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The AFM checks annual reports 2012 on credit risk, cash flows, provisions and integrated reporting

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In 2013, the Netherlands Authority for the Financial Markets (AFM) will perform four thematic reviews of the financial reporting of listed companies. The supervisor will pay extra attention to investments and receivables with an increased risk, the cash flow statement and provisions. These are important components of annual reports, because they provide essential information to investors and other users of these reports. The AFM will also pay attention to integrated reporting.

The AFM supervises the annual reports of Dutch listed companies. It is the task of the AFM to establish whether companies apply the financial reporting standards (IFRS) correctly. This should provide investors and other interested parties with an accurate picture of the financial condition of a company.

Generally speaking, the supervisor assesses annual reports on a continuous basis, but it also performs several thematic reviews every year in order to draw attention to specific aspects of reporting. The themes are announced before the annual reports are drawn up, so that companies and auditors can include these themes in the financial reporting for 2012 and the audit thereof. This contributes to the improvement of the quality of financial reporting.

The AFM discusses the determination of the themes with among others the Financial Reporting and Accountancy committee, on which experts from the market have a seat. The themes are also discussed with the other EU supervisors in this field. The conclusions from the thematic reviews will be published in the second half of 2013.

Thematic reviews generally lead to recommendations concerning the various components of financial reporting. If necessary, the AFM can also confront individual companies with defects in the financial statements that have been reviewed.

Please find below an explanation of each theme.

Reporting on credit risks arising from investments and receivables

The AFM sees credit risks increasing in the current economic climate. Companies are increasingly often unable to collect their receivables, and financial institutions run the same increased risk as regards outstanding credit and investments. It is important for investors that all companies are transparent about these credit risks and about what they are doing to control them. A company has to be transparent in this respect in its financial reporting.

Investors want to know, in particular, to what extent the increased risks have influenced the valuation of the important items in the financial statements. It will be the second time for financial institutions that the AFM pays extra attention to these types of risks. Previously, in 2012, the AFM made recommendations in the report  entitled ’Measurement and transparency of bonds and other positions in countries with sovereign risk’. These recommendations will be included in the new thematic reviews.

Cash flow statement

In addition to the result and the balance, the cash flow statement also constitutes an important component of the financial statements. The cash flow statement should provide an 'fair view’ of the incoming and outgoing cash flows. The AFM has observed in recent years that the cash flow statement is the component with the most imperfections. The operational cash flow is in some cases represented with too high a figure, by incorrectly moving entries from or to 'other cash flows'.

In addition, the AFM found examples where components were included that do not belong in a cash flow statement, such as the conversion of loans into share capital or equity. Payments of interest and profits tax are represented in an unclear manner, as well.

As (operational) cash flows are important indicators for investors, to enable them to assess how the performance of the company has contributed to its financial condition, this component will receive extra attention in the AFM’s supervision in 2013.

Provisions

The importance of provisions in the financial statements increases in financially turbulent times. It is permitted to take account of probable future expenses if the company is obliged to incur them. Recent scientific research shows, however, that precisely this item on the balance sheet can be used to steer the financial results in an undesirable manner ('earnings management').

Determining the best estimate, and the question of whether a provision should be made, requires a very careful estimate on the part of the company's management. The reporting standard on provisions (IAS 37) contains several requirements concerning the disclosures on provisions that are intended to mitigate the risk of the earnings being managed too much. For example, a company has to include a so-called movement schedule in the financial statements for each class of provisions. A company will also have to provide a description of the nature of the provision and the uncertainties in the size and timing of the cash flows that could accompany it.

Integrated reporting

Integrated reporting is a more comprehensive form of reporting whereby a company makes a connection between strategy, governance, performance and outlook, and combines the financial implications with the social, economic and environmental aspects in the company's direct environment.

The emphasis of the current model of reporting is mainly on the financial performance and the financial position of a company. The possibilities of communicating with investors concerning other important factors that determine the value, performance and continuity of a company, such as human capital, intellectual capital and the use of natural resources are very limited. As regards this more comprehensive form of reporting, there is currently no generally accepted system of standards against which annual reports can be checked.

But at the same time, it is a theme that is receiving increasingly more attention from investors as well as from society in general, and we expect that it will make ever higher demands of transparency on the part of companies concerning the aforementioned themes.

In 2013, the AFM will use one of its thematic reviews to perform a baseline measurement in order to establish how companies currently already apply (parts of) integrated reporting. The AFM will use the results, inter alia, to further support the implementation of integrated reporting. The AFM will therefore actively participate in the debate that is being conducted worldwide concerning this subject. The contribution will take place from the perspective of the supervision of financial reporting, but where possible also from other disciplines within the AFM in the context of theme-based supervision.

The AFM is committed to promoting fair and transparent financial markets.

As an independent market conduct authority, we contribute to a sustainable financial system and prosperity in the Netherlands.

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