By considering users in the development of financial statements, entities are able to reduce the volume of disclosures while creating a high-quality document.
7.1 Alignment of monthly and year-end reporting processes
Maintaining good financial reporting practices throughout the year enables entities to be responsive to change, and significantly enhances the quality of financial statements.
Adopting good financial reporting practices throughout the year is the major factor contributing to most entities being able to complete their financial statements in a timely and efficient manner.
Better practice entities view financial management and reporting as a continuous process that encompasses budget allocations through to the preparation of monthly financial statements and annual financial statements. Within-year reporting is integral to making year‑end preparation processes more effective, as financial statements have been systematically prepared and reviewed as an important, albeit routine, part of ‘business as usual’ activities throughout the year.
While a full set of notes to the monthly financial statements would not be expected to be prepared, it is important that key reconciliations are performed throughout the year and anomalies are investigated and rectified as they are identified.
Where the monthly financial reporting process is aligned with the preparation of the annual financial statements, entities experience less difficulty and delay in completing their year-end processes as:
- errors and problems are identified and rectified, to the extent possible, well in advance of year-end
- business areas, other entities that collect and/or expend money on the entity’s behalf, service providers and the financial statements team are familiar with financial reporting requirements, and are well equipped to complete the required tasks within agreed timeframes
- the financial statements team, business areas and other entities that process financial transactions on the entity’s behalf, including service providers, are ‘on the same wave length’ and work together, making the co-ordination process easier.
7.1.1 Financial reporting—from monthly to year-end
Financial management by better practice entities is characterised by the following:
- preparation of monthly accrual financial statements, and keeping the accountable authority informed of any significant changes in accounting policies as they occur
- monthly reporting to the accountable authority includes an analysis of the financial position and the projected financial outcome at year-end; this analysis will include recommendations designed to address any significant variations from budget
- a detailed budget review, at least half-yearly, providing entities with the opportunity to revise their internal budget based on year-to-date actual performance.
Better practice entities will also streamline and simplify routine end-of-month processes, such as calculating and estimating (where appropriate) accruals, performing reconciliations and processing journal entries and clearing suspense accounts.
Within-year financial reporting will also be used to identify and address, to the extent practicable, issues that have the potential to adversely affect the preparation of the annual financial statements.
Errors or misstatements are often identified by review and quality assurance processes during the year and at year-end. If they remain uncorrected, errors or misstatements, either individually or collectively, may have a material effect on the financial statements.
Errors or misstatements identified during the year should be investigated and analysed to determine their root cause. A misstatement, even if it is immaterial in amount, can indicate a broader issue that warrants investigation. Where an error or correction is expected to be of material impact on the year-end process, this should be discussed with the audit committee and the auditor as appropriate.
7.2 The application of materiality
The materiality concept recognises that the reporting of excessive information may be counterproductive to making and evaluating decisions concerning the allocation of resources and recognises that achieving greater accuracy or greater precision in financial statements will generally demand greater use of resources, higher costs and take more time to prepare.
Linked to risk management, setting appropriate materiality thresholds enables entities to undertake risk assessments and establish appropriate risk treatments. While it is expected that an entity’s accounts and records will record all financial transactions and other events as a basis for preparing the entity’s financial statements, the concept of materiality and its application are important considerations. AASB 101 (and AASB 1060 for Tier 2 entities) states that:
- omissions or misstatements of items are material if they could, individually or collectively, influence the economic decisions that users make on the basis of the financial statements
- materiality depends on the size and nature of the omission or misstatement judged in the surrounding circumstances. The size or nature of the item, or a combination of both, could be the determining factor.
7.2.1 Areas where materiality is commonly applied
Two areas where materiality considerations are commonly applied are:
- the calculation of accruals and prepayments at year-end
- the capitalisation of eligible expenditure.
In both these areas, judgements are routinely made about the effect on the financial statements of not including transactions under a certain threshold, for example:
- For accruals and prepayments - entities generally set a timeframe for the identification and recognition of accruals for revenue and expenses as well as setting an amount below which accruals and prepayments will not be recognised.
- For capitalisation of expenditure - it is common practice to set a threshold below which expenditure on PPE is expensed, rather than capitalised. This practice removes the need for detailed ongoing accounting for immaterial items of PPE.
Such a practice is acceptable as long as it can be demonstrated that, in aggregate, an immaterial amount of PPE falls below the threshold and will clearly not affect the entity’s overall financial position and results. An example of this would be amounts too small to warrant disclosure in normal circumstances that may be considered material if they arise from abnormal or unusual transactions or events.
For control purposes, entities will normally maintain a register of portable and attractive assets that could be reviewed periodically to assist in assessing the materiality of assets that are not capitalised.
7.2.2 Practical steps when planning for materiality
The following are practical steps for planning and scheduling the application of materiality:
- in consultation with the CFO, consider the previous year’s approach to materiality and any issues that may have been encountered and develop a proposed approach for the current year
- obtain audit committee endorsement to the proposed approach
- advise the accountable authority of the proposed approach
- well in advance of the year-end, develop guidance material on the application of materiality, the relevance and readability of the financial statements, and adjustment of errors and misstatements that take account of qualitative and quantitative factors
- periodically review the materiality approach and supporting guidance, and monitor its application
- encourage feedback from the financial statements team and business areas on its application.
7.2.3 Materiality thresholds for errors and misstatements
Setting appropriate materiality thresholds for the adjustments of errors or misstatements for year-end processing will minimise the likelihood that the financial statements team will spend disproportionate resources on correcting matters that that are of immaterial impact to the financial statements.
Better practice entities will promote an environment in which the correction of errors or misstatements is seen as an appropriate course of action, regardless of whether or not they are considered to be material. Such an approach will also help to remove the difficulties that can arise in relation to the effect on current year financial statements of uncorrected prior year misstatements and minimise unadjusted audit differences.
However, there may be instances where adjustments are not considered appropriate, due to reporting timeframes, the practicality of making the change, the risk of error in other aspects of the financial statements process, and the relative materiality of the errors (for example, it falls below the entity’s materiality threshold). Therefore each error needs to be assessed individually and in aggregate with any other unadjusted errors to determine the materiality of the error in terms of both its quantitative and qualitative impact on the financial statements.
As the assessment of the qualitative impact of an error involves professional judgment, better practice entities will also have a review and sign-off on the schedule of adjusted and unadjusted errors.
See information at: 7.5.2 Analysis and adjustment of errors or misstatements.
7.2.4 Responsibility for determining the application of materiality
The responsibility rests with both those charged with governance of the entity and its management for determining:
- the overall approach to applying the concept of materiality
- the application of materiality thresholds to particular transactions and other events.
The entity and the auditor both have a responsibility to consider and apply materiality in the context of the accounting and auditing standards respectively. These materiality thresholds may differ, so it is important that an entity is aware of the auditor’s approach, and wherever practicable makes corrections for all audit identified adjustments.
7.2.5 Setting a materiality threshold
In applying materiality in the preparation of its financial statements, an overall materiality threshold may be a useful reference point to guide decisions about the application of materiality to particular items or groupings of items and in determining the approach to be followed in respect of the correction of errors and misstatements.
These matters should first be discussed with the audit committee and the auditor during the planning phase of the financial statements preparation process.
7.2.6 Assessing materiality
In making assessments on recognition, measurement, classification and disclosures in the financial statements, the responsibility of preparers is to include all information users require to understand the entity’s financial performance and position during the reporting period.
In a public sector context, these assessments must include any additional information required by the Finance Minister and take into account significant matters of interest to the Parliament.
7.2.7 Materiality and record keeping
The application of materiality in the context of preparing the financial statements should not, however, detract from the responsibilities of entities to maintain proper accounts and records, and for those accounts and records, including relevant systems, to accurately record the entity’s financial transactions and other events.
7.2.8 Materiality and disclosures
Financial statements note disclosures is another area where the concept of materiality can usefully be applied. The overall readability and usefulness of financial statements can be adversely affected by excessive length and the complexity of particular disclosures, or by excessive brevity.
Better practice note disclosures are concise and assist the reader to understand how the financial operations of the entity have been reflected in the financial statements. It is therefore good practice if entities conduct a review of financial statement disclosures periodically.
7.2.9 Additional resources
|Resource name||Resource description|
This paper is useful for documenting your entities decisions in regards to materiality.
7.3 Undertaking preparatory work before year-end
To improve data integrity and the efficiency of year-end procedures, better practice entities prepare some work well in advance of the year-end. A major benefit derived from the elimination of peaks in activity is that staff involved in the preparation of financial statements are able to operate in a less pressurised manner, thus allowing more time to perform critical tasks well, and allow time for review and quality assurance. This in turn reduces the incidence of error, and is likely to improve the overall efficiency of the process.
Many entities also use hard or soft close processes, or a combination of both approaches, to prepare work prior to year-end.
- A full hard close - involves the full production of financial statements, including notes that meet legislative and policy requirements.
- A soft close - involves the verification and computation of individual balances on a selective basis, based on a risk assessment.
The common aim of each of these approaches is to enable an entity to expedite the finalisation of the financial statements at year-end and to achieve timely audit clearance.
7.3.1 Deciding on a hard or soft close process
The decision to undertake a particular close process will generally depend on the effectiveness of an entity’s systems and processes, the nature and complexity of its transactions and operations and whether there are advantages in spreading the workload involved in preparing the financial statements over a longer period. However, while the need to conduct a hard close may diminish as entities’ systems and processes mature, the ability to provide reliable and timely financial statements improves and leads to accurate full accrual monthly financial statements being produced.
An entity’s judgement about the appropriate approach to adopt will be influenced by:
- the availability of staff and/or independent parties with the necessary skills and experience, including experience with producing financial statements using the entity’s systems and financial statements model
- the level of confidence the accountable authority and management have in the entity’s existing financial systems, controls and related processes
- the level of assurance that the accountable authority and management require about the entity’s ability and capacity to meet its year-end financial statements responsibilities
- the benefits to the audit and/or financial statements sub-committees in meeting their responsibilities.
These factors should be considered and discussed with the entity’s audit committee.
To maximise the effectiveness of the particular approach adopted, the auditors should also be consulted on the feasibility and efficiency of conducting an audit of the hard close statements or those elements completed for a soft close. A decision on whether the auditor will conduct an audit and how long it will take will be influenced by the capacity of entities to prepare satisfactory auditable financial statements, working papers and other supporting documentation within an agreed timeframe. The audit approach will therefore depend on each entity’s particular circumstances.
Entities should consult their auditors at an early date so that both parties can discuss and agree an approach that is mutually beneficial. Entities may also see benefit from internal audit, or an independent party, reviewing the outcome of the particular close process.
7.3.2 Hard close considerations
In effect a full hard close is regarded as a full trial run of the end-of-year processes, recognising that some balances and processes can only realistically be calculated or conducted at or after year-end. A hard close typically involves:
- performing reconciliations
- examining transactions for undetected accruals or transactions processed into the wrong period (cut-off)
- verification of physical balances through stock counts
- an analysis of current period transactions and balances to highlight possible errors arising from misclassification or incorrect posting.
Hard closes should also involve independent valuation and estimates for balances that are not able to be determined by other means. For example, the valuation of non-current assets and the actuarial assessments of certain liabilities.
Such an approach may be resource intensive and many entities prefer to undertake a modified hard close that involves preparing the majority of their financial statements but not completing tasks such as stocktakes and asset valuations. Often it is more cost-effective to complete such tasks once as at year-end.
A key determinant in timing a hard close is the nature and timing of key financial transactions or events. For example, an entity that processes significant financial transactions in May and June may benefit from conducting a hard close as at the end of March or April.
By contrast, an entity whose business cycle is relatively stable and consistent may schedule a hard close at the end of April or May, noting that the later a hard close is undertaken, the less time entities have to resolve issues before preparing the annual statements.
7.3.3 Soft close considerations
A soft close involves ‘closing the books’ with enough precision to provide specified key financial information to management. In practice most, if not all, entities undertake a soft close periodically during the year to meet their monthly or quarterly management reporting obligations. In a soft close:
- certain balances may not be calculated
- all financial statements reconciliations may not be undertaken, or may be replaced with variance analysis
- certain accruals and estimates may not be calculated, may be calculated other than at period-end, or may be estimated
- cut-offs for transaction processing may be brought forward prior to period-end.
However, a number of issues can impede the full-year financial statements preparation and the audit clearance process including the:
- adequacy of disclosures
- appropriateness of valuations
- determination of contingencies
- calculation of provisions
- reporting of appropriation information, including when MoG changes have affected entity operations.
It is therefore important that such issues are addressed prior to the preparation of the full year’s financial statements.
7.3.4 Additional resources
|Resource name||Resource description|
This risk assessment demonstrates a risk that could be mitigated by inclusion in a hard or soft close.
7.4 Developing accounting estimates
Due to inherent uncertainties in business activities, some financial statements items cannot be measured with precision, and must be estimated. Such accounting estimates require the exercise of judgement, based on pre-determined assumptions and therefore have a higher inherent risk of material misstatement.
Accounting estimates are frequently required for items such as:
- impairment allowances
- useful lives and residual values of non-current assets
- employee entitlements
- taxation revenue
- provisions for future expense claims
- costs arising from litigation settlements and judgements.
In some cases, assumptions will be based on government statistics such as inflation rates, interest rates, exchange rates, mortality rates, employment rates and taxation. In other cases, the assumptions will be specific to the entity and will be based on current and/or historical internally generated and/or service provider data.
Better practice development of accounting estimates is characterised by:
- identifying applicable financial reporting requirements including conditions or methods for the recognition, measurement and disclosure of the item
- using appropriate accounting policies and prescribing estimation processes
- developing and documenting soundly based assumptions about future conditions, transactions or events that affect the estimates
- ensuring relevant government and management policy decisions, as well as relevant legislation, have been considered
- interdependencies being taken into account when developing assumptions, as an assumption may appear reasonable when used in isolation, may not be reasonable when used in conjunction with, or taking account of, other assumptions
- collecting sufficient, relevant reliable and quality assured data on which to base accounting estimates
- regularly reviewing the circumstances that give rise to the estimates and underlying assumptions and adjusting the estimates if necessary
- undertaking ‘look-back’ analysis, that is, comparing the actual results with prior year estimates to determine the historical accuracy of the estimate
- preparing concise accounting position papers that detail the estimation process, including the assessment of assumptions and supporting documentation
- review and approval of all final estimates, including those prepared by internal or external experts, by personnel with the appropriate skill and authority levels
- audit committee endorsement, plus the auditor’s agreement of accounting position papers prior to year-end.
7.4.1 Accounting estimates - controls and expertise
As the inherent risk of material misstatement is greater when financial statement balances are based on accounting estimates, it is essential that entities establish and maintain a process to develop and produce reliable accounting estimates. A high degree of specialised knowledge and judgement may be required in the case of complex accounting estimates where the risk of developing unreliable estimates increases. Qualified personnel with the necessary skills and knowledge should be selected to prepare accounting estimates. If appropriate, experts within or outside the entity can also be used. These personnel should have:
- sufficient business and accounting knowledge of the item
- a good understanding of its underlying business drivers, processes and controls
- skills in business modelling.
7.4.2 Risk assessment for accounting estimates
In assessing the risks of material misstatement in accounting estimates, entities should identify factors that may affect their reliability and assess whether the level of estimation variance lies within an acceptable tolerance level.
For example, a change in assumption could materially affect the estimate recognised in the financial statements. The existence of recognised measurement techniques should assist in mitigating the degree of uncertainty associated with an estimate.
A change in circumstances such as new legislation may require the entity to revise or develop new accounting estimates. Entities should incorporate mechanisms in their risk management process to identify the need for revised or new accounting estimates.
7.4.3 Analysing the effect of uncertainty
Sensitivity analysis can be used to analyse the effect of uncertainty. Varying the level of inputs or assumptions may help to determine the degree of variation in the monetary amount of an accounting estimate. It also helps to identify the assumptions that are likely to create the most significant variation or degree of unreliability.
An assessment of the degree or range of variation provides a basis for assessing the potential risk of error in the financial statements. Disclosure of estimation uncertainty may assist entities to meet the applicable financial reporting requirements (such as AASB 13 Fair Value Measurement and AASB 119 Employee Benefits).
7.4.4 Documentation of accounting estimates
Documentation to support accounting estimates is particularly important, as it:
- helps to maintain consistency between years
- provides supporting evidence on how decisions were made, assumptions employed, sources of data, and the management of risk arising from significant variations
- assists management to provide explanations of variances and to improve its estimation techniques.
Documentation should include information on:
- management policies and processes
- sources and reliability of data (such as budget documentation, legislation, government policy, executive and/or other committee minutes and business management information systems)
- selection or construction of significant assumptions, with details of alternative assumptions including the basis for rejecting those assumptions
- changes in accounting estimates from one period to another.
7.5 Using analytical procedures
Rigorous and objective analytical procedures undertaken during the financial statements preparation process will help to improve the accuracy of the statements. Analytical procedures are used to identify unusual relationships and items in the statements that may affect their accuracy and completeness, or assist in identifying potential errors or omissions.
Procedures can range from simple comparisons of items to complex analytical models of relationships. More sophisticated procedures are often used to analyse administered items.
Various analytical procedures can be used. In selecting and applying procedures, including, but not limited to:
- simple comparisons - comparing a current year item to a norm, for example:
- percentage or dollar value changes from prior year results
- comparing actual amounts to budgets
- reasonableness relationships such as staff numbers to payroll and depreciation to non-current assets
- trend analysis - analysing financial statements items expressed as a percentage of a selected base year
- predictive analytics - can include more complex procedures such as financial modelling, as well as relatively simple procedures, and are useful in analysing administered items where transactions are:
- closely related to non-financial information, such as the number of organisations in receipt of grants
- not always directly comparable to prior periods because of changes in eligibility rules, demographics, demand patterns and government policy
- ratio analysis - examining relationships between financial statements items to either identify or confirm changes in expected relationships. Examples of ratios include:
- quick asset ratio
- current ratio
- receivables turnover.
An entity should consider factors such as the complexity and nature of its activities, the availability and reliability of information used for comparison, and the skills and knowledge of the analysts.
Analytical procedures require significant business expertise and judgements as well as a good understanding of accounting principles and processes.
7.5.1 How to implement analytical procedures
Entities should consider the following when incorporating analytical procedures into their systems and processes:
- Use analytical procedures throughout the year - to review monthly financial statements. Reviewing against budget, previous years’ results and month-on-month results can identify items such as expected expenditure amounts that have not been invoiced or accrued. Unusual items can be identified and explained, thus minimising problems at year-end.
- Apply analytical procedures to each line item of the financial statements - during the preparation process to help provide additional assurance, conduct comparisons of current figures against the budget and past periods, and perform an analysis of what might be expected in view of known circumstances. Predictive analytical procedures are usually more useful, but they require a deeper understanding of the business. The financial statements team could seek assistance from business areas in preparing such analysis.
- Review information provided by business areas - and seek explanations for variances. Information from one area can be compared with another to identify any unusual trends. Information from business areas can also be compared with other related information in the statements to check consistency. The procedure helps to highlight possible errors before final compilation of the statements, which the entity can then:
- investigate any unusual relationships and items in the statements promptly - these may indicate the possibility of systematic breakdowns in internal controls and whether there might be similar errors in other accounts or items
- conduct in-depth analytical reviews of the financial statements - particularly the first and final drafts. This process should involve providing explanations of significant changes in financial results from the previous year, and from budget.
7.5.2 Analysis and adjustment of errors or misstatements
When errors or misstatements are identified during the year-end process, it is important for entities to:
- analyse the misstatements to consider their implications for the financial statements
- assess the risk of other similar misstatements or omissions occurring
- assess if there is a need to investigate and quantify possible errors in a particular financial statements line item
- correct all errors or misstatements, unless they are trivial
- maintain a listing of any uncorrected misstatements, including those that arose in earlier periods and are of continued applicability in the current period, and assess their effect on the financial statements
- advise appropriate levels of management, the audit committee and the auditor of all unadjusted errors or misstatements.
7.5.3 Additional resources
|Resource name||Resource description|
This schedule allows an entity to keeps a record of all adjustments proposed/ made and to enable the changes to be considered and actioned as a whole.
7.6 Using technology
Many entities process a number of journals at the end of each month and at year-end for a variety of reasons including posting accruals, allocating costs and reclassifying income and expenditure. In many instances, these journals are manually compiled and processed, and some are of a recurring nature.
Better practice entities seek to automate the computation and processing of recurring journals to improve the efficiency of processing, and to minimise the occurrence of human error.
Better practice entities also regularly review journals that are raised to correct processing errors. By analysing the type and frequency of errors, entities may be able to find and eliminate their root cause, thereby improving the efficiency of the year-end close process.
Regular reviews of arrangements for, and personnel with, systems access should also be undertaken and documented to ensure that access is only provided to appropriately skilled personnel and segregation of duties is maintained wherever possible.
7.6.1 Use of technology for faster, more accurate processing
Increasingly, entities are using technology to automate, simplify and streamline particular tasks and functions, including production of monthly reports, year-end financial statements, bank reconciliations, purchasing and payments. Apart from the obvious efficiencies involved, automation of financial statements processes helps to:
- eliminate the risk of keying and transposition errors
- enable multiple draft statements to be produced with minimal effort
- align various reporting requirements with financial statements processes
- manage versions and updates
- reduce the number of reconciliations that are required.
The integrity of mapping general ledger accounts to financial statement line items should be periodically confirmed through review and quality assurance processes, and strict controls need to be in place to manage any software upgrades or changes.
In addition to a centralised FMIS, better practice entities require data entry at source, preferably online and in real time. Better practice entities also foster a culture of ‘getting it right’ the first time, with errors returned to the originator of the data for correction.
7.6.2 Managing the dependency on technology
It is important that the financial statements team is aware of any systems risks, issues and changes that could impact on the preparation of the financial statements.
Better practice entities work collaboratively with the ICT team to establish processes, controls (including cyber security controls), and timeframes for discussing and addressing any system upgrades, breakdowns or other risks that may affect the integrity or timeliness of financial information.
7.7 Preparing accounting position papers
Accounting position papers are an important tool that better practice entities use to document key decisions and to keep stakeholders apprised of updates to accounting policies and processes, plus their impact on the entity’s financial statements.
Accounting position papers may also address yearly assessments or plans for addressing complex items or accounting estimates, such as:
- administered investments
- stocktake and valuation plans
- new material, complex or significant transactions
- upcoming changes to accounting standards.
7.7.1 Content and structure of accounting position papers
Accounting position papers should document all the matters considered when making the decision, and would normally include the following information:
- the scope of the paper and any assumptions made
- the related legislation and guidance, and how it has changed
- a risk analysis of the change in policies or process
- the proposed treatment (preferably with an example when possible)
- the impact to the financial statements (such as which notes and disclosures will be affected and by estimated quantum)
- implementation plan (timing and resources required)
- a clear list of the interdependencies of the notes and disclosures affected
- stakeholders affected by the change, including key senior officers within the entity and portfolio department
- a copy of any external advice that has been received, including from an external expert and Finance.
7.7.2 Additional resources
|Resource name||Resource description|
This template provides a useful structure/guidance to assist in the development of an accounting position paper.
7.8 Collecting information from business areas
While processing and reporting activity is generally centralised in the entity’s financial statements team, key transactions are often recorded by business areas. Entities may need to collect source documentation for inclusion in or to support their financial statement working papers from business areas and/or third parties. This documentation may also assist the audit.
The information generally required from business areas relates to:
- accrued expenses
- asset stocktake discrepancies
- internally developed software
- executive remuneration
- commitments (payable and receivables)
- unearned revenue
- open purchase orders and goods received/invoice receipt
- resources provided free of charge.
Entities should determine the information that is available in the FMIS and the additional information that must be collected manually. For the manual collection process, better practice entities collect information, at hard close and year-end, by using a reporting package (usually a standardised information collection pack).
7.8.1 Additional resources
|Resource name||Resource description|
This checklist provides suggestions for instructions which may be contained in a reporting pack.
7.9 Shared services
Shared services generally involve an entity providing corporate or other services to one or more other entities.
Outsourcing functionality through shared services arrangements is becoming increasingly common in Government. As entities continue to be accountable for the risks associated with the function(s) being delivered by the shared services provider, as well as the quality of financial data in these circumstances, it is important for entities to maintain close working relationships with shared services providers and effectively manage the shared services arrangements.
Better practice entities will ensure that: there is clear agreement on:
- the nature and frequency of reporting of data completeness and accuracy by the service provider
- timely provision of details of any internal or external audit findings raised by the service provider’s auditors that could impact on the completeness and/or accuracy of the entity’s data.
7.9.1 Managing shared services arrangements
Strong management of shared services arrangements, in line with the examples identified below, supports an effective financial statements preparation processes:
- Formalised expectations - put a contract or formal agreement in place with relevant parties that includes:
- clearly defined roles and responsibilities and related timeframes in relation to the provision and quality of information that affects the reporting entity’s financial statements
- the nature and timing of information required, together with certification and assurance requirements of the reporting entity and the provisions that allow the reporting entity access to relevant accounting records of shared services providers
- service standards and performance measures to assess the performance of shared services providers
- provisions that facilitate the external audit of the shared services provider hub.
- Risk identification and assessment - identify and assess the risks of material misstatement, fraud and non-compliance with financial reporting requirements specific to shared services. This process should inform the internal controls and assurance provision needed to mitigate risks.
- Internal controls - implement control activities to assist in verifying the completeness and reliability of financial information supplied by the shared services provider hub. Such procedures could include the physical inspection of records and the interrogation of electronic records of the shared services provider considering authorisation, recognition and allocation of financial transactions or balances.
- Assurance from the shared services provider - formal assurance statements should be sought at least annually from shared services providers on the operation of their control framework, along with the timely reporting of any material breakdowns in shared services providers’ internal control framework that could affect the reporting entity.
Assurance requirements should be included in a formal agreement with shared services providers. Some entities have found it useful to invite representatives from shared services hubs to attend governance fora meetings (such as the audit and risk committee, a financial statements sub-committee, executive board depending upon the structure and risk profile of the entity) to discuss the assurance framework and walk through assurance items.
7.9.2 Issue management
Better practice entities establish an escalation matrix with shared services providers to promote effective problem resolution. Formalised service standards and performance measures, along with close engagement commencing in the planning stages of the financial statements can support the identification and resolution of any difficulties that arise in a timely manner.
7.10 Sourcing experts
Financial statements items that may require specialist expertise and knowledge can often be material and may involve fair value measurement and disclosure for a number of asset and liability balances at year-end. The following steps should be undertaken to obtain the required assurance about the work undertaken by an expert:
- determine the need to use the work of an expert
- determine the appropriate scope of the work and the responsibilities of the parties
- assess the professional competence and objectivity/independence of the expert
- manage the engagement, including timing of draft and final reports
- evaluate the work of the expert.
To facilitate both the internal quality assurance process and audit, the above steps should be clearly documented.
7.10.1 Clarifying the expert’s scope of work
Once an expert has been engaged, matters that need to be clearly determined and communicated to the expert in writing include:
- the scope of the work to be undertaken and the specific matters that the expert’s report must cover. It would be expected that, as a minimum, the expert’s report would include:
- the assumptions used
- an outline of the approach or methodology used
- the key calculations that underpin the final estimates or valuation
- relevant characteristics of the data used
- any limitations or qualifications to the work performed
- how they will satisfy the entity that any potential conflicts of interest have been declared and are being managed effectively
- the intended use of the expert’s work and the expected disclosure of the expert’s identity and details of work undertaken
- determining the responsibilities of both parties for the accuracy and reliability of the source data to be used by the expert (generally it would be expected that the entity is responsible for this)
- determining the responsibilities of both parties in relation to the accounting aspects of the engagement, including the application of applicable accounting standards
- requirements for upholding the entity’s policies and procedures
- the protocols for accessing relevant data and information, including any security considerations
- ensuring the contractual arrangements provide for access to the expert by the auditors and/or a person nominated by the auditor
- the expert’s quality assurance or peer review arrangements
- the timeframes in which the services are to be provided.
7.10.2 Considerations for experts engaged to measure fair value
The following matters are particularly important when an expert is engaged to assist in measuring fair value:
- the measurement must be objective, as fair value accounting estimates are expressed in terms of the value of a current transaction or financial statements item, based on conditions prevalent at the measurement date
- the need to incorporate judgements concerning significant assumptions that may be made by others, such as experts employed or engaged by the entity or the auditor
- the availability (or lack thereof) of information or evidence and its reliability
- the breadth of assets and liabilities to which fair value accounting may be, or is required to be applied
- the choice and sophistication of acceptable valuation techniques and models
- the need for appropriate disclosure in the financial statements about measurement methods and uncertainty, especially when relevant markets are liquid.
7.10.3 Engaging an expert
When proposing to use an expert, management should assess the professional competence and objectivity of the person or firm they propose to engage. Factors to consider include:
- professional reputation
- possible conflicts of interest
- accreditation or membership of an appropriate professional body.
References should generally be obtained to assist in substantiating the expert’s credentials.
It is important that the engagement be actively managed to help ensure the work performance of the expert is satisfactory and the entity’s requirements are met.
The key tasks involved in managing the engagement are to ensure that:
- the expert is provided with all necessary information and quality assured data required for the purpose of the engagement
- staff are available to assist the expert where required
- milestones and deadlines are met or renegotiated
- any clarification sought or questions from the expert are responded to promptly
- the expert is advised of any emerging issues in the entity’s operations that could affect his/her work or the integrity of information provided.
7.10.4 Evaluating the work of the expert
Management may rely on the professional expertise of relevant experts. However, to be in a position to assess whether the expert’s assessment or valuation is suitable for inclusion in the entity’s financial statements, management should form their own conclusions based on a review of the work undertaken, asking relevant questions, and evaluating the answers so that the entity is satisfied that the assessment or valuation is appropriate for inclusion in the financial statements. The review would generally involve:
- establishing whether the source data used is accurate and appropriate in the circumstances. Questions that could be asked include:
- is the source data used by the actuary in the valuation of accrued long service leave liabilities consistent with the information from the entity’s human resource system?
- obtaining an understanding of the assumptions and methodology used and assessing whether they are appropriate and reasonable in the context of the entity’s business and are consistent with any applicable legislation or accounting standards. Questions that could be asked include:
- are the assumptions within acceptable ranges and consistent with industry practice?
- are the valuation methods consistent with those used in prior periods?
- does the expert’s sensitivity analysis highlight those assumptions and methods that can significantly affect the results?
The extent of management’s review will depend on a number of factors such as:
- the materiality of the item(s) in question
- the complexity of the subject matter and any changes in the entity’s business environment that may affect the subject matter concerned
- the extent of variations in the estimate(s) from the previous year and an understanding of the reasons for the change.