This article was first published in the June 2012 UK edition of Accounting and Business magazine.
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The Accounting Standards Board (ASB) in the UK has published financial reporting exposure drafts (FREDs) setting out revised proposals for the future of financial reporting in the UK and Republic of Ireland.
The proposals are contained in the following:
- FRED 46 (draft FRS 100), Application of Financial Reporting Requirements.
- FRED 47 (draft FRS 101), Reduced Disclosure Framework.
- FRED 48 (draft FRS 102), The Financial Reporting Standard Applicable in the UK and Republic of Ireland, which will be the new FRS for UK GAAP reporters.
The proposals recommend replacing all extant financial reporting standards (FRS), statements of standard accounting practice (SSAP), and Urgent Issues Task Force (UITF) abstracts in the UK and Republic of Ireland with a single FRS, introducing a reduced disclosure framework for the financial reporting of certain qualifying entities, and retaining and updating the Financial Reporting Standard for Smaller Entities (FRSSE).
Consistent with its previous proposals, the ASB is proposing an adaptation of the International Accounting Standard Board’s IFRS for SMEs to replace current FRS. FRED 48 goes some way towards this aim with the use of some International Financial Reporting Standards (IFRS) principles.
The ASB is proposing significant changes to its previous proposals, including the elimination of the tier system, which was dependent on the status of an entity. It now says that where an accounting treatment is currently permitted in UK and Irish accounting standards and in IFRS, then it should be utilised. The proposals also incorporate guidance for public benefit entities.
FRED 46 outlines the revised framework:
- Entities required by company law to apply EU-adopted IFRS must do so.
- Entities that are not small and not required to apply EU-adopted IFRS will apply the draft FRS 102 applicable in the UK and Republic of Ireland.
- Small entities may apply the FRSSE.
- Qualifying entities may apply the reduced disclosure framework.
If the entity is not eligible to apply the FRSSE, or is eligible but chooses not to, it has a choice of applying the new FRS or IFRS. The ASB’s previous exposure drafts proposed the use of EU-adopted IFRS for entities that have public accountability. The ASB has removed the reference to public accountability and now proposes that the requirement to use IFRS only applies to consolidated financial statements of entities listed on a regulated market in the EU.
The proposed replacement for UK generally accepted accounting principles (GAAP) continues to be based on the IFRS for SMEs and in response to comments on the previous FRED, the ASB has tried to simplify the transition process to IFRS for many UK entities.
The ASB has looked at the principles for amending the IFRS for SMEs for application in the UK and this has resulted in the allowance of certain accounting practices that include the options to revalue land and buildings, capitalise borrowing costs or carry forward certain development expenses. Additionally, merger accounting is permitted for group reconstructions and grants may be recognised in the profit and loss account on a systematic basis.
The ASB also proposes a timing differences approach to accounting for tax, rather than applying the full requirements of IAS 12, Income Tax, as well as allowing hedge accounting for net investments in foreign operations. There is also reference to IFRS for areas including segment reporting, interim reporting, recognition and measurement of financial instruments, insurance and earnings per share.
Further changes to the previous exposure drafts include:
- replacing the primary statements based on the IFRS for SMEs with formats based on UK company law;
- restricting the presumed useful life for goodwill and intangible assets, when an entity is otherwise unable to make a reliable estimate, to five rather than 10 years; and
- including the revisions to IAS 19, Employee Benefits, regarding the change in the method of calculating net interest for defined benefit pension schemes.
The ASB intends to publish a supplementary exposure draft to the new FRS for financial instruments once the remaining phases of IFRS 9, Financial Instruments, are complete. These changes should help to reduce the administrative burden by enabling companies to follow consistent accounting policies in those areas where group accounts are prepared under EU-IFRS.
All entities reporting under UK GAAP will be affected, as they will have to decide whether to apply IFRS, the new FRS or, if eligible, the FRSSE. Qualifying entities will need to consider whether they wish to use the reduced disclosure framework. This may be attractive to subsidiaries in IFRS groups that wish to have statutory accounts prepared on a consistent basis with the IFRS consolidation, but with reduced disclosures. It will allow many subsidiaries of entities applying EU-adopted IFRS to use accounting policies consistent with those of their parent, without needing to apply the full requirements of EU-IFRS.
IFRS groups in particular may be interested in early adoption of the IFRS reduced disclosure framework if this eases their statutory reporting burden. Although the ASB is pushing ahead with moving UK GAAP onto an IFRS-based framework, it has decided to defer the mandatory effective date of the revised framework to 1 January 2015. This is because of the interaction with the potential effective dates of new IFRSs, including revenue recognition, leases and financial instruments projects, which could have resulted in companies making several accounting changes in the short term.
The revised date effectively allows entities a choice, either to undertake the accounting changes in a single period, or adopt a more gradual approach over a longer period if early adoption is chosen. Some entities will delay moving away from current UK GAAP until 2015.
The ASB’s drive towards an IFRS framework is likely to be supported by the majority of finance leaders as they will see benefits in global consistency of accounting and reporting.
When deciding whether to apply IFRS or the new FRS, management should consider the consequences for tax, ability to pay dividends, data and systems requirements and corporate structures. The choice of reporting approach and timing for an entity needs to take account of numerous factors including the tax impacts of conversion, the impact of GAAP differences and how these could affect key performance indicators and distributable reserves, whether the options available under one particular GAAP may align better with the business, the opportunities afforded by first-time adoption, the benefit of avoiding dual reporting by groups, and the size and complexity of the entity as the fewer requirements of FRED 48 may be attractive.
Complex groups with large numbers of subsidiaries could particularly benefit from early planning. This is particularly true of tax planning. Moving from UK GAAP to the new framework could have a significant impact on tax payable. For each GAAP difference, consideration needs to be given to whether there is an impact on tax payable, which may be subject to transitional rules or specific exemption. If the tax treatment follows the new accounting treatment, there could be tax effects.
Lease accounting changes could be significant. For example, both current UK accounting standards and FRED 48 require an entity to classify each of its leases as either a finance lease or an operating lease. Under UK GAAP, a finance lease is defined as one ‘that transfers substantially all the risks and rewards of ownership of an asset to the lessee’. There is a rebuttable presumption that if, at inception, the present value of the minimum lease payments amounts to 90% or more of the fair value of the leased asset, the lease is a finance lease.
FRED 48 also takes a risk and reward approach to lease classification and has an almost identical definition for a finance lease. However, there is no direct equivalent to the 90% test and leased assets that are of such a specialised nature that only the lessee can use them without major modifications, are finance leases. These changes are representative of a move towards accounting under IAS 17, Leases.
Similarly, under UK GAAP and FRED 48 there is an option to revalue items of property, plant and equipment. However, one potentially significant difference is that the revaluation model in FRED 48 may be applied to individual items, whereas UK GAAP requires application to an entire class of assets. In certain circumstances, FRED 48 permits a property held under an operating lease to be treated as an investment property. Current UK GAAP is not explicit on this point, and therefore it may occur at present, although it is likely to be applied rarely in practice, and thus it will usually constitute a change when applying FRED 48.
The ASB’s latest proposed timetable for the new financial reporting regime is that it should apply to accounting periods commencing on or after 1 January 2015, requiring a transitional balance sheet at 31 December 2013.Companies will be able to adopt these proposals early once the final standards have been issued. This is expected to occur in the second half of 2012. The ASB sought comments on the FREDs by 30 April 2012.
Graham Holt is an examiner for ACCA, and associate dean and head of the accounting, finance and economics department at Manchester Metropolitan University Business School