UK: Financial Reporting, A Briefing For Finance Directors, November 2007

Last Updated: 8 November 2007
Article by Yvonne Lang

While it is a widely held view that principles-based standards provide a better financial reporting framework than those that adhere to ‘rules’, the application of these principles can be anything but straightforward. We look at a number of recently issued interpretations of IFRS that seek to provide clarity. In addition, changes to UK corporate law are set to affect all companies.


Companies with defined benefit schemes face further changes following the issue of IFRIC 14.

In many countries, including the UK, entities are required to make minimum contributions to post-employment benefit plans for a stated period of time in order to provide greater security for the beneficiaries. However, companies have accounted for these obligations in a number of ways, and now the International Financial Reporting Interpretations Committee (IFRIC) has recently issued clarification.

IAS 19 ‘Employee benefits’ limits the measurement of a defined benefit asset to "the present value of economic benefits available in the form of refunds from the plan or reductions in future contributions to the plan". The interpretation of this paragraph and the possible effect of a minimum funding requirement on the ability to recognise an asset are dealt with in IFRIC 14 ‘IAS 19 The limit on a defined benefit asset, minimum funding requirements and their interaction’. IFRIC 14 also discusses when a minimum funding requirement might give rise to a liability.

Refunds And Reductions

The availability of a refund or reduction in future contributions should be determined by reference to the terms and conditions of the plan, together with any statutory requirements of the relevant jurisdiction. The economic benefit, whether a refund or reduction in contributions, should be regarded as available if it can be realised at some point during the life of the plan or when the liabilities are settled.

A refund is available only if the entity has an unconditional right to one. Where the right to a refund of a surplus depends on the occurrence or non-occurrence of one or more uncertain events not wholly within the control of the entity, no asset should be recognised.

Minimum Funding Requirement

Minimum funding requirements need to be analysed between contributions in order to cover any existing shortfall for past services and the future accrual of benefits. If the future minimum funding contribution required in respect of the future accrual of benefits exceeds the future service cost calculated in accordance with IAS 19 in any year, the present value of the excess reduces the amount of the asset. Thus, it can never fall below zero.

Where there is an obligation under a minimum funding requirement to pay contributions in order to cover an existing shortfall on the minimum funding basis in respect of services already received, the entity should determine whether the contributions payable will be available as a refund or reduction in contributions. If these are not available as a refund or reduction, a liability should be recognised.

IFRIC 14 is applicable for periods beginning on or after 1 January 2008. Earlier application is encouraged. While there are statutory minimum funding requirements in the UK, these are not as stringent as those in other European and Switzerland. The clarification provided by IFRIC 14 should not, in most cases, have a significant effect on the accounts of UK companies following existing best practice. However, all companies with defined benefit schemes should review their accounting and ensure that it is consistent with the clarified principles of IFRIC 14.

Smith & Williamson Commentary

This interpretation does not change accounting principles. However, pensions remain a sensitive area and thus the significant press comment following the release of IFRIC 14 and its effect on pension funding was inevitable. But the International Accounting Standards Board (IASB) took the unusual step of issuing its own press release to explain that IFRIC 14 would only impact on accounting. In particular, the IASB felt it necessary to point out that accounting rules could not affect the funding requirements in any given jurisdiction, and did not affect an entity’s ability to get a refund where this was determined by the jurisdiction’s statutory regulations and the scheme’s rules.


It is common practice in certain industries to reward customers for the purchases that they make through, for example, frequent-flyer programmes and supermarket loyalty points.

The application of accounting principles to loyalty schemes has resulted in different treatments arising in practice. IFRIC has recently issued an interpretation dealing with this specific issue.

IFRIC 13 ‘Customer Loyalty Programmes’ requires that where an entity grants loyalty points, it should allocate the proceeds received on the related sale between revenue and the future obligation to provide ‘bonus’ products or services. The liability should be measured at the fair value of the loyalty point credits granted, determined by ascertaining the price that the entity would be able to charge if it were to sell the loyalty point credits separately. Revenue will be initially recognised net of the future liability, which will remain on the balance sheet until it is recognised within revenue.

The remaining revenue will only be recognised once the entity has either fulfilled its obligation to provide the relevant bonus products or services, either by supplying them or paying a third party to provide them on its behalf, or when the points expire. The interpretation contains specific guidance on how fair value should be assessed.

IFRIC 13 will take effect for periods beginning on or after 1 July 2008, although early application will be permitted.

Smith & Williamson Commentary

Customer loyalty schemes have become increasingly common and guidance on achieving a uniform accounting treatment is welcome. A number of respondents to the IASB’s initial proposals did, however, question whether the existence of a customer loyalty scheme should affect the value of turnover, as opposed to being a component of the cost of making the sale.


Differences between reporting entities as to the timing of recognition of revenue in respect of ‘off-plan’ real estate sales has attracted the attention of IFRIC.

IFRIC has published draft interpretation D21 ‘Real Estate Sales’ to provide guidance on when an off-plan sale should be accounted for as a sale of goods under IAS 18 ‘Revenue’, and the circumstances where it might be appropriate to account for the sale under IAS 11 ‘Construction contracts’. It also revises the guidance on applying IAS 18 to real estate sales in general.

Contract Arrangements

The most usual type of arrangement is where a buyer enters into an agreement to buy a specified unit once it is complete, in return for a deposit that is only refundable if the developer fails to deliver the property.

However, other types of arrangement do exist, including the following examples.

  • The sale of the whole development to a single buyer.
  • The buyer may agree to make progress payments between the inception of the contract and its final completion.
  • Construction might be complete before the sale concludes.

The draft consensus in D21 is that IAS 11 applies only if the arrangement meets the definition of a construction contract, and revenue and profit are recognised as the contract progresses. However, where the arrangement is an agreement for the sale of goods, i.e. completed real estate, it will be the provisions of IAS 18 that will prevail, with revenue only recognised when the buyer has effective control of the property.


The proposed interpretation identifies certain factors that might indicate there is a construction contract.

  • The buyer is able to specify the major structural elements of the real estate design before construction begins, and/ or specify major structural changes once construction is in progress.
  • The seller transfers to the buyer control and the significant risks and rewards of ownership, as construction progresses.

Indicators that the seller has transferred control include the following.

  • Construction taking place on land that is owned or leased by the buyer.
  • The buyer having the right to take over the work in progress during construction.
  • In the event of the agreement being terminated before construction is complete, the buyer retains the work in progress and the seller has the right to be paid for work performed.

Features that may indicate a sale of goods include the following.

  • The negotiation between buyer and seller – primarily concerning the amount and timing of payments, with the buyer having limited ability to specify the real estate design.
  • The agreement only gives the buyer the right to acquire the completed real estate at a later date, with the seller retaining control and the significant risks and rewards of ownership of the underlying work in progress at that date.

Smith & Williamson Commentary

In the UK, application of this proposed interpretation to straightforward house sales is unlikely to result in a change in accounting treatment. Those involved in larger and more complex property developments may, however, need to reassess whether their existing accounting policies are appropriate once the interpretation comes into force.


Guidance has been issued on identifying foreign currency risks on the hedging of investments in foreign operations.

IAS 21 ‘The effects of changes in foreign exchange rates’ requires a reporting entity to determine the functional currency of each of its foreign operations. Functional currency is the currency of the primary economic environment of that operation. Foreign exchange differences that arise on translation to the parent entity’s presentation currency are recognised in equity until the foreign operation is disposed of.

IAS 39 ‘Financial instruments: recognition and measurement’ permits the use of hedge accounting in either individual or consolidated financial statements in respect of the foreign currency risk arising from the net investment in a foreign operation. To the extent that there is an effective hedge, the gain or loss arising can be recognised directly in equity, offset against the translation of the foreign operation into the presentation currency.

A draft IFRIC interpretation D22 ‘Hedges of a net investment in a foreign operation’ has been issued to provide guidance on identifying the foreign currency risks that qualify as a hedged item and addresses two issues.

The draft extract proposes that the hedged risk that may be designated is that arising between the functional currency of the foreign operation and the functional currency of the parent. Where the parent’s presentation currency differs from its functional currency, it would not be permitted to apply hedge accounting to translation differences arising between the functional currency of the foreign operation and the presentation currency of the parent.

The draft interpretation also considers that it would be acceptable for the hedging instrument to be held anywhere within the group (other than in the foreign operation that is being hedged), as long as the designation, documentation and effectiveness requirements of IAS 39 are met. Effectiveness would be measured by reference to the functional currency of the parent. Any exposure to foreign exchange risk may only qualify for hedge accounting once. If the same risk is hedged by more than one parent entity within the group, only one hedge relationship will qualify.

Smith & Williamson Commentary

The guidance in the proposed interpretation is clearly grounded in a common sense approach, while taking account of the complexity of group structures and the way they may be funded.


The new Companies Act received Royal Assent in November 2006 and guidance on implementation continues to be issued.

The Companies Act 2006 (the Act) received Royal Assent in November last year. At over 700 pages long, with 1,300 clauses, it is the longest piece of UK legislation to ever be laid before Parliament.

Although the Act was approved and published last November, many of its requirements have yet to be implemented. A limited number of provisions commenced in 2006 and early 2007, however the majority of significant changes will not be effective until October 2007 or later.

The Act is intended to simplify and modernise existing rules, many of which date back to when the first UK Companies Act was published in 1856. This objective is reflected in many of the changes which came into effect on 1 October 2007.

Meetings And Resolutions

A much-publicised benefit of the Act has been its ‘think small first’ focus, aimed at reducing the administrative burden on smaller companies. This can clearly be seen in the relaxation of the rules surrounding meetings and resolutions for private companies, which changed from October 2007.

Private companies will no longer be required to hold an annual general meeting (AGM), unless expressly required by the company’s articles. It is therefore envisaged that a private company will pass the majority of its resolutions by written resolution, a process which has also been made easier under the Act. A simple majority (for an ordinary resolution) or 75% (for a special resolution) is now required, in comparison to the unanimous consent required under the Companies Act 1985.

In addition, the financial statements of private companies no longer need to be laid before members at an AGM (although the accounts must still be circulated to members). A company’s auditors will be deemed to be reappointed each year, unless a company chooses to ‘opt in’ to a regime of annual appointment. However, the Act retains the Companies Act 1985 prohibition on using a written resolution to dismiss a director or auditor.

Loans To Directors

One simplification which has been widely welcomed is the removal of the existing general prohibition on companies providing loans to directors. Since 1 October, subject to obtaining shareholder approval, both public and private companies have been able to give loans and quasi-loans to directors, as well as act as guarantors and engage in credit transactions on behalf of directors. In addition, the Act contains exemptions allowing companies to enter into certain transactions with directors without shareholder approval, e.g. for loans up to a value of £50,000 and credit transactions up to £15,000 per director.


Several provisions of the Act which will become effective in 2008, impact on the preparation and audit of statutory accounts. The general format of statutory accounts will not be changed from the existing requirements in the 1985 Act. However, for periods beginning on or after 6 April 2008, the exemption from preparing group accounts, which at present applies to both small and medium-sized groups, will only apply to small groups.

Smith & Williamson Commentary

The removal of the group accounts exemption for medium-sized groups is far from a simplifying measure. Many companies that have never had to prepare consolidated accounts previously, will now need to do so for the first time. The need for comparatives brings forward the application date of the requirement, and those involved in the preparation of accounts for medium-sized groups will need to start to consider some of the issues they are likely to face.


The Government has proposed a revision to the late filing penalty regimes, with additional fines for persistent offenders.

The existing penalty scheme for late filing of accounts was introduced in 1992 and there has been no increase in the level of fines imposed since then. It appears that many companies regard a £100 fine as a small price to pay in return for a three-month extension to their accounts filing deadline. The Government has decided it is time to take action against companies that persistently file their accounts late. A revision to the late filing penalty regime has been proposed.

The changes, which incorporate both the effects of inflation from 1992 to 2007 (a 50% increase), as well as accelerated increases in penalties for persistent offenders, are shown in Figure 1 below.

Where a company’s accounts were also filed late in the previous year, the relevant late filing penalty will be doubled.

The proposed changes to the late filing penalty regime will not take effect until 1 February 2009. It coincides with the reduction in filing deadlines for private and public companies, which become one month shorter, i.e. nine months for private and six months for public companies.

Smith & Williamson Commentary

While the proposed changes will have a financial impact on companies, many commentators question whether they go far enough. It is likely to be the larger companies that have the most to gain from late filing, and they are also the ones most able to afford the increased fines.


An amendment to FRS 3 confirms that recycling previously recognised gains and losses is allowed in some circumstances.

It has long been a tenet of UK financial reporting that once gains have been recognised, whether in the profit and loss account or the statement of recognised gains and losses, they should not be recognised again. However, some of the more recent UK standards based on IFRS require the ‘recycling of gains and losses’ recognised initially in reserves back through the profit and loss account.

In July, the Accounting Standards Board (ASB) published a limited amendment to FRS 3 confirming that recycling previously recognised gains and losses is permitted in certain limited circumstances.

FRS 3 contains a blanket prohibition on recycling, but FRS 26 ‘Financial instruments: measurement’ and FRS 23 ‘Foreign exchange’ require recycling in certain circumstances. For example, FRS 26 requires unrealised gains and losses on ‘available for sale’ financial assets to be recognised in the statement of changes in equity, and then recognised again in profit and loss when those gains are realised on a sale. While FRS 3 has now been amended to allow recycling in these specific circumstances, the ASB has, however, reiterated that it is opposed to recycling as a principle, and does not want to promote it as a concept.

Smith & Williamson Commentary

The question of recycling highlights that some fundamental conceptual differences between IFRS and UK GAAP still exist. Many UK GAAP preparers and users have reservations about recycling. Nevertheless, it would appear that this concept is now here to stay in UK GAAP.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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