Financial Reporting: The UK Accounting Standards Board Is Proposing a Three-Tier Approach to Developing UK Gaap Converged with IFRS

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We will soon see the end of financial reporting standards (FRSs) and their older colleagues, statements of standard accounting practice (SSAPs). At least that's the intention of the Accounting Standards Board (ASB), which published plans to this effect in a consultation paper entitled "Policy proposal: the future of UK Gaap" in August.

The document sets out the board's strategy for the future basis of UK and Irish Gaap and its convergence with international financial reporting standards (IFRS). The key proposal is that all FRSs and SSAPs be withdrawn and replaced with the new IFRS for small and medium-sized enterprises (SMEs), published by the International Accounting Standards Board in July. Entities in the UK and Ireland would then be faced with three possible accounting regimes: IFRS as adopted by the European Union; the new IFRS for SMEs; or the financial reporting standard for smaller entities (FRSSE). The basis for deciding which one applies will rest largely on whether a company is "pubLicly accountable". Entities that are publicly accountable would need to apply EU-adopted IFRS, whereas those that are not publicly accountable would be covered by IFRS for SMEs. The exception to this would be that the smallest firms could still apply the FRSSE (see table).

If we focus on the entities in tiers 1 and 2 of the table, we can see that size is not a determining factor in terms of public accountability. Not everyone agrees with this. For example, many UK building and friendly societies are small and some people argue that the extension of EU-adopted IFRS to all such societies would not benefit their members. Other people argue that any large company, even if it's unlisted, is publicly accountable. Having considered these views, the ASB has concluded that, if an entity is deemed publicly accountable, it should apply EU-adopted IFRS, irrespective of size. While it's possible to "trade up" from any tier--eg, tier-2 companies can take on EU-adopted IFRS--many users of accounts will be uncomfortable with the idea that a large company could adopt IFRS for SMEs because it is not publicly accountable.

The ASB's proposals for determining public accountability are as follows. First, if an entity has debt or equity instruments traded on a public market or is in the process of issuing such instruments, it is publicly accountable. Alternatively, if it's a deposit-taking entity and/ or holds assets in a fiduciary capacity for a broad range of outsiders as its main business, it is also publicly accountable and would, therefore, have to apply EU-adopted IFRS.

Examples of the latter group include banks, credit unions, insurance firms, mutual funds, building societies and friendly societies.

Most entities that would fall into tier 1 have been applying EU-adopted IFRS for some time. For those companies for which this would be a new experience, at least the main body of the new accounting standards to apply has existed for a while. But IFRS for SMEs was published barely three months ago. Although its contents had been debated for years, applying them would entail some important changes in the following areas:

* The cash flow statement. Whereas FRS1 exempts entities such as certain subsidiary undertakings from preparing a cash flow statement, IFRS for SMEs offers no such exemption.

* Consolidated accounts. IFRS for SMEs focuses on the power to control, whereas the UK Gaap definition also encompasses situations in which control is actually exercised in practice, irrespective of whether the power to control is present.

* Business combinations. UK Gaap allows these to be accounted for using either the merger accounting approach (in which the carrying values of assets and liabilities of the parties don't have to be adjusted to fair value on consolidation) or the acquisition accounting model (whereby the identifiable assets and liabilities of the acquired company are included in the consolidated balance sheet at fair value). …