Latest proposals on future of UK GAAP issued
The ASB has issued its revised proposals for UK GAAP, consisting of draft standards FRS 100, FRS 101 and FRS 102 (FREDs 46 to 48). The revised proposals would introduce a new accounting framework, new accounting policy choices and changes to accounting requirements in several areas that should align UK GAAP more broadly with EU-IFRS. This should facilitate the transition process for many and allow subsidiaries of those parent entities applying EU-IFRS to apply accounting policies consistent with those of their parent, without needing to apply the full requirements of EU-IFRS.
As reported in the February 2012 issue of Financial Reporting Matters, the Accounting Standards Board (ASB) has recently issued its latest Financial Reporting Exposure Drafts (FREDs 46 to 48) outlining the proposed future for financial reporting in the UK.
In response to comments received on the previous FREDs issued in October 2010, the ASB has made a number of changes to its previous proposals, including:
- dropping the proposed tiered approach to financial reporting based on public accountability. The application of full EU-IFRSs would be mandated only for those entities currently required by law or regulation to apply those standards;
- retaining accounting treatments permitted under current UK GAAP and EU-IFRSs, for example, the revaluation of property, plant and equipment, and the capitalisation of borrowing and development costs; and
- making further revisions and clarifications to the IFRS for SMEs, on which the proposed replacement for UK GAAP is based, to help reduce unnecessary diversity in practice. This includes the alignment of the accounting for defined benefit pension schemes with the requirements of IAS 19 (Revised) Employee benefits; retention of the merger accounting requirements of current FRS 6 Acquisitions and mergers for group reconstructions; and a simplified approach to accounting for tax, rather than applying the full requirements of IAS 12 Income taxes.
The proposed new financial reporting regime may be summarised as follows:
|| Applicable to
Those required to apply by law or regulation
Optional for others*
Group accounts of EU listed entities
Group accounts of AIM companies
|FRS 101 - 102
||Other large and medium-sized entities
Parent of a listed group
Subsidiary of a listed group
Large and medium private companies
||Qualifying small entities
||Small private entities|
* Charitable companies cannot, under current law, elect to apply full EU-IFRSs.
Entities not applying full EU-IFRS or the FRSSE would have to apply either FRS 101 or FRS 102. A decision (which is not always a free choice) would be required as to which to apply. Draft FRS 101 (FRED 47 Reduced disclosure framework) comprises the recognition and measurement requirements of EU-IFRSs, but with reduced disclosure requirements, and may be applied by qualifying group entities. Draft FRS 102 (FRED 48 The Financial Reporting Standard applicable in the UK and Republic of Ireland, no longer to be known as the FRSME) comprises the recognition, measurement and disclosure requirements derived from the IFRS for SMEs, as noted above. Whilst draft FRS 102 also provides a number of disclosure exemptions for qualifying group entities, neither these exemptions nor draft FRS 101 are available in group accounts or the individual accounts of entities not part of a group.
The proposed changes to the requirements of the IFRS for SMEs, together with the availability of the reduced disclosure framework, should ease the transition process for many entities and permit consistent accounting policies to be applied in the individual accounts of subsidiaries of groups which report under full EU-IFRSs, without necessarily having to apply the full requirements of EU-IFRSs.
Directors should now start to consider which accounting framework to apply. In making this assessment, it is worth noting that individual accounts prepared under either FRS 101 or FRS 102 would be 'Companies Act accounts' for the purposes of the consistent financial reporting framework requirements of the Companies Act 2006 (the Act).† It would therefore be possible for different subsidiaries within a group to apply a mixture of FRS 102 and EU-IFRSs with reduced disclosures (under FRS 101) in their individual accounts.‡
However, one potential difficulty is that all Companies Act accounts must follow the presentation formats for accounts as set out in the Act; the ASB notes that those applying FRS 101 would need to exercise care to ensure compliance with the formats of both IAS 1 Presentation of financial statements and the Act. For example, the definition of fixed assets under the Act may not align in all cases with the definition of non-current assets under IAS 1, which may lead to conflicting classification requirements for deferred tax assets or long term receivables. A similar issue arises in relation to the classification of provisions for liabilities. Under the Act this is a separate line item outside current liabilities, yet IAS 1 requires provisions to be classified as current or non-current as appropriate. In addition, certain accounting requirements of FRS 101 differ from those of full EU-IFRSs in order to achieve compliance with the requirements of the Act (for example, the treatment of ‘negative goodwill’) and the non-amortisation of goodwill under IFRS 3 Business combinations would require the use of a true and fair override of the requirements of the Act. These matters are discussed in more detail in Appendix 1 of FRED 47 (draft FRS 101).
We discuss briefly below three of the areas where the proposed accounting requirements under draft FRS 102 would represent a change for many entities currently reporting under UK GAAP.
Defined benefit pension schemes
The ASB’s proposals in relation to accounting for defined benefit pension schemes are consistent with the amended version of IAS 19 Employee benefits. This will be effective (once endorsed) for periods commencing on or after 1 January 2013 for those that currently apply EU-IFRSs.
Contrary to the requirements of current FRS 17 Retirement benefits, draft FRS 102 would require the expected return on scheme assets recognised in profit or loss to be calculated using the discount rate applied in determining the defined benefit obligation. This may reduce the reported level of profit for many entities with defined benefit schemes compared with current UK GAAP, although there would be no effect on net assets.
For group schemes, many UK entities apply the so-called 'multi-employer exemption' under FRS 17, which can mean that no liability is recognised in the individual accounts of any group entity. This exemption would no longer be available for group schemes under FRS 102, which proposes instead to apply the requirements of IAS 19 in this respect. If there is a contractual agreement or stated policy for charging the net defined benefit cost for the scheme as a whole to individual group entities, the relevant share of that cost would be recognised in the individual accounts of each group entity. If there is no such agreement or policy, the net defined benefit cost would be recognised in the individual accounts of the group entity that is legally the sponsoring employer for the scheme and the other group entities would recognise a cost equal to their contribution payable for the period. Hence the liability would be recognised, in many cases for the first time, in at least one individual entity balance sheet within the group, with a consequential effect on net assets and (potentially) distributable profits.
Under FRS 102, derivatives would be required to be recognised on the balance sheet at their fair value. This could be a significant change for those not already applying FRS 26 under current UK GAAP. Although this requirement has the potential to increase volatility in accounts (changes in fair value of derivatives would generally be recognised in profit or loss), entities holding (for example) interest rate swaps or foreign exchange forward contracts in order to provide an economic hedge of their exposure to risk in these areas may be able to apply hedge accounting under FRS 102 in order to mitigate this volatility. We encourage entities to consider the hedge accounting criteria of the draft standard early on, as documentation of the hedge relationship would be required from the date from which hedge accounting would be applied.
Hedge accounting in relation to the foreign exchange risk in a net investment in a foreign operation would, as for those currently applying FRS 26 or full EU-IFRSs, be possible only on consolidation; the 'cover concept' of SSAP 20 Foreign currency translation, whereby similar accounting may also be applied in the individual accounts of the investor, would no longer be available under FRS 102. Thus, the foreign exchange movements on foreign currency borrowings would always be recognised in profit or loss in the individual accounts of the investor and the carrying amount of the investment would not be retranslated as it would be a non-monetary asset.
The proposed 'timing differences plus' approach to accounting for tax is intended to be easier to apply than the requirements of IAS 12, whilst in many (but not all) cases resulting in the same accounting as under that standard. It builds on the familiar timing difference approach in FRS 19 Deferred tax, by including fewer exceptions to the recognition of deferred tax (for example, deferred tax would be recognised on any revaluations of property, plant and equipment). It would also require the recognition of deferred tax arising in a business combination. Coupled with the proposed business combination accounting requirements of draft FRS 102, which include the separate recognition of many intangible assets acquired in a business combination, an increase in the recognition of deferred tax liabilities under FRS 102 compared to current UK GAAP appears likely.
Notwithstanding that some of the requirements of draft FRS 102 may be unpopular with some, we believe that the proposed financial reporting regime will improve financial reporting in the UK, achieving the ASB’s stated objective of enabling “users of accounts to receive high-quality, understandable financial reporting proportionate to the size and complexity of the entity and the users’ information needs”.
The proposed effective date of the new regime is accounting periods commencing on or after 1 January 2015. Early adoption would be permitted, for periods commencing on or after the date of issue of the final standards. The ASB is seeking comments on the FREDs by 30 April 2012.
The full text of the FREDs and a useful Key Facts document are available on the ASB’s web site. KPMG in the UK has published a Financial Reporting Supplement, which provides a brief summary of the ASB's proposals. It is available for free download here.
† 'IAS accounts' under the Act are those prepared under full EU-IFRS.
‡ The Department for Business, Innovation & Skills (BIS) has consulted on making it easier for companies using EU-IFRS to switch back to using UK GAAP.