UK: Financial Reporting A Briefing For Finance Directors, October 2008

Last Updated: 15 October 2008
Article by Yvonne Lang

In this issue:

IFRS

Aiming High

Revised IAS 1

Improving IFRS

UK GAAP

The Future Of UK Financial Reporting: A Three-Tier Approach

Financial Reporting Round-Up

On The Horizon

With IFRS now applying to both full list and Aim companies, we look at the findings from our survey of the first Aim IFRS-compliant financial statements. We also consider the ASB's latest thinking on converging UK GAAP with IFRS.

IFRS

AIMING HIGH

The first IFRS financial statements Aim companies appear to be standing up well to the challenge of reporting under IFRS.

The revised Aim Rules require Aimlisted companies to present their financial statements in compliance with IFRS. This applies to periods beginning on or after 1 January 2007.

In the spring edition of this newsletter, we looked at some of the choices available to Aim companies for presenting their interim results and discussed the findings of our survey of 100 Aim companies' interim reports. We have since continued our research into the accounting choices available under IFRS by reviewing the annual reports of 100 Aim companies with December 2007 year ends, including the top 20 by market capitalisation as at April 2008.

The content of the annual report

Nearly half (47%) of the companies surveyed voluntarily presented a directors' remuneration report, despite this only being a mandatory requirement for fully listed companies. This proportion increases, as might be expected, to 65% when the 20 largest companies are considered.

The trend of Aim companies voluntarily disclosing increased narrative information was also illustrated by the following:

  • 98% presented a separate chairman's statement in addition to the mandatory directors' report
  • 70% presented a corporate governance statement, despite the Financial Service Authority (FSA) regulations on the Combined Code only applying to companies on the full list of the London Stock Exchange.

We also noticed an increased focus on environment and social issues, with 16% of the companies presenting a separate corporate social responsibility statement/ report alongside their financial statements.

Of those surveyed, the longest annual report contained 112 pages, while the average length was 65 pages. On average, narrative information made up 37% of the total content.

Reporting performance

In many areas of performance reporting IFRS allows for more choice and flexibility than UK GAAP.

In the income statement, IAS 1 provides the option to present expenses either by function (e.g. distribution costs, administrative costs, cost of sales) or nature (e.g. depreciation, amortisation, payroll costs, advertising costs) – a choice similar to that offered by the Companies Act. However, unlike UK GAAP, IFRS contains no requirement to draw a subtotal at operating profit.

97% of the surveyed companies continued to report an operating profit sub-total and 90% disclosed expenses by function rather than by nature.

In reporting other gains and losses outside the income statement, companies again have a choice under IFRS whereby they can present as a primary statement either a statement of changes in equity or a statement of recognised income and expense. Just over half of our sample (59%) chose to present a statement of changes in equity.

IAS 33 'Earnings per share' contains strict requirements as to how a company reports basic and diluted earnings per share. While additional per share measures (non-GAAP per share measures) can be calculated and presented, they cannot be included on the face of the income statement. 17% of the companies surveyed calculated a non- GAAP per share measure, although only 2 of the 20 largest companies presented such information.

The non-GAAP measures used included adjustments to profit after tax for amortisation and depreciation, provisions for impairments (primarily of goodwill or other intangible assets), exceptional costs or profits, fair value changes and share option or other 'non cash' expenses.

Parent company financial Statements

As permitted by UK company law, 47% of the groups surveyed opted to remain with UK GAAP for the parent's individual accounts. All of these companies presented the group and parent financial statements as separate sections in the annual report.

Share options

Out of the companies surveyed, only four had no employee share options in issue.

Under IFRS 2 'Share-based payments', accounting for equity-settled share-based payments results in a credit entry to equity. However, the standard does not specify where in equity this credit entry should be recorded. Therefore, there is a choice of treatment; the credit can either be taken to the profit and loss reserve or to a separate reserve established for this purpose.

67% of companies with employee options in issue opted to take the credit arising from the IFRS 2 share option charge directly to the profit and loss reserve rather than a separate reserve. Where companies established a separate reserve, the terminology was fairly consistent, with the most frequently used names being share-based payment reserve, share option reserve, equity option reserve and share scheme reserve.

Smith & Williamson commentary

Reporting under IFRS has undoubtedly been a challenge for Aim companies, many of which operate with relatively small finance functions. It is thus interesting to see that despite the additional requirements of the first year under a new financial reporting framework, narrative reporting has not taken a back seat.

Many Aim companies continue to provide levels of reporting which are close to those of full list companies – most notably in respect of corporate governance matters, including directors' remuneration reporting. This adds credence to the view that the importance of financial statements as a communication medium goes beyond just the numbers.

It is also interesting to note that, while it is no longer possible to show alternative measures of earnings per share on the face of the income statement, many companies still present such amounts as they offer useful information to shareholders about year-on-year performance.

ON THE FACE OF IT: REVISED IAS 1

The IASB has introduced a number of changes to the presentation of financial statements, including amendments to the balance sheet and cashflow statement.

The International Accounting Standards Board (IASB) has issued a revised version of IAS 1 'Presentation of Financial Statements'. While none of the changes are significant, they will still affect all IFRS-compliant financial statements. Subject to European Union (EU) endorsement, the revised standard is effective for periods beginning on or after 1 January 2009. Early adoption is permitted.

New terminology

The revised standard introduces new terminology to replace that which has been used for many years.

The statement of financial position

The majority of entities will continue to present a statement of financial position for the current and comparative periods (the immediately preceding financial period in the UK). However, the revised version of IAS 1 introduces the requirement for an additional statement of financial position where an entity retrospectively applies an accounting policy, retrospectively restates items in its accounts or reclassifies items in the financial statements. In these circumstances, an additional statement of financial position will be required for the beginning of the earliest comparative period. Therefore, in the UK, this will require presenting three years rather than the more usual two.

The statement of comprehensive income

Not only does the revised IAS 1 rename the statement of recognised income and expense, it also provides a new presentation option. The new statement of comprehensive income may now include all items of income and expense, thus combining the requirements of the existing income statement and statement of recognised income and expense. Entities will however still be able to present a separate income statement and statement of comprehensive income, but the latter must directly follow the income statement. It will no longer be possible to present other comprehensive income in the statement of changes in equity.

Income tax on items of other comprehensive income

The revised standard contains a new requirement to disclose income tax for each item included within comprehensive income. This may be achieved either by presenting each item net of tax effects, or by presenting a single amount for the cumulative amount of tax relating to all the items. It will also be necessary to disclose the amount of income tax expense allocated to each item of other comprehensive income in the notes to the accounts.

Reclassifications

Where an amount that has already been recognised in other comprehensive income is reclassified to profit and loss, it will be necessary to disclose the reclassification adjustment, either in the notes or in the statement of comprehensive income.

Smith & Williamson commentary

Using the new terminology (e.g. statement of financial position) is not mandatory but, as it will be used in future accounting standards, preparers of accounts may want to consider whether switching terminology now will aid comprehension.

The requirements in respect of an additional statement of financial position may well lead to many UK companies presenting three periods of balance sheets rather than two. While many new IFRS requirements are only applicable prospectively, this is certainly not the position for all. Likewise, with IFRS requiring prior period adjustment of material errors, as opposed to the UK GAAP requirement of fundamental errors, there is likely to be an increased frequency of prior period adjustments.

RAISING THE BAR: IMPROVING IFRS

As the result of its first improvement project, the IASB has 'tweaked' a number of standards including IAS 16, 38 and 40.

The IASB has recently issued revisions to a number of IFRS as a consequence of completing its first annual improvements project. The IASB views the project as an efficient way to make non-urgent but necessary amendments to IFRS.

The amendments, which are all contained in one document, were published in two parts. Part I contains the amendments that result in accounting changes to presentation, recognition or measurement, while Part II contains terminology or editorial changes only.

The majority of the changes in Part I deal with inconsistencies in some of the less widely applied aspects of standards and may therefore be of little relevance to most preparers. However, three of the improvements are likely to have wider application.

1. Assets that are both rented and subsequently sold

Some businesses, most notably in the leasing industry, both rent and subsequently sell the same asset. However, when such assets are derecognised (i.e. sold), IAS 16 'Property, plant and equipment' does not currently permit gains made to be included as part of revenue. IAS 16 has therefore been amended to permit entities whose normal business is both renting and subsequently selling the same asset to recognise both income from rental and from the subsequent sale as revenue. A consequential amendment to IAS 7 'Statement of cash flows' will also allow both rental and sale cash flows to be included as operating activities.

2. Advertising costs

Preparers' inconsistent interpretation of the application of IFRS to the treatment of advertising and promotion costs has been subject to considerable debate amongst international standards setters. Initially, the International Financial Reporting Interpretations Committee (IFRIC) was asked to issue an interpretation on the subject, but after lengthy consideration they concluded that this was a matter most appropriately addressed by an amendment to IAS 38 'Intangible assets'. This amendment now forms part of the annual improvement project.

The IASB concluded that it would be inconsistent for an entity to recognise as an asset the costs associated with an advertisement that had yet to be published if the economic benefits flowing to the entity were effectively the same as those arising as a result of a brand or customer relationship which, while enhanced, could not itself be recognised as an asset. Consequently, the amendment to IAS 38 prohibits recognising goods or services received in respect of future advertising or promotional activities as assets.

A number of respondents to the exposure draft of the amendment argued that mail-order catalogues are not a form of advertising and should therefore be But the IASB rejected their arguments and has included mail-order catalogues as a specific example of advertising costs.

3. Investment property under construction

Historically, investment property under construction was excluded from the scope of IAS 40 'Investment property'. This was instead dealt with in IAS 16 which required such assets to be accounted for as property, plant and equipment until they were complete – at which point they were transferred to investment property and accounted for under IAS 40.

However, the IASB has acknowledged that developments in the property market mean that it is now possible to measure the fair value of property under construction and, accordingly, it has amended IAS 40 to bring such property within its scope. The amendment allows property under construction to be measured at cost, where fair value cannot be measured reliably until either it becomes measurable or construction is complete. An amendment to IAS 16 removes the current accounting treatment.

These three amendments apply for periods beginning on or after 1 January 2009 with early application permitted in all cases. However, the amendment to IAS 40 can only be applied early if the fair value of investment properties under construction was determined at that date.

Other amendments

There are a number of further changes which are unlikely to have a widespread impact. The other standards subject to amendment are as follows.

  • IFRS 5 'Non-current assets held for sale and discontinued operations'
  • IAS 1 'Presentation of financial statements'
  • IAS 19 'Employee benefits'
  • IAS 20 'Accounting for government grants and disclosure of government assistance'
  • IAS 23 'Borrowing costs'
  • IAS 27 'Consolidated and separate financial statements'
  • IAS 28 'Investments in associates'
  • IAS 29 'Financial reporting in hyperinflationary economies'
  • IAS 31 'Interests in joint ventures'
  • IAS 36' Impairment of assets'
  • IAS 39 'Financial instruments: recognition and measurement'
  • IAS 41 'Agriculture'


Smith & Williamson commentary

Many of the amendments not discussed in detail relate to inconsistencies or vagaries in definitions which are unlikely to affect most preparers. However, anyone who currently has to apply any of these standards should make themselves familiar with the relevant changes.

Entities operating in the affected industries will welcome the changes in respect of the rental and sale of assets and investment property. Accounting treatments that best reflect the commercial nature of their transactions will no longer be prohibited by the accounting framework within which they have to operate.

While the requirement to write off advertising costs may not be popular with all preparers, introducing consistency in an area where the amounts spent can be very high is to be welcomed.

UK GAAP

THE FUTURE OF UK FINANCIAL REPORTING: A THREE-TIERED APPROACH

The ASB is looking to converge IFRS and UK GAAP by implementing a tier-based system.

The UK Accounting Standards Board (ASB) is preparing a discussion paper detailing its proposals for the convergence of UK GAAP with IFRS. The particulars were published in the April edition of its newsletter Inside Track. The paper is anticipated to set out a three-tier structure for UK financial reporting.

Tier 1: Publicly accountable Entities

These entities will have to apply full IFRS when preparing their financial statements. The ASB is yet to conclude which entities will be regarded as publicly accountable.

Tier 2: All entities that do not fall into tier 1 or 3

These entities will have to apply IFRS for Private Entities (the working title of the standard formerly known as IFRS for Small and Medium-sized Entities).

Tier 3: Smaller entities

Smaller entities will have to apply the ASB's Financial Reporting Standard for Smaller Entities (FRSSE).

Expected timetable

The ASB does not want to reach its final conclusions on such an important subject without proper consultation with interested parties. In addition to inviting comments on the discussion paper, it is also planning to hold a series of roundtable meetings – an approach that has proven to be extremely beneficial in the past.

The main issue upon which the ASB is still undecided is where to draw the cutoff points between the tiers. The ASB will need to consider the views of its constituents as well as how any tier-based system in the UK would interact with the EU's Accounting Directives.

The timetable for convergence will be significantly influenced by the publication of the IFRS for Private Entities. This is not expected until 2009 at the earliest and the standard is unlikely to be effective prior to 2011. In the past, the ASB has suggested that any move to a threetier approach would have to follow the successful introduction of IFRS for Private Entities.

Smith & Williamson commentary

A move to IFRS for Private Entities could be a big change for the considerable number of UK preparers who look set to fall into the middle tier. While the standard will be significantly less prescriptive than full IFRS and require comparatively few disclosures, entities will still need to plan ahead for the process of transition from UK GAAP.

Planning for transition will need to start as soon as the final timetable for convergence is published and the potential complexity of the task in hand should not be underestimated. Unless companies already have experience of implementing IFRS, it is likely that they will need to seek professional advice leading up to, and during, the transition process.

FINANCIAL REPORTING ROUND-UP

2008 has been relatively quiet in terms of financial reporting changes. However, IFRIC has recently published interpretations for IFRIC 15 and 16, while the ASB has updated the FRSSE.

UK GAAP

FRSSE

The ASB has issued a new version of the FRSSE. This incorporates the changes to the small companies accounting and reporting regime resulting from implementation of the Companies Act 2006. There are no changes to accounting requirements.

The FRSSE (effective April 2008) replaces the FRSSE (effective January 2007) for periods beginning on or after 6 April 2008. The direct interaction with company legislation means that earlier adoption is not permitted.

IFRS

IFRIC 15 'Agreements for the construction of real estate'

IFRIC 15 standardises the accounting treatment for the recognition of revenue by real estate developers for sales made 'off-plan'. The interpretation provides guidance on how to determine whether the related construction contract should be accounted for using IAS 11 'Construction contracts' or IAS 18 'Revenue recognition'. This interpretation applies for periods beginning on or after 1 January 2009 and applies retrospectively.

Smith & Williamson commentary

This interpretation is unlikely to have much impact in the UK due to the way in which such arrangements are typically structured.

Where a change in accounting treatment does arise as a consequence of adopting IFRIC 15, this is expected to mostly result in a shift from recognising revenue using the percentage completion basis to recognition at a single point in time.

IFRIC 16 'Hedges of a net investment in a foreign operation'

IFRIC 16 clarifies a number of issues relating to hedge accounting, including the following.

  • A parent entity may designate as a hedged risk only those foreign exchange differences arising between its own functional currency and that of its foreign operation. Using a different presentation currency does not create an exposure to which hedge accounting can be applied.
  • When applying hedge accounting in group accounts, the hedged item and the hedging instrument can be held by different entities within the same group.
  • IAS 39 'Financial Instruments: recognition and measurement' should be applied to calculate the amount of the reclassification to profit and loss from the foreign currency translation reserve in respect of the hedging instrument. However, IAS 21 'The effects of changes in foreign exchange rates' must be applied in respect of the hedged item.

ON THE HORIZON

The table below summarises the effective dates for new and revised IFRS and IFRIC interpretations. Those that are shaded have not yet been endorsed by the EU and the effective date will be contingent on successful endorsement.

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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