ASB: FRED 43, application of financial reporting standards, and FRED 44, financial reporting standard for medium-sized entities

Comments from ACCA to the Accounting Standards Board, April 2011.

ACCA is pleased to have this opportunity to comment on the above Financial Reporting Exposure Drafts ('FREDs') on the proposed future of financial reporting in the UK and Ireland. Since the consultation was published by the Accounting Standards Board, ACCA has consulted its members on high level issues around the revised framework, through public meetings and an on-line survey. The consultation was also considered by ACCA's Financial Reporting Committee and the views expressed in this letter take into consideration the opinions of the Committee, informed by the wider consultation with members.

General comments

We continue to support the long term convergence of UK GAAP with EU adopted International Financial Reporting Standards (IFRS), ultimately resulting in all companies in the UK and Ireland reporting under a single set of accounting principles. We therefore welcome the proposals to incorporate an adapted version of the IFRS for SMEs into UK GAAP which is a significant step in bringing consistency to financial reporting in the UK and Ireland. These sentiments were echoed in our survey of members, where 93% of members who took part, supported convergence.

As we have stated in previous comment letters to the Board's convergence plans with IFRS, we would prefer a future framework that consists of two tiers consisting of IFRS and the FRSME. Both tiers should include disclosure reductions for subsidiaries, while the latter should also include relevant derogations for smaller entities that can currently apply the FRSSE. Such a system would be more coherent and cost effective, and many of the benefits of convergence, as noted in the FRED, would be lost if some UK companies are left using the 'legacy' system. 

We strongly believe that the burden for small companies using the FRSME would not be significant given the nature of these entities. However, we do acknowledge the rationale for retaining the FRSSE for the foreseeable future, especially in relation to the conclusion on the micro-company exemptions from EU Directives. We would therefore urge the Board to make it a clear objective to ultimately phase out the FRSSE altogether. This also means in our view that the name of the document should be changed as it should not simply apply to medium-sized entities. Simply Financial Reporting Standard (FRS) or FRS for privately held entities would be better.

The FRED proposes a number of amendments to the IFRS for SMEs to adapt it for the UK and Ireland context. While in principle we would prefer a wholesale adoption of IFRS, we do acknowledge the necessity of some of these amendments, especially as they relate to otherwise inconsistent requirements in UK company law. We nonetheless urge the Board, wherever possible, to press for the relevant changes both at EU level, in terms of facilitating the use of the IFRS for SMEs, and with the IASB in terms of preferred amendments to the IFRS for SMEs itself.

Specific questions raised in the FRED

Q1. Do you agree that a differential financial reporting framework, based on public accountability, provides a targeted approach to relevant and understandable financial information that contributes to discharging stewardship obligations?

We support the proposals for a differential framework, based on public accountability. We also welcome the Board recognising that many small entities which would have otherwise been deemed as publicly accountable under earlier proposals would be disproportionately burdened by having to prepare financial statements under full IFRS. However, as we outline in our response to Question 4, we still have concerns that the proposed size criteria may not be sufficient to exclude from full IFRS all entities which, by virtue of their size, do not have the risks associated with entities that should be required to use IFRS.

Q2. Do you have any further comments on the proposed application of the tier system?

We are generally supportive of the application and criteria requirements for Tiers 1 and 2, including the proposed reduced disclosure framework for subsidiaries. The Board currently proposes to retain a third tier applying the FRSSE. However, as we indicated previously, we strongly believe that the FRSME should also replace the FRSSE to cement the convergence of UK GAAP to IFRS, especially as, with some additional exemptions, it should not be over burdensome for companies currently using the FRSSE.

We understand that in Ireland very few companies which are eligible to use the FRSSE currently do so. Under the proposals, these companies will now be faced with the option of moving to the FRSSE or the FRSME with no clear picture as to whether or not they will have to change again in a few years time, should they opt for the former.

We therefore urge the Board to set a clearer timetable for replacing the FRSSE. We should like to see this as being no longer than two years from the effective date of the proposed framework.

Q3. Appendix 1 'Note on the Legal Requirements in the United Kingdom and Republic of Ireland' to this FRED sets out a note on legal matters that are applicable to a tier system. Do you have any comments or queries on the scope or content of this Appendix?

These appear reasonably presented and we have no further comments at this stage.

Q4. Should entities that have public accountability, satisfy all three of the size conditions of a small company or small group, and are prudentially regulated, be permitted to apply the FRSME?

As noted in our response to Question 1, we have concerns that requiring entities to satisfy all three size criteria would result in many entities such as credit unions and mutual funds that have assets above the threshold being treated as publicly accountable and therefore required to use IFRS. We do not believe the nature of such entities given their size, requires IFRS to meet their stewardship obligations.

We would therefore prefer the size criteria to be relaxed to two out of the three currently proposed. This should both avoid unnecessary complexity in financial reporting for these entities, and retain consistency with the familiar requirements in the Companies Act.

Q5. Are the definition of public accountability and the accompanying application guidance sufficiently clear to enable an entity to determine if it has public accountability? If not, why not?

In general we believe that the application guidance should be sufficient for most companies to assess whether they have public accountability.

However, we still have concerns that certain types of entities, such as insurance brokers, investment, pension and mutual funds may remain unclear as to whether they would be deemed to have public accountability based on the proposed definition in the FRED. 

It is important for the definition and accompanying guidance to eliminate any uncertainty in this respect and especially in terms of definitions around what is meant by 'broader user groups' and who manages the risks associated with holding assets on their behalf.

Q6. The ASB is proposing to amend the IFRS for SMEs to comply with Company law. Do you agree with the amendments? If not, please explain your reason for disagreement and, if appropriate, suggest an alternative.

In principle we prefer a wholesale adoption of IFRS, including the IFRS for SMEs, into UK GAAP, with necessary amendments made through the IASB's standards themselves. However, we recognise that there are instances where the requirements in the IFRS for SMEs are not entirely compatible with either UK Company Law or the EU Directives. We therefore support the ASB's proposal to include amendments to ensure compliance with Company Law. For the wider encouragement of the application of the IFRS for SMEs in Europe, we believe that parallel efforts should be made to encourage appropriate amendments in the EU Directives to ensure compatibility with the IFRS for SMEs.

Q7. The ASB decided to evaluate possible amendments to the IFRS for SMEs using three guidelines:
(a) changes should be minimal;
(b) changes should be consistent with EU-adopted IFRS; and
(c) use should be made, where possible, of existing exemptions in Company law to avoid gold-plating.

Do you agree with these guidelines? If not, please explain why.

We agree with the above guidelines used by the Board to evaluate possible amendments.

Q8. The ASB has amended the IFRS for SMEs to: >
(a) replace section 29 Income Tax with IAS 12 'Income Taxes';
(b) provide transitional relief for dormant entities with intra-group balances;
(c) exempt an entity preparing consolidated financial statements from including a parent company cash flow statement; and
(d) revise the scope of section 9 such that an entity is required to prepare consolidated financial statements only when required to do so by Company law.

Do you agree with the amendments? If not, please explain your reason for disagreement and, if appropriate, your proposed alternative.

We agree with the rationale for the proposed amendments. In fact we believe it would be beneficial to include an additional exemption to remove the requirement for applying Section 29 altogether for small companies. As we discuss below, we do not believe that the FRSME would necessarily be a major burden for most small companies. However, we acknowledge that one relatively complex area for such companies can be that of accounting for deferred tax. By allowing an exemption for small companies, even as the FRSSE is retained, in the short term could encourage greater uptake of the FRSME.

Respondents to the ACCA members' survey were also generally supportive of the amendments noted in the question.

Q9. Do you agree with the proposed consequential amendments to the FRSSE?(appendix 3) If not, why not? Please state your reason for disagreement and, if appropriate, suggest an alternative.

As previously noted ACCA strongly believe that the Board should consider replacing the FRSSE with the FRSME, with additional exemptions in line with current requirements for small entities in UK GAAP. This would ensure a consistent accounting framework in the UK and Ireland.

As well as an exemption from the accounting for deferred tax noted in our response to Question 8, we also believe that exemptions in the FRSME for small companies would appropriately include:

  • no obligation for consolidated accounts to be prepared
  • no requirement for a cashflow statement
  • share-based payments being dealt with by note disclosure, and the cost not requiring to be recognised.

The Board should additionally consider other disclosure requirements that might be seen as burdensome or less relevant to small companies and the users of their accounts.

We do acknowledge there might be merit in a further consultation following the adoption of the FRSME, by which time more concrete details on the micro-company exemptions from EU Directives are also likely to be available However, we firmly believe that the Board should make it a clear objective to ultimately phase out the FRSSE.

The ACCA members' survey also showed a sizeable majority wanting the FRSSE to be replaced in line with their general views on convergence. Some members called for additional exemptions in IFRS while a sizeable percentage (36%) advocated its replacement after a review of how the rest of the proposals for convergence had fared.

With regard to the proposed consequential amendments which essentially address how the FRSSE will operate under the new financial reporting framework, these appear reasonable. However, we still have concerns with the fact that certain measurement and recognition options currently available in UK GAAP will remain in the FRSSE, but are not available in the FRSME. This causes both complexity in financial reporting as a whole and of course leads to inconsistency and incomparability - again a consequence of retaining the FRSSE as currently based on UK GAAP.

Q10. The ASB is proposing that subsidiary undertakings which apply the reduced disclosure framework should:
(a) disclose the disclosure exemptions taken;
(b) state in the notes the name of the parent undertaking in whose consolidated financial statements the subsidiary's results and relevant disclosures are included; and
(c) only be permitted to take the disclosure exemptions where the consolidated financial statements of the parent are publicly available.

Are these requirements necessary and sufficient to protect users of subsidiary financial statements?

We agree both with the rationale for the reduced disclosure framework and the proposed reductions for subsidiary undertakings.

However, we would reiterate that, in principle, we would prefer such derogations to be systematically assessed by the IASB and amended according to their due process.

We do, however, recognise that not all proposals for amendments may be initially incorporated into the IFRS for SMEs. Therefore in order to be pragmatic, and given that these amendments are based on sound rationale and relate to disclosure, we would accept them. Again, ACCA would fully support the Board in urging the IASB to make the relevant amendments to the IFRS for SMEs where it is felt that changes such as these are required.

Q11. The ASB proposes that disclosure exemptions should be permitted for all subsidiary undertakings: do you agree, or do you consider that there should be a minimum percentage ownership requirement?

We agree that the disclosure exemptions should be permitted for all subsidiary undertakings.

Q12. Do you consider that a disclosure exemption should or should not be provided for transactions between wholly-owned group undertakings? Please explain your reasoning.

We agree with the proposals to remove the disclosure exemptions, as per the rationale in the FRED, as this treatment is consistent with IFRS.

Q13. The reduced disclosure framework was developed in response to the feedback on the ASB's policy proposal issued in August 2009. Qualifying subsidiaries applying the reduced disclosure framework look to EU-adopted IFRS and the Appendix to the draft Application FRS to prepare their financial statements. Does this proposal adequately address preparers' needs?

We agree the proposals appear reasonable from the perspective of preparers.

Q14. Do you have any further suggestions for disclosure exemptions for qualifying subsidiaries? If so, please explain why you consider the disclosure is not required in the subsidiary financial statements.

We believe that the proposed exemptions and the rationale for their exemption are complete and have no further suggestions at this stage.

Q15. Do you agree with the detail of the ASB's proposal to streamline the number of SORPs for profit-seeking entities as set out above? If not, why not?

The proposals in respect of SORPs for profit-seeking entities are reasonable given the proposed changes to the UK and Irish financial reporting framework and the ongoing projects being undertaken by the IASB. A reduction in the number of SORPs will also help to simplify UK GAAP.

Impact assessment

Q16. Do you agree with the benefits that have been identified as arising after adoption of the proposed Financial Reporting Framework? If not, why not? Please provide examples, including quantification where possible, of any benefits you believe have not been taken into account.

We welcome the efforts made by the ASB to assess the costs and benefits of adopting the proposed framework, which includes the impact assessment request for responses conducted in August 2010. With regards the benefits noted in the FRED, we agree that many of these will accrue in time and that they would in general outweigh the costs. However, we question the value of placing estimates on some of the costs and benefits, given the difficulty in quantifying them, a point which is acknowledged in Question 19 itself.  

For example, we are unsure of the basis for the potential transition costs of £78.9m, and what the value of this number is to individual entities implementing the new framework. The FRED also suggests that a slight reduction in borrowing costs across these entities would outweigh those costs. While we support the argument that international trade will be facilitated we are unsure of the impact on cost of capital for SMEs. Indeed, the research commissioned by ACCA which showed a positive impact for UK entities on cost of capital of transition to IFRS, was very much related to equity capital. A positive impact on debt capital, on which privately-held companies are of course more reliant, is more difficult to assess.

Additionally, we agree that the FRSME would be a simplification to current full UK GAAP requirements. However, we note that some of the 'simplified' accounting options available in the FRSME (as per the IFRS for SMEs) will not be replicated in the FRSSE. This will result in the counter-intuitive situation where smaller entities would have more "complex" accounting options open to them than would be available to larger non-publicly accountable entities. In addition, while we fully support the adoption of the IFRS for SMEs to the greatest extent possible, we note that entities in some industries will find the restrictions in the FRSME relating to revaluations, borrowing costs and the treatment of R&D costs as significant issues.

Q17. In relation to the case study scenarios identifying the likely costs of transition for certain entities, do you agree with the nature and range of costs identified? It not, please provide details of any alternatives you would propose, including any comments on the assumptions underlying the calculation of the costs.

As noted above, it is difficult to assess the cost of implementation from an individual company perspective as this will differ considerably from entity to entity. However, we believe that the case studies make a reasonable, high level attempt at estimating the likely impact and costs for each of the various scenarios. To assist with this process, ACCA is commissioning more detailed field-testing on translating UK GAAP accounts into accounts based on the FRSME (as set out in the FRED). We hope these, like the similar testing conducted on the IFRS for SMEs (and largely companies using the FRSSE) noted in the FRED, will provide a clearer indication of the impact for UK companies transitioning to the FRSME.

The FRED suggests that costs of transition to the FRSME will be minimal for many users of UK GAAP who do not have complex transactions. We agree that these are likely to be restricted to presentation related issues and this is certainly borne out by evidence from the ACCA field-testing on the IFRS for SMEs.

We also agree that, to some extent, the costs of moving from UK GAAP to the FRSME would be akin to 'business as usual' costs of changes to standards and regulations which, in all likelihood, would be required were the FRSME not adopted.

Results from the ACCA members' survey again suggested cost was not an overwhelming concern for members. However, for smaller organisations, with limited financial reporting specialists, the initial transition would require the assistance of external experts. The need to invest in training in the new standards, as well as the potential for those standards to require more complex calculations, were also perceived by many members as likely to increase costs.

Q18. The [draft] Impact Assessment also gives an indication of the impact on the 'main affected groups'. Do you agree with this analysis? If not, why not?

We agree with the impact assessment on the main affected groups.

Q19. The benefits are hard to quantify; do you agree that they outweigh the costs of transition and any ongoing incremental costs? Do you have any comments on the estimates used?

We appreciate there will be challenges and transitional costs to adopting the FRSME as a replacement to UK GAAP for many entities. We have nevertheless consistently supported the use of a single set of globally accepted accounting standards and consider that the use of the FRSME by non-publicly accountable entities would complement and reinforce the use of full IFRS by publicly accountable entities. We therefore believe the benefits, many of which are outlined in the FRED, would certainly outweigh both the transition costs and the ongoing incremental costs for most entities.

Also, we firmly believe that the proposals for disclosure reductions will help to drive down application costs.

Q20. The ASB is proposing an effective date of July 2013, with early adoption permitted, which assumes an 18 month transition period. The ASB's rationale for this date is set out in paragraphs 11.121 to 11.126. Early adoption will permit entities to secure benefits as soon as possible, however other entities may wish to defer the effective date to permit businesses more time to prepare for transition. Do you agree with the proposed effective date and early adoption? If not, what would be your preferred date, and why?

The time required for transition will depend on whether an entity will be converting to full IFRS or from UK GAAP to the FRSME and, in the latter case, the level of complexity of the business. However, in general, we do not believe that the time required would be significant, especially when appropriate software packages are made available. Allowing for sufficient time for training and education, and for the incidence of companies with more sophisticated information systems and more complex accounting issues, we believe the proposed adoption date should be achievable. This is supported by evidence from our survey, which showed that more members (402) supported the proposed effective date than supported an extension to 1 July 2014 (258).

However, it is important that all stakeholders (including preparers, auditors, users and software providers) are given enough time to assess the impact of the final set of standards. Therefore, it is important that the final standards themselves are issued in good time before the effective date, which should (as proposed by the Board in its FRED on the subject) be the same as that for the final standard for public benefit entities.

Therefore, on balance, we would support an effective date of 1 January 2014, as this would coincide with the reporting dates of the majority of entities in the UK and Ireland while also helping to ensure sufficient preparation time for all entities. This also reflects the balance of opinion from members where 60% were comfortable with the proposed date, while the remainder preferred the effective date to be delayed to 2014.

We support an option for early application and the great majority of survey respondents (84%) also preferred early adoption to be permitted.

Q21. Please provide any other comments you may have on the [draft] Impact Assessment.

We have no other comments.

Boundary between tier 1 and tier 2

Q22 Do you agree that all the entities that the ASB has identified as falling within Tier 1 should be in Tier 1, or do you agree with the Alternative View that some could move to other tiers? If you do think some entities could be moved – which entities and to which tier?

As we noted in our responses to the earlier questions on the proposed framework and around public accountability, we are generally supportive of the targeted approach taken by the Board, and agree that publicly accountable entities should fall within Tier 1. Our two key concerns are that:

  • there still remains some ambiguity around the definition and guidance for determining public accountability; and 
  • there is a likelihood that many smaller entities which display attributes of financial fiduciaries would be deemed as being publicly accountable due to them not being able to fulfil all three size criteria resulting in such entities (small credit unions, mutual funds, etc) falling into Tier 1, whereas they should more appropriately be required to apply the FRSME.

Q23. Are you aware of any information that users of financial statements of publicly accountable entities require which would not be disclosed in financial statements prepared using the FRSME (the IFRS for SMEs adapted for use in the UK)? If so please identify such information and explain why it is required.

Full IFRS is designed to meet the needs of equity investors in companies in capital markets, and therefore has to cover a wide range of issues, include significant levels of implementation guidance and include disclosures appropriate for public companies. Users of the financial statements of SMEs do not have those needs; rather, they are more focused on assessing shorter-term cash flows, liquidity and solvency.

As such, full IFRS is clearly likely to impose a burden on SMEs. This is reflected in the increasing acceptance of the IFRS for SMEs in various markets where full IFRS was previously required for all entities. The IFRS for SMEs (as adapted for the FRSME) therefore meets the needs of users while balancing costs and benefits from a preparer perspective.

Accounting requirements for entities falling into tier 2 (FRSME)

Questions 24 and 25

Q24. Do you believe that the ASB's proposals for the FRSME should be changed to reduce complexity? If so, what changes would you suggest? Please explain how such changes would improve the balance between costs and benefits.

Q25. If the FRSME was changed in accordance with your response to Q24, would it still be suitable for use by some publicly accountable entities? If not, why not?

As we have noted earlier in this letter, we would ideally like to see the FRSSE replaced by a version of the FRSME, with some additional derogations relevant to small companies. One important derogation would be an exemption from requirements related to deferred tax, as noted in our response to Questions 7 & 8.

Boundary between tier 2 and tier 3

Q26. The current cut-off point for the FRSSE is the small company threshold (Turnover £5.6m, Balance Sheet £2.8m, Employees 50). Do you think the cut-off could be raised to permit all companies defined as medium-sized (Turnover £22.8m, Balance Sheet £11.4m, Employees 250) under the Companies Act to use the FRSSE without any additions to the FRSSE? If not, can you identify an intermediate level for the cut-off, and what would it be?

Q27. If you consider that the upper limit of the FRSSE could not be raised without amendment, what additional topics would the FRSSE need to cover if it was extended to include medium-sized entities, and why?

We do not support the extended use of the FRSSE. In fact, as we have outlined in the response to previous questions, we firmly believe that the use of the FRSME itself should be extended to include those small companies currently using the FRSSE. This would result in a more consistent and streamlined, two tier financial reporting regime in the UK and Ireland. While it would be beneficial to make some proportionate exemptions for small entities applying the FRSME, we do not believe that these entities would be over burdened by such an extension of the use of the FRSME. As noted in the FRED, field-testing conducted through ACCA further evidences this.