Executive Summary of the 2007 A&A ROSC Montenegro
This report provides an assessment of accounting, financial reporting, and auditing requirements and practices within the enterprise and financial sectors in Montenegro. It uses International Financial Reporting Standards (IFRS), International Standards on Auditing (ISA), and the relevant portions of the European Union (EU) body of law (also known as the acquis communautaire), as benchmarks.
Regulatory and institutional framework
During the transition to a market economy, the Republic of Montenegro successfully put in place many important elements of the institutional and statutory framework for financial reporting. However, this assessment demonstrates that Montenegro should take further steps in order to achieve its goal of a sound financial reporting framework tailored to the needs of the Montenegrin economy and aligned with the EU body of law (acquis communautaire), international standards and best practices. The government of the Republic of Montenegro is fully determined to undertake the necessary steps to further improve and align the financial reporting framework with the
The new law on accounting and auditing adopted in 2005 reflects this desire for continuousimprovement; however, the regulatory framework is not yet complete and not fully aligned with the acquis. The framework is not always consistent and limited human resources contribute to institutional weaknesses in some areas. In particular, the delay in the government decision on the body to which the government will delegate regulatory authority, including the adoption of IFRS (International Financial Reporting Standards) and ISA (International Standards on Auditing), created a regulatory vacuum and lack of clarity and legal certainty for companies, accountants and auditors.
International financial reporting and auditing requirements have recently become more complex and rigorous and also the acquis has evolved significantly recent years. In such a dynamic international regulatory environment, national financial reporting requirements can easily become out of line with the acquis. In particular the following issues need to be addressed: preparation of management reports, half year reporting for listed companies, electronic publication of financial statements, the approval and registration of audit firms, and the preparation of consolidated accounts.
The current requirement for the use of IAS/IFRS by all legal entities regardless of their size is not well suited for Small and Medium-sized Enterprises (SMEs) and puts an unnecessary strain on scarce institutional and professional accounting resources. The IFRS financial reporting framework has been developed for general purpose financial statements of listed companies and contains some complex accounting treatments and detailed disclosure requirements. The costs of application of the full body of IFRS, does not outweigh the benefits for SMEs. Moreover, in an environment with limited professional resources, proper application of IFRS by SMEs becomes a regulatory fiction instead of a well established sound financial reporting practice. It is recommended that the scope of IFRS application be re-examined with a view to defining a proportionate financial reporting framework properly linked to taxation accounting and taking into consideration the emerging draft IFRS on SME financial reporting.
The financial reporting framework applicable in Montenegro does, in principle, allow some limitation of the preparation and disclosure burden for SMEs by requiring cash-based accounting for companies with revenue of less than Euro 500,000 and the use of IFRS-based standard reporting forms issued as guidance by the Institute of Accountants and Auditors of Montenegro (IAAM) on the basis of the previous 2002 law on accounting and auditing. However, cash-based accounting is inconsistent with the IFRS framework and standards, which require accruals-based financial reporting. Moreover, the EU Accounting Directives would allow for much broader disclosure and publication exemptions. The regulatory framework for SME financial reporting should be reconsidered taking into account the optimal use of the exemption possibilities for preparation and disclosure of financial statements possible under the acquis. Future expansion of the scope of required IFRS application should be reinforced by parallel institutional and professional capacity building so that credible high quality financial reporting can be ensured and sustained.
There is a need to further strengthen institutional and professional capacity and to remove unnecessary demands on existing capacity. The capacity of supervisors, licensed auditors and certified accountants knowledgeable about IFRS is insufficient to properly implement the legal financial reporting obligations, with the possible exception of the banking sector. The new law on accounting and auditing (2005) introduced a Certified Accountant qualification in addition to the lower level Authorized Professional Accountant qualification. However, few accountants have obtained this higher qualification in the short time since 2005. Moreover, the law balanced the supply and regulatory demand for audits by significantly increasing the exemption criteria for statutory audits, combined with allowing foreign qualified auditors to become licensed. But despite these sound policy decisions, the current capacity of 34 licensed auditors remains too limited for the approximately 800 companies to be audited.
Overall, the Montenegrin education system with respect to accountants and auditors is of good quality, as was evidenced by an international study in 2005, but it would benefit from further strengthening. Areas for improvement to ensure the supply of highly qualified accountants include: completing an up-to-date accounting curriculum for the University of Montenegro; updating the outdated accounting text books (currently a 2001 translation of an international accounting text book is used); and developing properly supervised practical training for accountants and auditors and a system of continuing education for statutory auditors.
There is uncertainty about the organization of the accounting and audit profession in Montenegro. There is an urgent need for the professional organizations to come to a mutual agreement so that they can be equipped with the regulatory powers to complete the regulatory framework and to play their part in the training and (continuing) education of accountants and auditors.
Financial reporting issues in practice
The review of financial statements identified some systematic accounting issues that need to be properly addressed in practice. In addition to a lack of detailed disclosures required under IFRS, the review identified a number of common recognition and measurement issues, such as asset valuation (e.g. the lack of impairment tests) insufficient disclosure of related party transactions (including those involving the State), improper reflection of taxes in the annual financial statements, and pension accounting.
The financial statements of banks that were reviewed were generally of good quality. This can be largely attributed to the intensive on- and off-site supervision by the Central Bank of Montenegro and possibly the influence of the foreign banks that own local banks. The quality of the financial statements of several Montenegrin banks is comparable to that of peers in the European Union.
The financial information provided by most SMEs was found to be poor and not in compliance with full IFRS. A significant number of the financial statements of SME companies reviewed showed arithmetic and reconciliation errors, as well as a lack of disclosures required under IFRS, such as cash flow statements and notes to the financial statements. These poor results partly reflect the inappropriateness of IFRS for SMEs in general, the limited capacity to prepare IFRS financial statements, and the absence of an audit requirement for SMEs.
Enforcement of IFRS financial reporting by listed companies by the Securities and Exchange Commission (SEC) is not systematic and the SEC lacks some necessary powers. The SEC operates with a relatively small staff and its enforcement role is hampered as the Securities and Exchange Act does not provide a basis for enforcing accounting standards. The SEC cannot levy fines or penalties for improper financial reporting. Although the SEC has recently undertaken several concrete corrective measures, issues raised in qualified audit reports even in the A and B segment of the securities market were not always followed up. The Ministry of Finance recently established a working group that will for a sample of legal entities assess their compliance with the Law on Accounting and Auditing including a review of published financial statements of 4listed companies. Sound financial reporting is crucial for the Montenegrin securities markets in ensuring that the recent sharp increases of share prices remain based on underlying real economic factors. Insurance supervision does not yet exist and, as a result, the financial statements prepared by insurance companies do not generally match the quality those prepared by banks.
Public availability of financial statements is not common in practice. Despite a legal requirement for the publication of financial statements in the Central Registry of the Commercial Court, only 60% of the roughly 14.000 companies had filed their 2005 financial statements as of October 2006. This low percentage reflects the current lack of enforcement, limited sanctions, and the absence of “market discipline” incentives. The next challenge for Montenegro will be to ensure that audited individual and consolidated financial statements will be made available via electronic means in line with the acquis (First Company Law Directive).