance with the Standard meets these qualitative characteristics. For example, the reliability of information is affected by the level of uncertainty associated with the information. The proposed Standard therefore requires disclosure of the level of uncertainty and risks associated with assumptions. [Refer ED-103 paragraphs 9 and 10, the Basis for Conclusions paragraphs BC15 to BC-22 and Questions 2 and 7] Projections and forecasts The previous version of FRS-29 differentiated between forecasts and projections. In an attempt to remove uncertainty regarding the distinction between these terms and the appropriate labelling of information based on a mixture of forecasts and projections the FRSB proposed limited changes to FRS-29 (July 2003) to clarify: (a) the distinction between a forecast and a projection; and (b) the position where prospective financial information is part projection and part forecast. These changes were deferred pending this more detailed review. As part of this more detailed review the FRSB reconsidered the usefulness of the distinction between forecasts and projections. The matters considered by the FRSB are outlined in the Basis for Conclusions. Following consideration of these matters the FRSB agreed to remove the distinction between forecasts and projections and to place more emphasis on the disclosure of assumptions and the degree of uncertainty associated with prospective financial information. [Refer ED-103 Basis for Conclusions paragraphs BC23-BC-27 and Question 3] Assumptions The proposed Standard requires that assumptions used in preparing prospective financial information shall: (a) be prepared in accordance with the qualitative principles (as discussed above); (b) be based on best available information and estimates, consistent among themselves, consistent with the plans of the entity, and be applied consistently; and (c) have a reasonably objective basis. The requirement that assumptions be based on the best available information and estimates does not imply that prospective financial information should meet the best- estimate requirement previously associated with forecasts. Instead the FRSB intends 5
  6. 6. that entities applying the proposed Standard will have regard to relevant information available at the time of preparing the prospective financial information and be able to justify the assumptions used with reference to that information. The proposed Standard acknowledges that entities in start-up phase that are required to prepare prospective financial information may have some difficulty in meeting this requirement. It therefore provides guidance on the types of actions an entity in start- up phase may take in demonstrating that assumptions have a reasonably objective basis. Entities that are considering alternative possible scenarios and seeking to provide information on these alternative scenarios are not precluded from doing so by the proposed Standard, so long as there are reasonably objective bases for the assumptions under the alternative possible scenarios. [Refer ED-103 paragraphs 10 to 17, the Basis for Conclusions paragraphs BC28 to BC-35 and Question 4] Form and content of prospective financial statements The FRSB considered several issues relating to presentation of prospective financial statements including: (a) whether the Standard should encourage or require entities to present a full set of prospective financial statements; (b) the level of detail required as a minimum to be shown in prospective financial statements; and (c) whether the Standard should require prospective financial information to be presented for both a parent entity and a group if the historical financial information was presented in this manner. Individual statements vs complete set of statements In considering this issue the FRSB noted that legislative and regulatory requirements for different types of entities vary. For example, the Securities Regulations 1983 require only a cash flow statement but many public sector entities are required by legislation to prepare forecast financial statements. The FRSB considered that it would be inappropriate for the Standard to require entities to present more prospective financial information than the minimum legislative or regulatory requirements and that attempting to do so could be regarded as onerous and lead to widespread non-compliance. However, the FRSB considered that any entity preparing prospective financial information should be encouraged to present a complete set of prospective financial statements. Where an entity prepares an individual prospective financial statement, such as a prospective cash flow statement, it shall comply with the requirements in respect of that statement. [Refer ED-103 paragraphs 18 to 21 and 23 and the Basis for Conclusions paragraphs BC37 to BC-39] 6
  7. 7. Level of disclosure required The FRSB acknowledged that the disclosures required in historical general purpose financial statements would be too onerous for prospective financial information. However, the FRSB also decided that disclosures additional to those currently required by FRS-29 were appropriate to meet the objective of high quality financial reporting. For example, the proposed Standard requires more disclosure in respect of income statements and cash flow statements. [Refer ED-103 paragraphs 22 to 35, the Basis for Conclusions paragraphs BC37 to BC-39 and Question 5] Format of prospective financial information The FRSB noted that the Office of the Controller and Auditor-General had sought clarification of the requirements in FRS-29 regarding the format of prospective financial information. The requirement in FRS-29 to present prospective financial information in the format expected to be used in the future for reporting historical information did not specify whether prospective financial information was to be presented for both a parent entity and a group if the historical financial information was presented in this manner. The FRSB considered whether this issue should be specifically addressed in this Standard. The FRSB noted that the Local Government Act 2002 required forecast financial statements for the local authority parent entity and allowed for further forecast financial information. Therefore any requirement to present prospective financial information for both a parent entity and a group would be more onerous than that legislation and could create difficulties for local authorities that have controlling interests in commercial entities such as airports or ports. In view of these issues the FRSB decided that the Standard would not include specific reporting format requirements and that the format of prospective financial information should be influenced by the purpose for which the prospective financial information is prepared and any applicable legislation. [Refer ED-103 paragraphs 18 to 35, the Basis for Conclusions paragraph BC39 and Question 5] Periods covered by prospective financial information The proposed Standard requires that, except as otherwise required by legislation or regulations, the length of the reporting period should be the same as for historical financial statements (for example, a financial year). Another issue had been raised in relation to the number of reporting periods for which prospective financial information should be provided. The Office of the Controller and Auditor-General had expressed the view that the discussion of the number of reporting periods covered by prospective financial information in FRS-29 did not adequately reflect the public sector environment where prospective information for local authorities is required for a period of 10 years. The proposed Standard acknowledges that the number of reporting periods covered by prospective financial information may vary considerably depending on the legal requirements relating to the reporting of prospective financial information and the purpose and objective for which the prospective financial information is prepared. Entities should exercise caution about publishing prospective financial information 7
  8. 8. for periods beyond that required by legislation or regulation. Entities publishing prospective financial information, other than those required to publish it by legislation or regulation, should exercise caution in presenting prospective financial information for more than one reporting period. The reason for the cautions is the FRSB’s concern that prospective financial information generally becomes more unreliable and uncertain as the number of future reporting periods increases. [Refer ED-103 paragraphs 37 to 39 and the Basis for Conclusions paragraphs BC40 to BC42] Pro-forma information The proposed Standard is intended to apply to prospective pro-forma information which is published in conjunction with the types of general purpose prospective financial information set out in paragraph 4. However, it is not intended to apply to historical pro-forma information. [Refer Basis for Conclusions paragraphs BC8 and BC31 and Question 8] 8
  9. 9. Impact Analysis A summary of the key differences between FRS-29 and ED-103 is shown in the following table. ED-103 FRS-29 Comment Qualitative characteristics In order to meet the needs of FRS-29 did not refer to the four This requirement is intended to users, general purpose qualitative characteristics. improve the quality of prospective financial information provided to users. information is expected to be It is also consistent with the understandable, relevant, move to specifying principles in reliable and comparable. Standards. [paragraphs 9 and 10] Forecasts and projections The proposed Standard does not The definition of a forecast The Vertex Group Holdings Ltd distinguish between forecasts referred to best-estimate enquiry had highlighted and projections. assumptions. concerns about the difficulty of differentiating between a The definition of a projection forecast and a projection. referred to hypothetical assumptions. The FRSB concluded that high quality disclosure of the degree FRS-29 did not deal with the of uncertainty and risks relating classification of prospective to prospective financial financial information based on a information would provide most mixture of assumptions. benefit to users. [paragraphs 4.1 and 4.2] Prospective financial statements The proposed Standard specifies FRS-29 requires that Entities are not required to a complete set of prospective prospective financial prepare any particular financial statements but does information include a statement statements. However, the not require an entity to prepare a of prospective financial proposed Standard specifies complete set of prospective performance and a statement of minimum disclosures in respect financial statements. accounting policies. It may of individual prospective [paragraphs 18, 22 and 23] include other statements. financial statements and these [paragraph 5.3] minimum disclosures are generally greater than those under FRS-29. Disclosure Specifies disclosure Specifies disclosure Many of the disclosure requirements in relation to requirements including requirements are similar to assumptions, risks and assumptions, the nature of FRS-29. However, there is a uncertainties. prospective financial greater focus on disclosure of [paragraphs 40 to 46] information and the basis of the level of uncertainty assumptions. associated with prospective [paragraphs 5.15-5.32] financial information. 9
  10. 10. DISCUSSION QUESTIONS The FRSB welcomes comment on ED-103 generally. In particular, it encourages comments on the following questions by 16 August 2005. 1) The scope of the proposed Standard is set out in paragraph 4. Do you agree with the proposed scope of the Standard? If not, why not? 2) Do you agree that the four qualitative characteristics should form the basis for preparation of prospective financial information? If not, why not? 3) Do you agree with the elimination of the definitions of forecast and projection? If not, why not? 4) Do you agree that it is appropriate to require assumptions to have a reasonably objective basis? If not, why not? 5) Do you agree with the specific disclosure requirements for each prospective financial statement? If not, why not? 6) Do you agree with the disclosure requirements in the proposed Standard, other than those relating to specific prospective financial statements? If not, why not? 7) Do you agree that the proposed disclosure requirements are sufficiently comprehensive to ensure that prospective financial information meets the four qualitative characteristics? If not, why not? 8) Do you agree that the proposed Standard adequately addresses situations in which prospective pro forma information is provided? If not, why not? 9) Are there any regulatory issues or other issues arising in the New Zealand environment that may affect the implementation of the proposals, particularly any issues relating to: a) profit-oriented entities; b) public benefit entities; or c) the Privacy Act 1993? Please provide reasons supporting your response. 10) Do you consider that the proposed Standard is in the best interests of users of general-purpose financial reports in New Zealand? Please provide reasons supporting your response. 10

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