Accounting Standards Board Newsletter #5

Tips to improve the quality of your entity’s financial statements

It’s the time of year again when entities are in the process of compiling their financial statements and preparing for the upcoming audit.

The ASB has identified areas where preparers can improve the quality of their financial statements. These include:

Applying materiality in preparing the financial statements.
Reviewing and amending accounting policies so that they are relevant to the entity’s activities.
Disclosing information on judgements, assumptions, estimates and uncertainties.

Applying materiality in preparing the financial statements

The financial statements should provide users of the financial statements with relevant information that helps them to hold entities accountable and make decisions. Materiality helps preparers to determine what information will be relevant to users.

Materiality should be considered when formulating an entity’s accounting policies as well as deciding what information to present and disclose in the financial statements.

The Standards of GRAP only apply to material items. This means that an entity need not apply:

The recognition and measurement principles in the Standards of GRAP when formulating an accounting treatment for an item that is immaterial. An entity develops its own accounting treatments for immaterial items. Examples include not applying the asset-related Standards to low value assets or transaction costs that are immaterial. GRAP 3 on Accounting Policies, Changes in Accounting Estimates and Errors provides guidance on the development of accounting policies.
The presentation and disclosure requirements of the Standards if the effect of applying them is immaterial. For example, an entity may not separately present a type of asset on the face of the statement of financial position as required in GRAP 1 on Presentation of Financial Statements if it is immaterial.

Materiality is considered from both a quantitative and qualitative perspective. Thresholds and criteria should be developed to clearly identify what is material for an entity, as well as ensuring that consistent decisions are made by preparers when applying the Standards of GRAP to that entity.

Developing accounting policies and deciding what to present and disclose in the financial statements require judgement. Preparers should document their materiality considerations as well as discuss them with the relevant oversight structures, such as the audit committee.
The ASB’s Guideline on The Application of Materiality to Financial Statements provides guidance on how to apply materiality: http://www.asb.co.za/wp-content/uploads/2019/04/The-Application-of-Materiality-to-Financial-Statements.pdf.

Reviewing and amending accounting policies

Entities’ accounting policies frequently repeat the principles in the Standards without explaining how they have been applied by the entity, and often the financial statements include policies for transactions or events not undertaken by the entity.

Accounting policies need to be reviewed and amended so that they:

deal with transactions undertaken and events that occurred at an entity, or judgements and assessments that have been applied by management; and
explain how the principles in the Standards have been applied by an entity in preparing their financial statements.

The financial statements should also only include those accounting policies that are significant to an entity. An entity could, for example, present its significant accounting policies in the financial statements and include a complete list of all accounting policies on its website. This could be explained in the financial statements.

Examples of what can be done to improve existing accounting policies are included in the annexure (https://www.asb.co.za/wp-content/uploads/2020/06/Annexure.pdf). FAQ 3.2 issued by the Secretariat should also be consulted.

Disclosing information on judgements, assumptions, estimates and uncertainties

Entities are required to provide information where judgement, assumptions, and estimation uncertainty are applied in the preparation of the financial statements. This is an area where entities have historically provided either no, or poor, information. Given the uncertain environment within which entities will be preparing their financial statements as a result of the COVID-19 pandemic, there is an increased need to provide this type of information to users of the financial statements.

Entities should disclose information on estimates and uncertainties that require management’s most difficult, subjective or complex judgements.

GRAP 1 requires the following information to be disclosed in the notes to the financial statements, specifically where there is a significant risk of a material adjustment to the carrying amounts of assets and liabilities in the next financial year:

Key assumptions concerning the future, for example, assumptions such as projected cash flows and discount rates used in impairing assets.
Other key sources of estimation uncertainty at the reporting date, for example, where unobservable data is used to measure assets at fair value.

For the affected assets and liabilities, the notes should also include details of: (a) their nature; and (b) their carrying amount as at the reporting date.

When it is impracticable to disclose the extent of the possible effects of a key assumption or another key source of estimation uncertainty at the reporting date, an entity discloses that material adjustments may be required in the next financial year as a result of changes in assumptions used at the reporting date.

Accounting implications of COVID-19

Apart from the issues discussed above, preparers should carefully consider the effects that COVID-19 may have had on the accounting treatment of assets, liabilities, revenue and expenses at the reporting date. The ASB’s document discusses issues that preparers may need to consider in preparing their financial statements for the year ended 31 March or 30 June 2020. Access the document by following this link: https://www.asb.co.za/covid-19/.