• Significant changes proposed for UK GAAP – The ASB’s FRED on the future of UK GAAP proposes a tiered approach to financial reporting based on public accountability and size for accounting periods beginning on or after 1 July 2013.  The ASB proposes that entities without public accountability adopt an FRS for Medium-sized Entities (FRSME). This is based on the IFRS for SMEs but includes some key dispensations around preparation of consolidated accounts; disclosure requirements for qualifying subsidiaries and transitional relief for dormant companies.

• FRRP announces its priorities for 2011/12 – The FRRP announces priority sectors for 2011/12 and emphasises its wish to see transparency, clarity and a balanced account in financial and narrative reporting.

• FRRP specific review finding – Sabien Technology plc – The FRRP reports on its review of the financial statements for the year ended 30 June 2009 in respect of a cash flow statement error whereby the reclassification of convertible loans to current liabilities had been treated as a cash item.

• Improvements to FRSs 2010 – This new standard issued by the ASB contains amendments to FRS 29, FRS 8 and SSAP 25 that are effective for annual periods beginning on or after 1 January 2011.

In publishing Financial Reporting Exposure Drafts (FREDs) 43 Application of Financial Reporting Standards and 44 Financial Reporting Standard for Medium-sized Entities (FRSME), the Accounting Standards Board (ASB) is proposing to move to an IFRS-based accounting regime for all but the smallest entities in the UK. The proposals would apply for financial periods beginning on or after 1 July 2013.

The table below outlines the proposed accounting regime according to which tier an entity falls into, based on public accountability and size. Entities would be permitted to adopt the accounting regime applicable to a higher tier. 

Under the proposals:

• All publicly accountable entities would be required to apply EU-IFRSs. This would be an extension of the current requirements, catching publicly accountable companies’ individual accounts and possibly including, for example, pension schemes; insurance companies; credit unions; building societies; banks; incorporated or registered friendly societies; employee benefit trusts; investment mutual funds; custodians; brokers; and fund managers.
• Small entities without public accountability would be permitted to continue to apply the Financial Reporting Standard for Smaller Entities (FRSSE), which would remain unchanged for now, with the exception of consequential amendments arising from the introduction of the new regime.
• Entities without public accountability that are not small would be required to apply a new UK GAAP in which virtually all current FRSs, SSAPs and UITFs would be eliminated.  They would be replaced by a requirement at least to apply the new FRSME, which would be based on the IASB’s International Financial Reporting Standard for Small and Medium–sized Entities, amended as explained below.  Certain subsidiaries will qualify for disclosure exemptions from the requirements of the FRSME.

Any entity can choose to apply the regime applicable to a higher tier (see table) than is required.  While this may seem unattractive, it hides a key relief for many companies.  In a change from the previous consultation, the ASB proposes disclosure exemptions for certain subsidiaries.  Together, these may provide subsidiaries of entities that apply EU-IFRSs with an important practical concession:  to apply a version of UK GAAP that is based on EU-IFRSs (i.e., Tier 1), but with reduced disclosures.  This will facilitate a closer alignment of group and statutory reporting for groups that apply full EU-IFRSs.

In an important change to the IASB’s SME standard, the ASB proposes that the requirement to prepare consolidated financial statements (and the reliefs therefrom) in UK company law continue to apply to UK companies.

FRED 43 includes draft guidance to assist entities in determining whether they have public accountability. Publicly accountable entities that are prudentially regulated and meet all of the size criteria of the small companies’ regime would be permitted to apply the FRSME. 

The disclosure exemptions for certain subsidiaries are available only to non-publicly accountable subsidiaries.  There are no requirements for the subsidiary to be wholly-owned, but shareholders would have the right to require full disclosures.

The ASB also proposes transitional relief for dormant companies. No adjustments would be required on transition to the new regime until such time as there are new transactions or movements in the existing balances to be recorded.

What is the FRSME and how does it differ from current UK GAAP and EU-adopted IFRS?

The FRSME is based on the IFRS for SMEs as issued by the IASB but amended to ensure that it complies with EU accounting directives. It would include consolidation and cash flow exemptions and is amended to replace the income taxes section with the IFRS standard, IAS 12 Income Taxes.

Some of the differences between current UK GAAP, the FRSME, and full EU-adopted IFRS are summarised below:
 

Other frequently asked questions

Which subsidiaries would qualify for the disclosure exemptions?

Non-publicly accountable subsidiaries would be eligible for disclosure exemptions in their Companies Act individual accounts prepared either in accordance with UK GAAP based on EU-IFRS or under the FRSME if they are included in a publicly available consolidation, regardless of percentage ownership, and shareholders do not object.  No disclosure exemptions would be permitted in any group accounts required to be prepared by an intermediate holding company.

In considering whether qualifying subsidiaries preparing accounts under UK GAAP based on EU-IFRS wish to take advantage of the proposed disclosure exemptions, entities should be aware that as these will be ‘Companies Act accounts’, certain requirements of full EU-IFRSs would be modified to comply with the EU accounting directives. For example, a gain on a bargain purchase in a business combination may only be recognised in the income statement when it represents a realised profit, goodwill impairment may be reversed if the reasons for the impairment have ceased to apply, and the non-amortisation of goodwill in accordance with IFRS 3 Business combinations would require the use of a true and fair override of the Companies Act.

What types of disclosure exemptions are proposed?

The proposed disclosure exemptions relate to subsidiary cash flow statements and financial instruments disclosures (as under current UK GAAP) but additional exemptions are proposed in relation to areas managed on a group basis, including, for example, share-based payments and pensions.  No exemption is proposed from disclosure of intra-group related party transactions and the ASB is consulting specifically on whether such an exemption should be included.

Could some subsidiaries in a group apply the FRSME and some EU-IFRS with disclosure exemptions?

Yes.  A company adopting either the FRSME or UK GAAP based on EU-IFRS with disclosure exemptions would be considered to be preparing ‘Companies Act accounts’ within the meaning of the Companies Act.  Thus, different subsidiaries within a group would be able to apply either the FRSME, or UK GAAP based on EU-IFRS with disclosure exemptions, without violating the Companies Act requirement for companies within a group to apply a consistent financial reporting framework in their individual accounts.   

Would the existing Companies Act accounting requirements be retained?

Yes.  For companies applying the FRSME, or UK GAAP based on EU-IFRS with disclosure exemptions, the accounting regulations under the Companies Act would continue to apply, including for example the format of the primary statements.  Therefore, care would be needed to ensure that the format of financial statements complied with both the Act and the FRSME/UK GAAP based on EU-IFRS as appropriate.

Certain other Companies Act disclosure requirements which currently apply to all companies (for example, the content of the directors’ report, and disclosures in relation to employee numbers and costs and auditor remuneration) would continue to apply to all companies under the new proposals.

What about public benefit entities?

Public benefit entities (e.g., charities, housing associations, further and higher education entities) are within the scope of the proposals, although a supplementary public benefit entity standard is to be developed.  An exposure draft is expected in 2011.

 

Further information

The Financial Reporting Review Panel’s (FRRP) annual priorities press release seeks this year to emphasise the FRRP’s wish to see transparency, clarity and a balanced account in financial and narrative reporting.  The FRRP also announced the specific sectors and business models that it will focus on in its review activity of annual reports completed in the year to 31 March 2012.

The specific sectors identified were:

• Commercial property
• Insurance
• Support services, particularly those with significant exposure to public spending cuts
• Travel

It will have a particular interest in companies which operate in niche markets or which are outside the FTSE 350 as they are seen to be facing more risks in the current economic climate compared with larger diversified companies. 

The FRRP emphasised that it would challenge companies whose disclosures of principal risks and uncertainties are boiler-plate or take the form of a long list of generic risks.  This challenge will consider whether the risks identified are in the FRRP’s view principal risks and whether the descriptions are sufficiently specific to enable the threat to the company to be appreciated.

The FRRP has also noted the quoted company’s business review requirement to include information about environmental matters, employees and social and community issues as necessary to understand the development, performance or position of a company’s business.   When this information is required the FRRP would expect it to be provided in a fair, balanced and comprehensive manner, rather than focus solely on good news.

The FRRP will also continue to focus on disclosures in the financial statements on those areas where management has made key judgements.  These comments are consistent with the views expressed by the FRRP in their Annual report to 31 March 2010 issued in August 2010.

Regulators’ area of focus for 2010/11: reminder

The FRRP’s priority sectors for the year to 31 March 2011 are commercial property; advertising; recruitment, media; and information technology (see January/February 2010 Update).

Other areas of focus for the regulators for the same period include:

• the application of IFRS 8 Operating segments
• accounting policies for revenue recognition and expensing of costs
• capital management and share-based payment disclosures (see August Update)
• business combinations' reporting.
  

The FRRP has reported on its review of the financial statements of Sabien Technology Group Plc for the year ended 30 June 2009 in respect of a cash flow statement error.

In the group's consolidated cash flow statement the reclassification of convertible loan notes from non-current to current liabilities had been shown as an increase in trade and other payables within cash flows from operating activities and a repayment of long term borrowings in cash flows from financing activities. However, as this reclassification of convertible loan notes did not require the use of cash or cash equivalents it should be excluded from a cash flow statement and disclosed instead. There was no net error in the change in cash and cash equivalents in the year.

The directors have corrected this error with a prior year adjustment shown in the preliminary announcement of the company’s annual results for the year ended 30 June 2010.

The ASB has issued Improvements to Financial Reporting Standards 2010, which is effective for annual periods beginning on or after 1 January 2011.
The principal amendments are summarised in the table below: