Presentation and Disclosure of Financial Instruments
Management’s responsibilities include the preparation of the financial report in accordance with the applicable financial reporting framework. Financial reporting frameworks, including Australian Accounting Standards, often require disclosures in the financial report to enable users of the financial report to make meaningful assessments of the effects of the entity’s financial instrument activities, including the risks and uncertainties associated with these financial instruments. The importance of disclosures regarding the basis of measurement increases as the measurement uncertainty of the financial instruments increases and is also affected by the level of the fair value hierarchy.
In representing that the financial report is in accordance with the applicable financial reporting framework, management implicitly or explicitly makes assertions regarding the presentation and disclosure of the various elements of financial statements and related disclosures. Assertions about presentation and disclosure encompass:
- Occurrence and rights and obligations—disclosed events, transactions, and other matters have occurred and pertain to the entity.
- Completeness—all disclosures that should have been included in the financial report have been included.
- Classification and understandability—financial information is appropriately presented and described, and disclosures are clearly expressed.
- Accuracy and valuation—financial and other information are disclosed fairly and at appropriate amounts.
The auditor’s procedures around auditing disclosures are designed in consideration of these assertions.
Procedures Relating to the Presentation and Disclosure of Financial Instruments
In relation to the presentation and disclosures of financial instruments, areas of particular importance include:
- Financial reporting frameworks generally require additional disclosures regarding estimates, and related risks and uncertainties, to supplement and explain assets, liabilities, income, and expenses. The auditor’s focus may need to be on the disclosures relating to risks and sensitivity analysis. Information obtained during the auditor’s risk assessment procedures and testing of control activities may provide evidence in order for the auditor to conclude about whether the disclosures in the financial report are in accordance with the requirements of the applicable financial reporting framework, for example about:
- The entity’s objectives and strategies for using financial instruments, including the entity’s stated accounting policies;
- The entity’s control framework for managing its risks associated with financial instruments; and
- The risks and uncertainties associated with the financial instruments.
- Information may come from systems outside traditional financial reporting systems, such as risk systems. Examples of procedures that the auditor may choose to perform in responding to assessed risks relative to disclosures include testing:
- The process used to derive the disclosed information; and
- The operating effectiveness of the controls over the data used in the preparation of disclosures.
- In relation to financial instruments having significant risk, even where the disclosures are in accordance with the applicable financial reporting framework, the auditor may conclude that the disclosure of estimation uncertainty is inadequate in light of the circumstances and facts involved and, accordingly, the financial report may not achieve fair presentation. ASA 705 provides guidance on the implications for the auditor’s opinion when the auditor believes that management’s disclosures in the financial report are inadequate or misleading.
- Auditors may also consider whether the disclosures are complete and understandable, for example, all relevant information may be included in the financial report (or accompanying reports) but it may be insufficiently drawn together to enable users of the financial report to obtain an understanding of the position or there may not be enough qualitative disclosure to give context to the amounts recorded in the financial statements. For example, even when an entity has included sensitivity analysis disclosures, the disclosure may not fully describe the risks and uncertainties that may arise because of changes in valuation, possible effects on debt covenants, collateral requirements, and the entity’s liquidity. ASA 260 contains requirements and guidance about communicating with those charged with governance, including the auditor’s views about significant qualitative aspects of the entity’s accounting practices, including accounting policies, accounting estimates and financial statement disclosures.
Consideration of the appropriateness of presentation, for example on short-term and long-term classification, in substantive testing of financial instruments is relevant to the auditor’s evaluation of the presentation and disclosure.
ASA 540, paragraph 20, requires the auditor to perform further procedures on disclosures relating to accounting estimates that give rise to significant risks to evaluate the adequacy of the disclosure of their estimation uncertainty in the financial report in the context of the applicable financial reporting framework.