Financial reporting reminders

The financial reporting closing process is crucial for all organizations, both public and non-public. The resulting final output, the financial statements, are required to be submitted to local regulators, which include the Securities and Exchange Commission (SEC).

The financial statements filed with the SEC are primarily the responsibility of the management of the reporting company. Consequently, the fairness of the representations made is an implicit and integral part of management’s responsibility.

The SEC, in exercising its regulatory function, may select and review financial statements to assess compliance with financial reporting requirements. In the course of reviewing, the SEC may have comments or findings which the reporting company or to some extent, its independent auditor, should respond to.

In a recent regulators’ forum, the SEC reported on areas of non-compliance identified from their review of financial statements. Out of the findings discussed, there are matters identified to be pervasive; thus, considered to be material and frequently occurring in several companies. It may be noteworthy to highlight these pervasive findings, as we may be unaware that these also apply to our financial statements.

Disclosures for components of equity

One of the most common findings relating to the Equity section in the balance sheet pertains to incomplete disclosure on appropriated retained earnings, particularly on the details of appropriation and timeline of implementation or usage and date of approval by the board of directors.

There are also cases of an entity’s retained earnings exceeding its paid-in capital by 100 percent but there is no disclosure of any appropriation to comply with Section 43 of the Corporation Code. The SEC has the authority to question such cases.

If the excess cannot be justified, it is likely that a corresponding sanction would be imposed on the entity. However, what if there is a valid basis for retaining surplus profits beyond the allowed threshold? Say, the entity is undergoing or is set to have an expansion project? Or it is prohibited under a loan agreement from declaring dividends? Or it anticipates a probable loss or contingency that would require it to tap its accumulated surplus for future payments? If so, then a company may transfer a portion of its retained earnings to a “restricted” or “appropriated” retained earnings account.

Relative to this, a stock corporation appropriating a portion of its retained earnings for a corporate expansion project, for instance, must disclose in its financial statements the details of the expansion, which include the project description and timeline to render the project definite, as well as the date of the approval by the board of directors. This will also similarly apply for other appropriations made such as for loss contingencies or in response to specific loan covenants.

Another pervasive finding on equity is on incomplete disclosures of companies of their Deposit for Future Stock Subscription account. Specifically, companies should include in their notes to the financial statements the date of approval by the board of directors and stockholders on increase in capitalization, the date of presentation or filing of application with the SEC, and status of the application.

Consolidation requirements

Despite the company’s control, what if it fails to prepare consolidated financial statements? And there is likewise no disclosure of its justification for non-consolidation of investment in subsidiary? This is likely to be a non-compliance matter.

A parent company doesn’t have to present consolidated financial statements if all of the following conditions are met:

(a) It is a subsidiary of another entity and its other owners have been informed about, and do not object to, the parent not presenting consolidated financial statements.

(b) Its debt or equity instruments are not traded in a public market.

(c) It did not file, nor is in the process of filing, its financial statements with regulatory organizations for the purpose of issuing instruments in a public market.

(d) Its ultimate or immediate parent company produces financial statements available for public use that comply with international financial reporting standards.

If any of the above conditions are not met, a parent company should prepare consolidated financial statements using uniform accounting policies for its subsidiaries.

Auditor’s report

The financial statements required to be submitted to the regulators shall be accompanied by an auditor’s report issued by an independent auditor.

One of the more significant findings on the auditor’s report is the lack of “emphasis of matter” paragraph that discusses specific management plans to address the company’s capital deficiency, or the lack of reference to the notes to the financial statements discussing the same, and that the auditor conducted sufficient audit procedures to verify the validity of the aforementioned plan. The SEC bulletin specifically mentions these requirements for a company with capital deficiency.

With the adoption of the SEC of the new and revised auditor reporting standards effective for periods on or after Dec. 15, 2016, a separate section “Material Uncertainty Related to Going Concern” is provided in the auditor’s report instead of an “emphasis of matter”paragraph. Further, a description of the respective responsibilities of management and the auditor for going concern is integrated as part of the enhanced auditor reporting on this matter.

A compilation of material findings on financial statements reviewed by the SEC can also be found on its website.

It is worth the effort to revisit the reporting requirements of the accounting standards and the local regulators. Now is a better time to do this when we are in the midst of completing the financial reports, rather than having to deal with comments on the financial statements later on or worse, having to pay penalties for non-compliance.

As always, an ounce of prevention is worth a pound of cure.