Part (i) In their “Observations” document issued in October 2013, the Irish Auditing & Accountancy Supervisory Authority (IAASA) identified a number of critical areas as issues requiring careful attention in the presentation of financial information for users. Specific examples of such issues are: (a) impairment testing: (b) forbearance measures: (c) deferred tax assets: (d) provisions and adequate disclosures: (e) pension liabilities: (f) alternative performance measures: Required: Prepare a Memorandum to critically discuss the concerns identified by IAASA in each of the above cases and explain how these areas could be seen to manipulate the information provided by published financial statements.

Introduction

The Irish Auditing & Accountancy Supervisory Authority (IAASA) has identified a number of critical areas in their “Observations” document issued in October 2013 as issues requiring careful attention in the presentation of financial information for users. This memorandum will provide a critical discussion of the concerns identified by IAASA in each of the cases of impairment testing, forbearance measures, deferred tax assets, provisions and adequate disclosures, pension liabilities and alternative performance measures and explain how they could potentially be used to manipulate the information provided by published financial statements.

Impairment Testing

Impairment testing is the process of assessing the recoverable amount of an asset, which is usually the higher of its value in use or its fair value less costs to sell. The recoverable amount is then compared to the asset’s carrying amount to determine whether an impairment loss should be recognised. The IAASA has expressed concern that impairment testing could be used to manipulate the information provided by published financial statements. This is because the recoverable amount of an asset is based on estimates and assumptions about future cash flows and other factors that are subject to a high degree of uncertainty. As a result, companies may be tempted to use overly optimistic assumptions or estimates in order to artificially reduce the impairment loss recognised, resulting in a higher reported profit.

Forbearance Measures

Forbearance measures refer to a lender’s decision to not exercise their rights in relation to a loan. This may include extending the repayment period, reducing the interest rate or waiving certain fees. The IAASA has expressed concern that companies may be tempted to engage in such measures in order to artificially reduce the amount of loan losses recognised in the financial statements. This is because the decision to not exercise its rights is based on subjective assessments of a borrower’s ability to meet its obligations in the future, which could be manipulated to reduce the amount of loan losses recognised.

Deferred Tax Assets

Deferred tax assets are the amount of tax that a company is allowed to claim in the future as a result of a loss or expense that was recognised in the current year. The IAASA has expressed concern that companies may be tempted to recognise large deferred tax assets in order to artificially reduce the amount of tax payable, resulting in a higher reported profit. This is because the recognition of deferred tax assets is based on estimates and assumptions about future taxable profits and other factors that are subject to a high degree of uncertainty. As a result, companies may be tempted to use overly optimistic assumptions or estimates in order to artificially reduce the amount of tax payable.

Provisions and Adequate Disclosures

Provisions refer to the amount of money that a company has set aside in order to cover a future liability. The IAASA has expressed concern that companies may be tempted to not recognise sufficient provisions in order to artificially reduce the amount of losses recognised in the financial statements. This is because the recognition of a provision is based on subjective assessments of a company’s future obligations, which could be manipulated to reduce the amount of losses recognised. In addition, the IAASA has also expressed concern that companies may not provide adequate disclosures of their provisions, which could lead to a lack of transparency in the financial statements.

Pension Liabilities

Pension liabilities refer to the amount of money that a company has set aside to cover the future cost of providing benefits to its employees. The IAASA has expressed concern that companies may be tempted to not recognise sufficient pension liabilities in order to artificially reduce the amount of losses recognised in the financial statements. This is because the recognition of a pension liability is based on estimates and assumptions about future benefit payments and other factors that are subject to a high degree of uncertainty. As a result, companies may be tempted to use overly optimistic assumptions or estimates in order to artificially reduce the amount of losses recognised.

Alternative Performance Measures

Alternative performance measures (APMs) are non-GAAP measures of performance that are used by companies to supplement the information provided by published financial statements. The IAASA has expressed concern that companies may be tempted to use APMs in order to manipulate the information provided by published financial statements. This is because APMs are not subject to the same level of scrutiny or regulation as GAAP measures and as a result, companies may be tempted to use APMs in order to artificially increase the reported performance of the company.