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An overview of accounting enforcement in Europe

By Michael Kavanagh

Michael Kavanagh summarises the key points in ESMA’s recently published report on the regulatory activities of the EU’s accounting enforcers.

Financial reporting plays an essential role in securing and maintaining investors’ confidence in financial markets. It is now universally accepted that effective financial reporting depends on the rigorous and consistent enforcement of high quality standards. Within the EU, enforcement of financial reporting standards is performed by individual national accounting enforcers with the Irish Auditing and Accounting Supervisory Authority (IAASA) performing this function in Ireland. To provide further oversight, ensure consistency and mitigate against regulatory arbitrage, the European Securities and Markets Authority (ESMA) has been tasked with coordinating financial reporting enforcement practices across Europe. As part of that remit, ESMA recently published its 2016 report on the enforcement and regulatory activities of accounting enforcers within the EU.

The ESMA’s report provides an overview of the activities of EU accounting enforcers and a summary of the results of their examinations of the financial information provided by listed entities in 2016. It also provides an overview of the main activities performed by ESMA at a European level, quantitative information on enforcement activities in Europe as well as ESMA’s contribution to the development of the single rulebook in the area of financial reporting. In addition, it also outlines ESMA’s activities for 2017 in the area of corporate reporting following its Supervisory Convergence Work Programme. Clearly, this short article cannot cover all aspects of the ESMA report but here are some key aspects as well as a summary of IAASA’s contribution to the wider EU process.

Quantitative data on accounting enforcement activities in the EU

European enforcers examined the interim and/or annual financial statements of more than 1,200 issuers representing an average examination rate of 21% of all IFRS issuers with securities listed on regulated markets. This represents a slight increase in activity compared to 2015, when about 20% of all issuers were examined. These examinations resulted in 311 actions taken to address material departures from IFRS. This represents in absolute numbers an increase of about 10%, compared to the 273 actions in 2015. The action rate also increased slightly from 25% in 2015 to 26% in 2016.

It is noteworthy that the areas where European accounting enforcers identified most infringements remained consistent when compared with 2015. Actions of significant importance related to:

  • Financial statement presentation;
  • Accounting for financial instruments; and
  • Impairment of non-financial assets.

These three areas represent more than 40% of all the issues covered by enforcement actions taken by European enforcers in 2016.

It is also interesting to note that the share of actions European enforcers took in these three areas, compared to all actions taken by them in 2016, remained broadly stable compared to last year. 14% of the actions taken related to accounting for financial instruments (13% in 2015); 17% to the financial statements presentation (21% in 2015); and 11% to impairments of non-financial assets (12% in 2015).

European common enforcement priorities

ESMA believes that an important step in fostering supervisory convergence in Europe is establishing common enforcement priorities for financial reporting and communicating them to stakeholders in advance of the finalisation of annual financial statements. The ESMA report revisits the 2015 priorities and analyses the findings by European enforcers in relation to 206 issuers, which led to 45 enforcement actions. The ESMA report also gives further background to the 2016 enforcement priorities, which encompass:

  • The presentation of financial performance;
  • The distinction between equity instruments and financial liabilities; and
  • Disclosure of the impact of the new standards issued by the International Accounting Standards Board (IASB) but not yet mandatorily applicable (IFRS 9 Financial Instruments, IFRS 15 Revenue from Contracts with Customers and IFRS 16 Leases).

ESMA and European enforcers also urge issuers to provide disclosures on their exposure to risks arising from Brexit and its expected impacts, and how management handles and plans to mitigate those risks.

IAASA’s contribution to accounting enforcement at a European level

The quantitative data on accounting enforcement activities in the EU is outlined above. From Ireland’s perspective, IAASA completed 42 examinations of individual financial statements during 2016 (33 in 2015) and corresponded with issuers in relation to 29 of these examinations (24 in 2015). As a consequence of IAASA’s examinations, in 23 instances issuers provided undertakings in respect of future periodic financial reports (17 in 2015). For unlimited scope examinations, a total of 33 voluntary undertakings were provided by issuers’ directors to amend future periods’ financial statements (61 in 2015) and 28 in respect of focused examinations and follow-up examinations (nine in 2015).

Statistically, this equates to an action rate of over 50% compared to the 26% European average. However, this can be partially explained by IAASA’s shift in emphasis from unlimited scope examinations to focused examinations. By its nature, a focused examination is directed at a particular area where there is an indication of potential non-compliance arising from an overview of the issuer’s preliminary announcement or financial report. It is worth noting that preliminary announcements are a feature of the UK and Irish equity markets and tend not to be used in the rest of Europe. A further explanation is the higher proportion of fund and debt entities within IAASA’s remit compared with the rest of Europe, and there tends to be a wide variation in the quality of their published financial reports.

IAASA plays a leading role at the ESMA accounting enforcers forum (EECS). I am a member of the agenda group, which selects emerging issues and decisions for discussion at EECS plenary meetings. I have also chaired sub-groups of ESMA, and IAASA has been an active member of many of the groups established to provide guidance to EU-listed entities on various financial reporting matters. Many of the topics in the common enforcement priorities outlined earlier originated from IAASA findings. Consequently, accounting enforcers across Europe will be required to pay particular attention to these topics when carrying out their examinations in 2017.

Additionally, throughout 2016 IAASA supplied information for ESMA publications and conducted surveys on the application of IFRS across the EU from an Irish perspective. IAASA submitted and presented enforcement decisions and contributed to various publications at ESMA-sponsored meetings. It also has continuing involvement in various ESMA working groups dealing with accounting enforcer-related matters.

Conclusion

The ESMA activity report shows how far European accounting enforcement has come since the group dealing with coordinating such activities (EECS) was established over 10 years ago. I was involved with EECS from the start of its journey, when a small group laid the foundations for its subsequent growth. IAASA’s fingerprints are to be found in most of the vast array of matters dealt with in the ESMA report. As I depart IAASA and consequently, ESMA, I look forward to Ireland continuing to play a leading role in Europe and, post-Brexit, enhancing that role further.

The ESMA Report on Enforcement and Regulatory Activities of Accounting Enforcers in 2016 can be downloaded at www.esma.europa.eu.

This article was originally published by Chartered Accountants Ireland in June 2017. You can read the article and see the full edition here.