Discuss what is meant by the term GAAP and whether it meets the needs of all UK entities.
Generally accepted accounting principles or GAAP refers to a set of principles, rules, methods and conventions that provides detailed guidelines and procedures for the preparation, presentation and handling financial and accounting cases. Institute of Chartered Accountants in England and Wales (ICAEW) defines “Generally Accepted Accounting Practice (UK GAAP) as the body of accounting standards and other guidance published by UK Accounting standards Board (ASB)”. In the UK, Financial Reporting Council (FRC) is responsible for setting accounting standards by working closely with national and international accounting standard-setters in order to influence the development of standards. In 2009, ASB proposed a strategy for the future of UK/Irish GAAP and its convergence with International Financial Reporting Standards (IFRS). The intention was to work under the IASB framework which provides detailed guidelines and procedures in the need of all UK entities, hence, cease the existence of UK GAAP. The Board’s proposals set out a three Tier system of differential arrangement based upon public accountability. UK entities would need to determine the appropriate framework to transition, as well as the impact of change to their financial reporting, tax status, business processes and operations in general (Ernst & Young, 2011). Currently in the UK, only entities listed on the regulated market are required to file their accounts in accordance to IFRS, whereas all other UK entities are permitted to use wither IFRS or follow UK GAAP. ASB (2009) proposed three new standards, FRS 100, FRS 101 and FRS 102, that replace all current UK standards. By December 2014, UK GAAP will cease to apply to the financial statements and becomes mandatory for all UK entities for the year end December 2015 or from January 2015 but this is subject to early adoption provisions (ASB, 2009). Early adoption of FRS 101 is allowable without restriction whereas FRS 102 can be allowed on or after the accounting year end 31 December 2012 (PWC, 2013). The impact of each FRS is briefly discussed below.
Needs of UK entities
Entities are of different types of varied sizes with different shareholding and management. Every entity has its own properties but has to act in accordance to the local laws and accounting standards when reporting that gives a user clear picture and nature of business performance. In accounting, “True and Fair View” plays a pivotal role in reporting and presenting financial statements. It remains a fundamental part to accounting within the local and international laws. Under company law, an entity is a separate legal body from its owners. A large entity can be easily distinguished who the owner/manager is, unlike sole traders where it is quite difficult to get a clearer picture although the business forms a separate identity. Charitable organizations, government bodies and some entities have different ways of reporting and in some cases they do not follow UK GAAP in full. Instead, they follow the rules and guidance prescribed by the state and the civil law. True and Fair view in terms of accounting standards may not be true and fair in terms of tax and to get a clear picture of business transactions, some items should be shown as expenses that wouldn’t be allowed for tax (Sweetman, 2009). Sweetman (2009, p.4) argues, “Very small businesses are unlikely to have fluctuations from year to year in most levels, and if in hard times the list of creditors grows then it seems reasonable to tax what is received rather than what may be received one day”. Listed and regulated companies are already following IFRS guidelines and procedures for preparation and reporting financial statements but not all entities are in the regulated market and listed. GAAP varies from nation to nation and hence comes IFRS to come into action. Not all the needs of all UK entities are met by GAAP. It may be because of the nature of transactions an entity has. Trading has become global and most companies, from small to large, trade across the borders and in different countries that have different set of rules and regulations which are to be followed in terms of exchange, tax regimes and other accounting standards. Since the globalisation of the business, a single accounting system has been a major debate for all accounting standard setters in the world. There has been a long standing debate for the convergence of UK GAAP into the IASB framework and this has become a reality following the strategic approach taken by ASB in the past few years.
ASB’s Strategy for UK GAAP
In 2009, ASB proposed a “Three-Tier” approach to the transition of UK GAAP into IFRS to the fullest extent possible with the needs of UK entities. This three-tier approach was based on the public accountability. Tier 1 - All listed and regulated market entities are to follow EU adopted IFRS under this accounting regime. Tier 2 - All non-publicly accountable entities are to follow IFRS for SMEs under this regime Tier 3 - All small entities such as private companies are to follow Financial Reporting Standards for smaller entities (FRSSE) under this regime. Under this proposed change, all entities will have the option to voluntarily adopt a higher tier. One of the objectives of ASB is to offer a comprehensive and clear guidance for all entities by providing high levels of transparency and accountability (ASB, 2009). ASB (2009) believes that the strategic change will improve the financial reporting in many ways such as simplifying the reporting requirements based on the entity’s accountability and size, basing UK GAAP on IFRS provides a consistent basis of preparation of financial statements with better understanding at all levels of users and improved comparability of financial reports will boost investors’ confidence in the capital markets.
UK GAAP v IFRS: Key Differences
- Goodwill: Under IFRS, there is no amortisation used but annual impairment test.
- Borrowing costs and development costs: If criteria are met then the costs are capitalised under IFRS but is optional under UK GAAP
- Deferred Tax: Temporary differences are recorded under IFRS
- Holiday pay accrual: This must be recognised under IFRS
- Financial Instruments: Recognition of derivatives under IFRS but only recognised if FRS 26 adopted in UK GAAP
Impact of New Standards
The Financial Reporting Council (FRC) issued three financial reporting standards (FRSs) 100, 101 and 102 following several consultations to move from current FRSs to IFRS framework. Small entities remain unchanged to the standards as there will be no changes to FRSSE with exceptions to minor amendments (FRC, 2013). The FRC (2013) produced an impact assessment for all these new standards which are discussed below in brief.
Application of Financial Reporting Requirements, FRS 100, provides guidance about the reporting requirements for all entities. This tells the companies or LLPs which set of standards they may or must follow. Listed and regulated companies must use their IFRS in their group accounts. Small companies defined by Companies Act 2006 use FRSSE but a revised version from January 2015 with some minor amendments and other entities that are not small have various choices depending upon the situation. Such as FRS 102, the main new UK GAAP and FRS 101, the reduced disclosure framework or adopt the full IFRS. This suggests that companies which are currently using Statements of Standard Accounting Practices (SSAPs) and FRS will end up using FRS 102. FRC (2013) states that the introduction of new standards will have positive impact on the entities where the benefits are impossible to quantify. FRC believes that the main quantifiable cost is the transition costs for individual entities and those entities that apply for reduced disclosure framework.
FRS 101 Reduced Disclosure Framework creates a new type of standard in the UK. It allows subsidiaries of groups preparing consolidated financial statements in accordance with EU adopted IFRS to apply accounting policies that are consistent with the group accounts. FRS 101 allows some qualifying companies to use IFRS and such entities can take exemptions from following items.
- Cash flow statements- entities are exempt from preparing cash flow statements
- Share based payments- entities are exempt from most of the disclosure requirements by IFRS 2 except description is needed in some areas such as, options exercised in the year and outstanding in the year end
- Business combinations- entities are exempt from most of the disclosure requirements but some basic information would still need to be disclosed on the acquisition
- Discontinued operations- entities are exempt from the disclosure of net cash flows attributable to the operating, investing and financing activities
- Financial instruments- entities which are adopting FRS 101 are exempt from all of the disclosure requirements of IFRS 7, except financial institutions
- Fair Values- most entities are exempt from all of the disclosure requirements of IFRS 13 except financial institutions in relation to financial instruments
- Impairments- entities are exempt from the disclosure of assumptions, valuation techniques and sensitivities arising from impairments
- Related Party Disclosures- as part of the Companies Act 2006, directors’ remuneration is still required to be disclosed but entities are exempt in disclosing the related party transactions
- Accounting policies, changes in accounting estimates and errors- entities are exempt from the disclosure and also exempt from disclosing the impact of the application of those standards
- Comparatives information- entities are exempt from comparatives for movements on property, plant and equipment (PPE), share capital, intangible assets, and investment property
- Capital Management- entities are exempt from the disclosure requirements of capital management but not available to financial institutions
FRS 102, the Financial Reporting Standard is based on IFRS for SMEs and mainly used IFRS language. There are some changes in the terminology of words used in the financial statements, such as, instead of fixed assets, property, plant and equipment has been introduced. There have been significant changes in the financial instruments. Previously, in the UK GAAP, derivatives with zero cost were not recognised but under the new standards, this will be recognised as even small entities have derivatives due to the global trading. ASB realized that FRS 26 (IAS 39) Financial Instruments: Recognition and measurement was not a proportionate solution for all UK entities and hence further areas were expected as part of the convergence process with EU-adopted IFRS. FRS 102 brings in significant improvements in the transparency of financial reporting of financial instruments (FRC, 2013). FRS 102 requires derivatives and some equity instruments to be measured at Fair Value Through Profit and Loss (FVTPL).
The ideas of convergence of UK/Irish GAAP into IFRS have been widely accepted ever since the debate started and it was warmly welcomed. The new UK GAAP will become mandatory for most entities which prepare financial statements for the year end December 2015. The three FRSs will be put in place that replace all the UK accounting standards. Most members were reasonably satisfied with the amendments proposed to the IFRS for SMEs with some unsatisfactory responses for negative goodwill and the removal of fair value option, based on conflicts with EU Directives (ACCA, 2011). Association of Chartered Certified Accountants (ACCA) stated in their report in 2010 following the ASB consultation paper that the new standards would inevitably benefit cross-border trade, reduce costs for companies by providing a single consistent basis of standards, and the cost and time involved in maintaining a separate UK GAAP would be avoided. There might be a number of reasons why convergence was necessary. The application of IFRS may also be driven by national GAAP because of inertia to minimise the changes in financial reporting for stakeholders caused by switching from one set of accounting rules to another (Nobes, 2006). Firms may choose to end their national accounting traditions following the adoption of IFRS (Haller and Wehrfritz, 2013). There might be variations in IFRS reporting due to country-specific factors (Haller and Wehrfritz, 2013). In the wake of global business and trading relationships across the globe, new accounting standards had to be evolved for a consistent and transparent reporting. This not only creates and boosts confidence to users but also provides clear and concise understanding of the financial reporting systems to any stakeholders or users. The transition for UK GAAP to move and adopt IFRS has remained a huge success and widely accepted by all levels of institutions and individuals. There is no doubt that the standards have to evolve over time. The new level of UK GAAP will provide better understanding and try to remove any ambiguities that are engraved in the accounting standards.
- ACCA (2010), “What is the future of UK GAAP?”, Accountants for Business. [Online] Available from http://www.accaglobal.com/content/dam/acca/global/PDF-technical/financial-reporting/tech-afb-fukg.pdf [Accessed: 29th September 2014].
- ACCA (2011), “Future of financial reporting in the UK and Ireland: Summary of ACCA Member Surveys”. [Online] Available from http://www.accaglobal.com/content/dam/acca/global/PDF-technical/financial-reporting/tech-tp-fofr3.pdf [Accessed: 30th September 2014].
- ASB (2009), Consultation Paper, “The Future of UK GAAP”.[Online]Available from https://www.frc.org.uk/getattachment/b106b739-316d-4b22-8703-a2ed94ff9863/Consultation-Paper-Policy-Proposal-The-Future-of-U.pdf. [Accessed: 29th September 2014].
- Clive Owen & Co LLP, (2012), “The Future of UK GAAP”.[Online] Available from http://documents.cliveowen.com/Future%20of%20UK%20GAAP%20%28Oct-12%29.pdf [Accessed: 29th September 2014].
- Deloitte (2014), “Summary FRS 101: Reduced Disclosure Framework”.[Online] Available from http://www.iasplus.com/en-gb/standards/uk-gaap/frs101 [Accessed: 30th September 2014].
- Ernst & Young (2011), “UK GAAP vs IFRS” [Online] Available from http://www.ey.com/Publication/vwLUAssets/UK_GAAP_v_IFRS_-_The_basics_-_Spring_2011/$FILE/EY_UK_GAAP_vs_IFRS_-_The%20basics_-_Spring_2011%20.pdf [Accessed: 30th September 2014].
- Financial Reporting Council,(2011), “True and Fair”.[Online]Available from https://www.frc.org.uk/FRC-Documents/FRC/Paper-True-and-Fair.pdf [Accessed: 29th September 2014].
- Financial Reporting Council (2013), “Impact Assessment” [Online] Available from https://www.frc.org.uk/Our-Work/Publications/Accounting-and-Reporting-Policy/Impact-Assessment-FRS-100,-FRS-101-and-FRS-102.pdf [Accessed: 29th September 2014].
- Haller, A & Wehrfritz, M. (2013), "The impact of national GAAP and accounting traditions on IFRS policy selection: evidence from Germany and the UK", Journal of international accounting auditing & taxation, 22(1), pp. 39-56.
- Institute of Chartered Accountants of England and Wales (2014), “ UK GAAP” [Online] Available from http://www.icaew.com/en/technical/financial-reporting/uk-gaap [Accessed: 30th September 2014].
- Nobes, C. (2006). “The survival of international differences under IFRS: Towards a research agenda”. Accounting and Business Research, 36(3), 233–245.
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- O'Keeffe, I. & Hackett, F. (2010), “The End of UK/Irish GAAP A lot done, more to do”, Institute of Chartered Accountants In Ireland, Dublin; June 2010; 42,3; ProQuest Business Collection; p.16
- Smetanka, R. (2012), “GAAP or Non-GAAP?”, Financial Executives; November; 28,9; ProQuest Business Collection; p.13
- Sweetman, S. (2009), “Does one size fit all?” [Online] 14th February. Available from http://www.taxation.co.uk/taxation/articles/2009/04/14/18222/does-one-size-fit-all [Accessed:29th September 2014].
- Wright, G.B., Fernandez, D., Burns, J., Hawkins, R., Hornsby, C. & Patel, S. (2012), "Big GAAP/Little GAAP: Will The Debate Ever End?", Journal of Business & Economics Research (Online), 10(5), pp. 291.