Accounting for the tax changes announced in the 2011 Budget
As part of the phased reduction to 23 per cent, the UK corporation tax rate fell to 26 per cent with effect from 1 April 2011. As substantive enactment of the rate change occurred on 29 March 2011, for March interim and full year ends, deferred tax balances should be re-measured based on 26 per cent.
The Budget on 23 March 2011 revised the previously announced phased reduction in the main UK corporation tax rate. The rate is now proposed to reduce to 23 per cent (this was to be 24 per cent) by 1 April 2014, with the first reduction to 26 per cent taking effect from 1 April 2011 (this was to be 27 per cent).
When measuring deferred tax balances, this means that:
- For December 2010 year ends, deferred tax balances continue to be measured based on a rate of 27 per cent.
- For 31 March 2011 interims and full year ends, deferred tax balances should be re-measured based on a rate of 26 per cent (as this rate was substantively enacted on 29 March 2011).
- For balance sheets prepared to a date after substantive enactment of the 2011 Finance Bill (expected by the end of July 2011), deferred tax balances should be re-measured based on a rate of 26 or 25 per cent, depending on the expected timing of reversal of the related timing or temporary difference. As discussed below, the rate is proposed to fall to 25 per cent with effect from 1 April 2012.
- The effect of any re-measurement will be taken to the income statement, to other comprehensive income (OCI), or directly to equity depending on where the original entry to recognise the deferred tax was recorded.
- In all cases, disclosure should be made of the significant effect on future current tax and on deferred tax balances of the rate decrease to 25 per cent together with a general indication of the likely effect of the expected further 2 per cent reduction.
IAS 12 Income taxes (and FRS 19 Deferred tax) requires that deferred tax assets and liabilities are measured at the tax rates that are expected to apply to the period when the asset is realised or the liability settled, based on rates that have been enacted or substantively enacted by the balance sheet date. For interim reporting, IAS 34 Interim financial reporting also requires the use of tax rates that have been enacted or substantively enacted at the interim balance sheet date.
A UK tax rate can be regarded as “substantively enacted” under IFRS and UK GAAP† if it is included in either:
- a Bill that has been passed by the House of Commons and is awaiting only passage through the House of Lords and Royal Assent; or
- a resolution having statutory effect that has been passed under the Provisional Collection of Taxes Act 1968 (PCTA 1968).
The first 1 per cent reduction from 28 per cent to 27 per cent from 1 April 2011 had already been enacted in the 2010 Finance Act in July 2010. The additional 1 per cent reduction to 26 per cent from 1 April 2011 was passed by a resolution under the PCTA 1968 on 29 March 2011 and is substantively enacted from that date. Therefore the new rate of 26 per cent must be used in calculating deferred tax balances under IFRS and UK GAAP for 31 March 2011 period ends. For periods ending before 29 March 2011, deferred tax continues to be measured based on a rate of 27 per cent.
For companies with other than a 31 March accounting period end, the tax rate applicable to the accounting period crossing 1 April will be a time-apportioned rate. For example, the applicable rate for a 31 December 2011 year end will be 26.5 per cent (three months at 28 per cent and nine months at 26 per cent).
The reduction to 25 per cent from 1 April 2012 will be included in the 2011 Finance Bill, which is expected to be substantively enacted for the purposes of IFRS and UK GAAP (i.e. having completed its Commons stages) by the end of July 2011. For period ends after substantive enactment of the rate change to 25 per cent, this will mean re-measurement based on 26 per cent for temporary/timing differences that are expected to reverse between 1 April 2011 and 31 March 2012 and re-measurement based on 25 per cent for temporary/timing differences that are expected to reverse on or after 1 April 2012.
The remaining 2 per cent reduction is expected to be included on a phased basis in future Finance Bills. The effect of these changes cannot be reflected in interims or full year-ends prior to substantive enactment of the respective Finance Bill.
Effect of re-measurement
The effect of the re-measurement will be taken to the income statement, to other comprehensive income (OCI), or directly to equity depending on where the original entry to recognise the deferred tax was recorded. For example, the effect of re-measuring the deferred tax liability under IAS 12 in relation to an upwards revaluation of own-use property (above cost) will be recognised in other comprehensive income.
In some circumstances IAS 12 (and FRS 19) acknowledges that it may be difficult to determine the precise amount of the re-measurement that relates to an item recognised outside profit or loss. In cases of difficulty, IAS 12 (and FRS 19) requires that a reasonable pro rata allocation should be made, or another allocation that is more appropriate in the circumstances.
IAS 12 (and FRS 19) effectively requires disclosure of significant factors that could affect the future relationship between tax expense and accounting profit. Therefore, in advance of substantive enactment, if the anticipated effect of the announced changes is significant, disclosure should be made.
Where the announcement or enactment of the change takes place after the balance sheet date but prior to the approval of the financial statements, IAS 12‡ specifically requires disclosure to be made of any significant effect of a change in tax rates. For interim reporting, IAS 34 also requires disclosure of material events subsequent to the end of the interim period that have not been reflected in the financial statements in the interim period.
In assessing the appropriate level of disclosure, any significant effect of the additional rate reduction to 25 per cent on deferred tax balances at the balance sheet date would be expected to be disclosed. In many cases it may not yet be practicable to determine the effect of the announced further 2 per cent rate reduction to 23 per cent. In such cases, as a minimum, disclosure of the announced rate change should be given, together with a general indication of the likely effect (for example, a further reduction in deferred tax liabilities or, in more simple cases, a reduction in the future current tax charge) or a statement that an estimate of the effect cannot be made.
† Note that under US GAAP, changes in tax rates are accounted for only once enacted, which will be when the 2011 Finance Act has received Royal Assent (expected to be during June or July 2011). For entities with a 31 March period end that report under both US GAAP and IFRS or UK GAAP, tax (both deferred and current) will be measured using different tax rates under each GAAP.
‡ See also IAS 10 (and FRS 21) Events after the balance sheet date.
Lease accounting: IASB reassesses original proposals
The IASB and US FASB’s joint lease accounting project has undergone significant revisions and the eventual new leases standard will be much changed compared to the 2010 ED proposals. It will have a reduced effect on lessees’ balance sheets and income statements compared to the original ED proposals and, at times, reverts back to accounting similar to that under IAS 17.
2011 has seen the IASB and US FASB’s joint lease accounting project undergo significant revisions with the boards devoting significant time and effort to reassessing some of the original controversial proposals set out in their 2010 exposure draft (ED). In their redeliberations, the Boards have been responsive to certain of the criticisms levelled at the original proposals, in particular their complexity and that they would be difficult to apply. It is now clear that the IASB’s eventual new leases standard will be much changed compared with the ED; it will have a reduced effect on lessees’ balance sheets and income statements compared with the ED and, at times, reverts back to accounting similar to that under IAS 17.
The overall approach continues to be based on the ED’s right-of-use model, resulting in more leases being on-balance sheet for lessees than is currently the case. ‘In-substance sales’ transactions remain excluded from scope but will be identified based on the revenue recognition standard as opposed to a leases standard.
However, so far the Boards have made the following major tentative decisions affecting the ED proposals:
- Leases will be classified as finance leases or ‘other-than-finance’ leases. Other-than-finance leases will still be recognised on-balance sheet although the finance and depreciation charges for these other-than-finance leases would be presented as a single line item and set to achieve the intended smooth straight-line lease expense over the lease term. The criteria for distinguishing between the two types of lease will be based on existing IAS 17 lease classification criteria.
- Renewal periods are included in the lease term only if there is a significant economic incentive to renew the lease.
- Purchase options are included in lease accounting if the options provide a significant economic incentive to purchase the asset.
- Short term leases, i.e., those with a maximum possible term of a year, can be treated as off-balance sheet by lessees (and lessors). In this situation, both lessees and lessors would then recognise the rental expense/income on a straight-line basis.
- Contingent rents will be included on initial recognition if they are based on a rate or index or if they are in-substance fixed. All other contingent rentals will be recognised as income/expense in the period in which they are incurred.
- The definition of a lease is to include a specified asset that is uniquely identifiable (and could be a distinct portion of a larger asset) along with a control criterion that will be aligned with the proposed new revenue recognition standard.
- Lessors will always account separately for leases and non-lease elements of a multiple element contract; lessees will do so as well when there are observable purchase prices for at least some of the elements.
- Sale and leaseback assessment and accounting - the sale leg will need to meet the criteria in the proposed revenue recognition standard.
- Additional application guidance will be developed on issues such as discount rates.
The Boards still have a number of key issues to consider in detail:
- Lessor accounting, including whether to retain the original two lessor accounting approaches.
- Accounting for lease modification and extinguishment.
- Presentation and disclosure.
- Transitional issues, including fully retrospective application.
- Cost/benefit consideration of the proposals as a whole.
We understand that the Boards still plan to issue a final standard once this review process is complete and that they have no plans to offer a general opportunity to comment on the revised package as a whole. The Boards have and continue to perform targeted outreach activities to assess the implications of the proposed changes.
It is not totally clear when this process will be completed. The IASB work plan now indicates that a new standard will be issued in the second half of 2011. The IASB project on effective dates for new standards is ongoing with no current conclusion as to an appropriate effective date for this standard; so far ‘accounting periods beginning on or after 1 January 2015’ has been suggested as a common implementation date for this and other standards.
This is a brief summary of the discussions. Additional discussion and detail of these changes are included in IFRS – Leases Newsletter April 2011.
Cutting clutter from annual reports: ASB issues calls for action
The Accounting Standards Board (ASB) has published Cutting Clutter: Combating clutter in annual reports. The report provides preparers of annual reports with practical aids for reducing clutter, giving ideas for how disclosures might look without the clutter, and factors to consider when planning the annual report process. Some of the suggestions will require regulatory change. In the meantime, we believe that companies can already begin to “cut clutter” and enhance their communication with stakeholders.
The Accounting Standards Board (ASB) has issued a discussion paper Cutting Clutter: Combating clutter in annual reports. The paper builds on the first principle of effective communication from the FRC paper Louder than Words (June 2009) that annual reports should be focussed, highlight important information and avoid distracting readers with immaterial clutter.
In this paper, the ASB proposes that clutter undermines the usefulness of annual reports by obscuring important messages and inhibiting a clear understanding of the business and the issues it faces. It has identified two problem areas that may contribute to clutter in either the narrative sections or in the financial statements themselves:
- immaterial disclosures that obscure relevant information; and
- explanatory information that remains unchanged from year to year.
Some of the suggested approaches to reducing “clutter” will require regulatory change before they could be implemented, for example to present certain information outside the annual report. However, the paper also notes that behavioural aspects, for example repeating prior period disclosures and a fear of challenge from regulators, contribute to clutter and some of these may be capable of more immediate response. The paper includes illustrative examples of how de-cluttered disclosures might appear, including in respect of share-based payments.
The paper acknowledges that a longer term response is needed and sets out three calls for action.
First, to encourage debate as to what materiality means from a disclosure perspective. This is a current “hot topic” and several related initiatives are already in progress in Europe and globally; for example, the European Financial Reporting Advisory Group (EFRAG) and the International Auditing and Assurance Standards Board (IAASB) already have projects to consider materiality in the context of disclosures.
Second, to investigate the separation of explanatory information within or outside the printed annual report. This would represent a significant shift in the structure of corporate reporting away from the current “annual report” and would require changes to existing requirements.
Third, for companies and others to engage with other stakeholders to ensure that legitimate information needs can be met without adding clutter to annual reports. The ASB seeks comments on the paper by 30 September 2011 and plans to hold meetings with interested parties in the Autumn. We believe that annual reports have an important role in corporate communication and encourage you to contribute to the debate about clutter and complexity and how to improve the usefulness of annual reports.
In the meantime, we believe that companies can already begin to “cut clutter” and so enhance their communication with stakeholders. As the paper suggests, cutting clutter cannot be achieved just by taking a red pen to a late printer’s proof. Our experience helping clients to enhance their corporate communication, including their annual report, is that achieving significant improvement takes a vision and a plan.
ASB issues draft Financial Reporting Standard for Public Benefit Entities
The ASB has issued FRED 45 which would apply to public benefit entities (PBE) falling within the scope of the proposed Financial Reporting Standard for Medium-sized Entities (FRSME). It aims to address some accounting issues that are specific to the PBE sector, including concessionary loans, property held for the provision of social benefits, impairment of assets and donations
The ASB has issued FRED 45 Financial Reporting Standard for Public Benefit Entities (FRSPBE) as part of its wider proposals on the future of UK GAAP (as set out in FREDs 43 and 44).
Public benefit entities (PBEs) include housing associations, charities and higher and further education establishments. A PBE is defined as: ‘An entity whose primary objective is to provide goods or services for the general public, community or social benefit and where any equity is provided with a view to supporting the entity’s primary objectives rather than with a view to providing a financial return to equity providers, shareholders or members.’
The FRSPBE would apply to PBEs falling with the scope of the proposed Financial Reporting Standard for Medium-sized Entities (FRSME). It aims to address some accounting issues that are specific to the PBE sector, including concessionary loans, property held for the provision of social benefits, impairment of assets and donations.
A revision to the draft FRSME to incorporate the requirements of FRS 30 Heritage Assets, is also proposed.
Comments are requested by 31 July 2011. The ASB press notice and a copy of the FRED are available here.
FRRP specific review finding - Rio Tinto PLC
The FRRP has issued a statement following the conclusion of discussions with Rio Tinto Plc and the inclusion of information about certain environmental matters, social and community issues and related reputational risks related to certain of the group’s mining projects in its report and accounts for the year ended 31 December 2010.
The Financial Reporting Review Panel (FRRP) has issued a statement following the conclusion of discussions with Rio Tinto Plc and the inclusion in its report and accounts for the year ended 31 December 2010 of information about certain environmental matters, social and community issues and related reputational risks related to certain of the group’s mining projects.
An environmental lobby group, ClientEarth, made a submission to the FRRP which queried whether the disclosures provided by Rio Tinto plc in its 31 December 2008 report and accounts met the Companies Act 2006 section 417 requirements regarding business review disclosures, including those applying to quoted companies in respect of environmental, social and community issues.
The discussion between the FRRP and Rio Tinto appears to have considered whether additional information about some of the company’s projects ought to have been included in the business review to comply with the Act’s requirement for a balanced analysis. The FRRP noted that, so far as it is aware, the additional information now provided does not materially add to or alter information already in the public domain although it had not previously been included in Rio Tinto’s report and accounts.
It is unclear whether the FRRP finally concluded that the information was necessary under the Act or not, as the company moved to provide it anyway.
The press release is available here.
News in Brief
Going concern assessments: FRC panel launched
The FRC’s panel, led by Lord Sharman, will seek input from a wide range of interested parties into how going concern and liquidity risks are assessed and monitored. It will also assess how the consideration of such risks can best be incorporated into other aspects of stewardship and whether the existing reporting regime and related guidance should be developed.
Further information is available in the FRC press release.
Board effectiveness: FRC issues new guidance
Guidance on Board Effectiveness is one in a series of guidance notes issued by the FRC to assist companies in applying the principles of the UK Corporate Governance Code. It reflects the changes made to the Code in 2010 and deals with the sections of the Code relating to Board leadership and effectiveness.
Further information is available in the FRC press release.
Although the UK Corporate Governance Code was amended only last year to require that listed companies search for Board candidates with due regard for diversity, the FRC is to consult on whether the Code should be amended to require listed companies to establish a policy concerning Board diversity.
ASB issues proposed amendments to FRS 29 (IFRS 7) Financial instruments: disclosures
The proposed amendments are identical to the IASB’s amendments to IFRS 7, Transfers of financial assets, issued in October 2010. The proposals incorporate new disclosure requirements that would help users of financial statements evaluate an entity’s risk exposure arising from transfers of financial assets, as well as any resulting impact on its financial position.
The FRED is available here.
IFRS newsletters and other publications
KPMG in the UK publishes Financial Reporting Matters, a short newsletter to alert you to key changes in UK and International Financial Reporting Standards and UK Company Law. It is available for download here. Alternatively, you may subscribe by sending an email to Financial Reporting Matters.
KPMG IFRG Limited has published the following since the January/February 2011 Update, which are available on its Web site at http://www.kpmgifrg.com/:
The Application of IFRS: Media Companies (March 2011)
The New World for Insurance: Business perspectives on Phase II (March 2011)
KPMG IFRG Limited also publishes In the Headlines, which provide information in relation to new exposure drafts and standards issued by the IASB, as well as any other relevant developments affecting current and future IFRS reporters, including summaries of IASB meetings on a monthly basis.
In the Headlines Issue 6 – The challenges of the evolving nature of disclosures
In the Headlines Issue 7 – February 2011 IASB meetings
In the Headlines Issue 8 – Effective dates of IFRSs
In the Headlines Issue 9 – March 2011 IASB meetings
In the Headlines Issue 10 – Update on IASB’s work plan
In the Headlines Issue 11 – IASB/FASB convegence update