ADAA IFRS digest

IFRS news, updates from ADAA, IASB and the Accounting Profession December 2017

WHAT’S NEW FROM IFAC AND THE IASB

Key Audit Matters. IFAC get in on the act. IPSAS and IFRS. Increased alignment. Proposals aim to bridge the gap regarding revenue and financial assets. Internal Control. Implementation Tool for Auditors from CPA Known unknowns of IFRS 9 and 17. KPMG survey of insurers who will be heavily impacted by the new standards.

Annual improvements to 2015-2017 cycle issued. affects IFRS 3, 11, IAS 12, 23. Lead by example. How to present information about your entity. PWC Applying IFRS 15 in the Real Estate Industry. EY Current SEC and PCAOB developments. “The work of auditors is critical…” And on the back page The first of the famous five an insight from ADAA’s Amna Huwail.

Key Audit Matters. You may have noticed the auditor opinion looks a little this year. Its longer and it’s got more information in it on what work the auditor did to address significant risks. But is longer better? IFAC KAM IPSAS and IFRS. In the light of the conversion process between the IFRS and the public sector standards, the IPSASB published a new exposure draft to amend some principles towards the respective standards under the IFRS. One proposal is to amend IPSAS 29 Financial Instruments towards IFRS 9, with simplified classification and measurement requirements for financial assets, a forward looking impairment model, and a flexible hedge accounting model. Find the comparison between IPASAS and IFRS and more here. Another proposal is to amend the recognition and measurement criteria for revenue and non-exchange expenses under IPSAS 23 towards IFRS 15. More here.

Annual improvements 2015-2017 cycle issued. Some small (in IASB language narrow scope) amendments effective from 1 January 2019, with early application permitted. They clarify:

An entity remeasures its previously held interest in a joint operation when it obtains control. While it does not remeasure it’s previously held interest in a joint operation when it obtains joint control under IFRS 11.

IAS 12 to recognize income tax consequences of dividends on P&L, and Any borrowing costs incurred after the asset is ready for use or sale,

becomes part of general funds when calculating the capitalization rate on general borrowings under IAS 23. More here.

Lead by example. In the link is a starter kit to help you think about how to present information about your entity. It’s called Integrated reporting For SMEs but the principles are the same for any entity.

Internal Control. Implementation Tool for Auditors from CPA Canada: Specific requirements of CAS 315 identified in practice inspection as areas where auditors struggle to meet the requirements. Equipped with an understanding of common pitfalls, the tool provides an approach for appropriately identifying and assessing the risks of material misstatement through understanding the entity and its environment, including the entity’s internal control. KPMG Known unknowns of IFRS 9 and 17. KPMG survey of insurers who will be heavily impacted by the new standards. 85% are still assessing, or not finished assessing the impact of IFRS 17, whilst 65% said the same for IFRS 9. The survey provides information about the effect on data, systems and processes. Big changes required, no surprises there. It also discusses the business impact. Explore the lessons and tips that emerge here.

PWC Applying IFRS 15 in the Real Estate Industry. Just because 34c) says you can, it doesn’t mean you have to! IFRIC 15 overturned a rather bullish application of IAS 18. IFRS 15 was unfortunately hijacked during development by the developers and 34c) has brought that rather bullish application back. Scrutinize your contracts very carefully. If there is no alternative use for the good you are selling to the customer and you have the right to payment from the customer for performance to date. You have to recognise revenue. Which means you might have to borrow to pay dividends. Fine if the development gets finished, not so fine if it doesn’t. More here. EY Current SEC and PCAOB developments. “The work of auditors is critical in protecting investors and helping registrants and audit committees fulfill their respective duties. External audit the “linchpin of trust that holds our system of public market capital formation together” and highlighted the important role the PCAOB has played in promoting investor trust and the independence of the auditing profession.” All the issues in AICPACompendium.pdf

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ADAA IFRS digest

IFRS news, updates from ADAA, IASB and the Accounting Profession December 2017

The first of the famous five, Control Environment– an insight from ADAA’s Amna Huwail

In ADAA IFRS Digest September 2017 we highlighted the importance of internal controls in the context of an audit of historic financial statements. Published in the Official Gazette 15th August 2017 is Decree number 1 of 2017. The decree requires Subject Entities to obtain from the Statutory Auditor (as part of the audit services) a separate report, on the effectiveness of the Subject Entities system of internal control. To assess the design effectiveness of a system, a Framework is required. Although the decree is framework neutral, COSO is one framework that might be applied. In September we highlighted the five components and seventeen steps of COSO. In this, and our next four publications, we go through the components and steps in more detail. Management is responsible for the preparation of their financial statements. Management is responsible for the system of internal control being designed and operating effectively. Internal Audit is a key tool in management making that assessment. COSO has many useful tools and publications available on their website, some of which are utilized in preparing this publication. The five components:

Control Environment

Risk Assessment

Control Activities

Information and Communication

Monitoring Activities Component One - Control Environment There are five principles that together demonstrates if the control environment is operating effectively. 1) The entity demonstrates a commitment to integrity and ethical

values. Tone at the top: Management, Directors, Those Charged with Governance lead by example. Their values, their integrity, their ethics, their behavior, sets the tone. The judgements they make, the quality of evidence they accept, the guidance they provide, their commitment to do what is right sets an example to all in the organization. In smaller organizations, it will be felt, evidence will be face to face, the owner’s presence setting the tone. In larger organizations it is found in mission and values statements, codes of conduct, policies, procedures and practices. The importance of tone from the top cannot be underestimated. Do as I do, is more powerful than, do as I say. Standards of conduct: Establish what is right and what is wrong. Provide guidance for operating in between and what the associated risks might be. They take account of local laws and regulations, and custom and practice. The more international an organization becomes the greater the need to define standards. If something is not acceptable in one part of an organization in one part of the world how can it be deemed acceptable elsewhere? Standards of conduct don’t just apply to directors, management and employees, they apply to suppliers, customers and financiers. In fact, they apply to all stakeholders.

Adherence and deviations: Setting the tone and having standards is not effective without periodic assessment, intervention and enforcement. Assessment requires gathering evidence in support of an objective evaluation of performance in accordance with the prescribed standards. The decree refers to ‘testing the effectiveness of internal control over the financial reporting process’ and whilst it maybe SAP or Oracle or some other software that facilitates your financial reporting, it is people that apply it and oversee it. Evaluating adherence involves Internal Audit conducting assignments to assess people’s performance in their roles (and not just those at the bottom of the organization). It requires Audit Committees to assess themselves. It requires Audit Committees to evaluate the supplier of audit services. It requires Audit Committees to assess Internal Audit. It requires assessment of employees, managements and directors’ performance and remuneration. It requires assessment of procurement services, sales peoples’ incentive programs and potential collusions with customers.

The enforcement question has to be addressed too. Is the response to a deviation a penalty or a training activity? What changes must be made?

2) The Board of Directors demonstrates independence from management

and exercises oversight of the development and performance of internal control.

Authorities and responsibilities: The Board (or other oversight body) comprises both executive and non-executive members normally with a majority of non-executives. The CEO and senior management are responsible for designing and implementing the internal control system, the Board provides oversight and challenge. To facilitate oversight structures are put in place, either voluntarily, or because of local laws and regulations, including stock exchange listing requirements. These include:

Nomination committees for the selection of directors and evaluation of senior management and the Board of directors.

Remuneration committees to assess policies for executives and senior management to ensure a balance between long and short term decision making and an assessment of risk.

Audit Committees for oversight of financial reporting, integrity, transparency and internal control.

Other Committees to address specific risks arising from local regulations or perceived risks. E.g a Rick Committee.

Independence and relevant experience: Independence has according to the IESBA Code of Ethics two qualities:

Independence of mind – the state of mind that permits the expression of a conclusion without being affected by influences that compromise professional judgement, thereby allowing an individual to act with integrity, exercise objectivity and professional skepticism

Independence in appearance – the avoidance of facts and circumstances that a reasonable and informed third party would likely conclude a person’s integrity, objectivity, or professional skepticism is compromised.

Relevant experience can be difficult to find. Industry, regulatory and market experience are most likely found in the skillsets of the CEOs and Senior management employed by competitors! For this reason, retired

• Making explicit the consequences for deviations from standards of conduct at any level in the organization. • Ensuring that new and existing employees are trained on the entity’s standards of conduct and continuing education. • Developing performance evaluation process. • Providing staff with ethics training opportunities. Example, The senior management of Zanzibar Co, a publicly traded company emphasizes the company’s code of business conduct and ethical standards to all employees and external parties. He ensures that the code of conducts and ethical values communicated to the all level of the global organization. He uses the technological resources like web-based training sessions on various aspects of the code of ethical standards. Moreover, they set a code of conduct for the supplier to its vendor as part of its services level agreement. It include the relevant language to highlight the company’s standard of conduct. This code of conduct provide a basis for the evaluation combined with product/service delivery evaluation. Approach: Leading by example on matters of integrity and ethics: The CEO and key members of management must emphasis and demonstrate the importance of integrity and ethical values. The mechanisms used to do this may include

• Communications from senior management that support the expected standards of conduct and that stay consistent as they permeate the organization.

• Day-to-day actions and decision making at all levels of the organization that are consistent with the expected standards of conduct.

• Interactions with suppliers, customers and other external parties’ that reflect fair and honest dealing.

• Corrective action when deviations from expected standards of conduct occur

Example,Aerospacial S.A a small supplier to the aerospace industry exercise the approach of emphasize the importance of exercising sound integrity and ethical values by providing a monthly newsletter to employees, outsourced services providers, business partners, and other external parties. The newsletter highlights the points of the resources available to resolve ethical issues and the ethical decision making consequences of violations of the code. Approach: evaluating management and other personnel, Out-sourced Service Providers, and Business Partners for adherence to standards of Conduct: The board of directors and senior management evaluate adherence to the company’s standards of conduct. This accomplished in a variety of ways,

• Assessing results from training and ethics certification processes

ADAA IFRS digest

IFRS news, updates from ADAA, IASB and the Accounting Profession December 2017

former CEOs, other senior management and Audit Partners are often sought. A key activity of the Board is to challenge the CEO and Senior management by asking probing questions and requiring follow up. 3) Management establishes, with Board oversight, structures, reporting

lines, and appropriate authorities and responsibilities in their pursuit of the objectives.

Organizational structures and reporting lines: Centralized, decentralized. Flat, pyramid. Matrix. Geographical, product or service. Insourced, outsourced? They are a myriad of structures and operating models management might adopt. Each structure requires an evaluation of reporting lines, information flows and potential conflicts of interest. Authorities and responsibilities: Once entities grow to a certain size the owner manager model becomes ineffective. The question becomes how much empowerment is passed down inside the organization? Limitations of Authority: to prevent the unintended consequences of a person acting inside their authority level but outside their competency level thereby taking on inappropriate risks, limitations must be put in place. Limitations can be system driven, or structurally driven they can include access controls both physical and virtual and segregation of duties. 4) The organization demonstrates a commitment to attract, develop

and retain competent individuals in alignment with objectives. Policies and Practices: Provide the foundation for defining competence required to achieve objectives and provide a basis for evaluating performance. A rocket scientist requires a recognised degree from an appropriate University in rocket design, manufacture and operation. Evaluate Competence: Competence is demonstrated from professional experience, training and certifications. The Board of directors evaluate the competence of the CEO. The CEO of Senior management. Senior management of Management and employees. Attracting, developing and retaining: Competent, experienced and skilled people make less mistakes. They will embed and test internal control systems so that the systems are effective, minimizing the risks of fraud or error. As a colleague once said: “there are those who know they know, learn from them. There are those that don’t know they know, teach them. There are those that know they don’t know, be kind to them. And there are those who don’t know they don’t know…” Plan and prepare for succession: The unplanned loss of key personnel at any level in an organization can have a detrimental impact on the effectiveness of a system of internal control. Sometimes people don’t know why they are doing what they are doing, so they don’t understand its importance. The cumulative knowledge of an organization should grow over time, but it will only do so if key employees are not cherry picked by its competition. Ask Ferrari. 5) The organization holds individuals accountable for their internal

control responsibilities in pursuit of objectives. Accountability for Internal Control: The CEO is ultimately accountable to the Board of Directors for identifying and understanding the risks to the entity and establishing an effective system of internal control. To achieve such accountability, objectives, guidance, training, performance reporting, deviation measures etc. are pushed down to appropriate positions in the organization.

The question becomes how much accountability can or should be pushed down and what positions is it appropriate to hold accountable? Experience and qualification is a key consideration, as is growth and headroom. Clarity of responsibility is key, as are communication channels for people to feel comfortable about reporting deviations from the expectations set in standards. Performance measures, incentives and rewards: Reward is a great driver of behavior. Reward comes in many forms it is not just cash. Having an effective system of internal control is not a short term goal it is ongoing. Organizations change, people change, technology changes. Performance measures, incentives and rewards need to be current and be flexible to change. Objectives should be clear, communicated and understood at the appropriate levels in the organization. Measure expected performance compared to actual performance and both positive and negative deviations. Trends indicate the direction of travel and can identify the possibility of a negative deviation before it happens. Pressures: are an inevitable consequence of setting objectives. Pressure to achieve can be overwhelming and can result in unintended behavior. Objectives need to be stretching but realistically achievable. History demonstrates unrealistic objectives are not only unachievable, they can result in people doing things they would not normally do. Such as bringing forward revenue recognition and stretching valuations and provisions to hit budget. The role of finance teams is to ensure transactions are accounted for appropriately and information presented fairly not to play with accounting to achieve a desired result. Performance Evaluation and rewards: Performance evaluation and award allocation always contains elements of subjectivity. Minimizing subjectivity is difficult. Being clear from the outset about objectives and awards helps. As do 360 degree evaluations. Feedback must be fair and freely given and evaluation outcomes fair and free from bias. Final thoughts Leading by example. Demonstrating a commitment to integrity and ethical values contributes to a higher valued organization. Valued higher by all stakeholders. Greater value is perceived in the quality of goods and services provided to customers. Suppliers are attracted at lower costs. And employees more motivated and committed. A strong control environment with the appropriate tone from the top is not a ‘nice to have.’ In the modern globally interconnected world, it is a must have.

• Considering anomalies in key performance indicators and internal analytical review of operational and financial information that could be a potential indicator of fraudulent financial reporting or other misconduct.

• Considering the results from ongoing and separate evaluations of internal control, which include evaluations of internal control at outsourced service providers and business provider.

ADAA IFRS digest

IFRS news, updates from ADAA, IASB and the Accounting Profession December 2017

Sara Al Sajwani

Hasina Al Adawi

Hanan Al Harati

Amna Huwail

Ebrahim Al Shaikh Ali

Dawood Al Hammadi

Mahmoud Shahin

Ahmed Al Mazrouei

Richard Wright

Steven Ralls

Head of Accounting and Auditing Standards

AASD@adaa.abudhabi.ae

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