Auditing and Filing Requirements
121. In addition to the obligation to prepare financial reports as described above, certain entities face two further obligations: firstly, the requirement to have their financial statements audited, and secondly, to register those financial statements with the Registrar of Companies.
122. In relation to public sector, the Public Audit Act 2001 requires audit of public entities, and various specific pieces of legislation require financial statements to be "filed" with some authority, such as being tabled in Parliament. This includes State Owned Enterprises, Crown entities, local authorities and government departments. Certain other types of entity also have specific requirements, in particular those such as banks and super schemes. However, the Financial Reporting Act only requires audit70 and filing71 by issuers and foreign companies. Most other comparative international jurisdictions have much broader requirements, and it is therefore appropriate to examine New Zealand's requirements.72 It should, however, be noted that this examination does not include a consideration of public sector entities, which are governed by the Public Audit Act. This discussion is therefore limited to other public benefit entities and profit-seeking corporates.
Comparative International Jurisdictions
The United Kingdom
123. In the United Kingdom, an entity that meets the requirements for a small company (as described above) is exempt if its turnover is less than ₤5.6 million.73 In addition, entities that fall within the medium-sized thresholds need only have the reduced reports audited, and the audit report does not need to be filed (although any qualifications on the report must be described).74 The auditor must also certify that the company is entitled to take advantage of the reduced reporting requirements by virtue of the fact it falls within the thresholds.75 All other companies must have their reports fully audited and file them.
Singapore
124. As stated above,76 Singapore has a three-tier regime for financial reporting, with the differences between tiers limited to auditing and filing requirements.
125. All first tier companies must prepare fully audited financial statements and file them the Registrar of Companies and Businesses.77
126. Second tier exempt private companies must maintain audited accounts that fully comply with the financial reporting standards. However, an exempt private company must only file an annual return and an "exempt private company certificate," the latter of which certifies that the directors, company secretary and auditors believe the company is solvent and has complied with the requirements for a private company. If it cannot file this certificate, a full set of audited accounts, notes to accounts, auditor's report and director's report must be filed.78
127. Third tier small exempt private companies must also maintain proper accounting records that comply with financial reporting standards that would allow their accounts to be audited if necessary. However, the requirement for audit is removed, and a small exempt private company must only file an annual return and an exempt private company certificate containing a declaration of solvency that does not need to be signed by an auditor. If it cannot provide such a certificate, it may file unaudited financial statements.79 However, shareholders representing five per cent or more of the company's shares, or the Registrar of Companies and Businesses, can require the company to prepare audited statements.
Australia
128. The Corporations Act requires all entities to have their financial reports audited.80 However, small proprietary companies (which are not required to produce financial reports unless shareholders request otherwise)81 are not required to have such reports audited unless that is also requested by shareholders.82 All financial reports that are produced (including on-request reports from small proprietary companies) must be lodged with ASIC.
Comment
129. In addition to the individual concerns relating to various costs and benefits outlined below, an issue of general concern is determining whether audit and/or filing requirements should correspond directly to the reporting tiers identified above, or whether there should be some separate requirements. Although setting auditing and filing requirements on the basis of tiers is attractive in its simplicity and certainty, it may be desirable to allow separate requirements that will provide for greater flexibility.
130. For example, allowing a "shifting" of audit or filing requirements on the basis of owner, shareholder or stakeholder opt-in or opt-out may prove beneficial. This is particularly applicable in the case of entities that are already in a given tier on the basis of five per cent of the owners, shareholders or stakeholders opting for such a shift. For example, if the owners, shareholders or stakeholders that vote for a tier 3 entity to shift to tier 2 would be satisfied with unaudited, unfiled financial reports, it may be desirable to allow them to decide not to require audit or filing of those reports.
Audit
131. Auditing is essentially concerned with ensuring the reliability of financial reports. The key issue to be addressed in relation to imposing audit requirements is determining which entities should be the subject of such, on the basis of whether the benefits produced are sufficient to displace the costs involved.
132. Requiring audit of financial reports could bring considerable benefits in terms of accountability, as there would be an added layer of oversight of management. However, this is unlikely to have much significance where there is little separation of ownership and management.
133. An audit requirement would also bring considerable benefits in terms of transparency. Any external parties seeking to rely on the reports would be considerably more confident that audited accounts accurately reflect the financial position and performance of the entity. As such, they are more likely to be willing to transact with the entity, and at reduced cost for the lower risk factor. On the other hand, as stated above,83 those dealing with smaller entities may be more likely to do so on the basis of existing relationships or alternatives (such as credit checks or special purpose reports), rather than rely on general purpose financial reports.
134. With regards to the monitoring and enforcement rationales, benefits are likely to flow from audit requirements, as an independent assessment of an entity's compliance with substantive requirements provides greater certainty that the financial reports accurately reflect the position of that entity.
135. These benefits must however be weighed up against the compliance costs involved, particularly in respect of smaller entities. The costs of having financial reports audited can be quite substantial, and may affect smaller entities disproportionately. Imposing a requirement for audit therefore needs to be carefully evaluated.
136. As for requiring financial reports to be produced,84 it is apparent that the benefits that flow from requiring financial reports to be audited are likely to be greater for larger or more important entities, while at the same time the costs that result are more easily justified. Correspondingly, requiring audit of smaller and medium-sized entities' financial reports would produce fewer benefits and impose a greater burden.
Figure 3: Should Small and Medium Entities Be Required to Have Their Financial Reports Audited? Summary of Factors For and Against
| | For | Against |
| Accountability | Greater certainty that reports reflect true position in holding management to account | Often no separation of ownership and management |
| Transparency | Greater certainty that reports reflect true position when transacting with entity | Relationships not usually determined by financial reports - either special purpose reports, personal relationships, credit checks etc. |
| Monitoring and Enforcement | Greater certainty that reports reflect true position | |
| Independent assessment of entity's compliance with substantive requirements | |
| Others | | Direct cost of audit services |
Filing
137. The primary issue in relation to filing financial reports is determining who is entitled to the information contained therein. Filing reports currently has the result of putting the information in the public domain, and therefore, the question becomes "what entities should provide their reports to the public?"
138. In relation to accountability of management to owners, shareholders or stakeholders, little benefit is likely to flow from requiring filing, since owners, shareholders or stakeholders typically are entitled to receive financial reports anyway. Further, for those entities that do not have separation of ownership and management, no benefits will flow from requiring public filing.
139. Requiring entities to file such financial reports could provide significant transparency benefits. A public register of financial reports would be open to all, not just those in sufficiently strong bargaining positions to demand such accounts if not publicly available, as for special purpose financial reports. This consideration may be particularly telling in the case of smaller entities, where a relatively high proportion of total assets and liabilities is likely to be made up of trade debtors and creditors. Further, such debtors and creditors are likely to be similarly situated smaller entities and likely to be without sufficient influence to demand such financial reports. On the other hand, as outlined above, many smaller debtors and creditors may not rely on such reports, even if available.
140. Requiring the filing of financial reports could also bring substantial monitoring and enforcement benefits, simply because the reports would be of public record and therefore able to be accessed by those wishing to make use of them.
141. Further, complying with a requirement to file financial reports that have already been produced is likely to impose only minimal (if any) compliance costs. However, this may be balanced by other negative impacts that result from filing. Public filing could reduce the privacy of natural persons, particularly in the case of smaller entities. For example, a sole owner-operator's income would be readily discernible (although it can also be considered one cost of doing business). Disclosure of financial information may also have adverse consequences for trade secrets or confidential operational information. For example, an entity operating in a competitive environment may have to disclose information that would allow its competitors to gain unfair advantages. This is particularly true for such structures as franchises and some co-operatives, where reporting and filing requirements are likely to apply to each individual entity that makes up the group. Each individual would therefore have to disclose its own financial information. On the other hand, entities that operate outlets would be able to consolidate all their financial information into one report.
142. Again, as for imposing requirements to prepare reports and to have those reports audited, it is apparent that requiring filing of financial reports is more easily justified in the case of large entities than for smaller:
Figure 4: Should Small and Medium Entities Be Required to File Financial Reports? Summary of Factors For and Against
| | For | Against |
| Accountability | | Owners, shareholders or stakeholders typically entitled to receive reports; |
| | Stakeholders etc. may be a part of management for smaller entities |
| Transparency | Greater access for interested external parties | Relationships not usually determined by financial reports - either special purpose reports, personal relationships, credit checks etc. |
| Monitoring and Enforcement | Official record of financial reports | |
| May encourage compliance with substantive requirements | |
| Others | | Concerns in regard other costs, for example, privacy of natural persons and trade secrets |
Alternatives to Filing
143. As stated above, where filing necessitates making information publicly available, the essential question of "who is entitled to the information" becomes reversed, instead asking "what entities should provide their reports to the public?" Although this may be appropriate, in the context of this review it may also be desirable to explore alternatives to making all filed financial reports publicly available.
144. This may be particularly true for smaller entities, where, as identified above,85 alternatives to general purpose financial reports, such as credit checks, special purpose reports or even personal relationships may play a more significant role in evaluating the position of the entity.
145. One alternative to requiring statements to be filed is to require a signed "Certificate of Compliance" from the directors (or equivalent) of an entity. Singapore does not require an entity to file its statements, so long as such a certificate is completed and sent to the Registrar.86 This could address some of the possible concerns identified in relation to the privacy of natural persons and trade secrets and so on, while still providing many of the benefits that would flow from requiring financial statements to be filed, particularly in relation to monitoring and enforcement. For example, requiring directors to complete a certificate saying that they have complied with the financial reporting requirements would ensure that directors' minds are turned to the issue and that they are aware of their obligations. It would also assist in monitoring compliance with the Financial Reporting Act, as the Registrar would be aware of those that have not filed a certificate. Further, it would assist in the enforcement of the Act, as any director could be made personally liable for signing a certificate that proved to be false (that is, financial records had not been kept).
146. Alternatively, with similar considerations as those above, it may be desirable to introduce a form of "limited" filing whereby the filed reports would not become public record. This could possibly occur by limiting access to regulatory bodies, or by the by the ability to designate certain portions of the report "confidential" and not disclose the information if certain criteria are met, or by some other method.
Ministry of Economic Development Conclusions
147. The Ministry of Economic Development has formed a tentative view that all tier 1 entities should be required to have their reports audited and filed. Further, the Ministry is inclined to exempt all tier 3 entities from any audit or filing requirement.
148. However, although tiers 1 and 3 are relatively easily categorised, tier 2 presents some issues because it will include a diverse range of entities. Tier 2 entities will typically fall within tier 2 due to their small size, or lack or reporting responsibilities. Nevertheless, entities in tier 2 will still have to produce reports and, in order to properly meet the policy rationales for requiring such reports, it may be necessary to require full audit and filing as for a tier 1 entity. As a compromise position, it may be desirable to again allow shifting tier (both up and down) on the basis of owner, shareholder or stakeholder vote.
The Trans-Tasman Perspective
149. The trans-Tasman considerations that apply in relation to audit and filing of financial reports are similar to those for requiring financial reports.87 Although it is not necessary to have exactly the same reporting structure as Australia, there may be benefits in doing so.
150. The benefits of one country not requiring audit or filing are likely to diminish if the other country does require such audit or filing. For example, if New Zealand does not require a particular entity to have its financial reports audited or filed, but that entity must also comply with Australian law that does require audit and filing, any costs benefits reaped from the New Zealand provisions are likely to be largely undone.
Question 2 - Auditing and Filing Requirements
- Should audit and filing requirements correspond directly with tiers of reporting entity? If not, what alternatives would be appropriate? A mechanism to allow audit and filing requirements to shift independently of reporting requirements, or some other approach?
- Which entities (either of tiers 1, 2 and 3, or some other measure) should be required to have their financial statements audited and why?
- Which entities (either of tiers 1, 2 and 3, or some other measure) should be required to file their financial statements and why?
- If you do not believe all entities should be required to file financial statements, do you believe some value would be gained from some form of alternative (whether those provided or otherwise) for those that do not file their reports?
- Are there any further issues (for example, in relation to trans-Tasman co-ordination or a possible joint institution) that need to be considered?
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