Loss Account, a Balance Sheet, an Auditor’s Report and specified notes to the accounts.
Specific requirements of the Companies Act will be discussed throughout this book.
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The accounting rules
The accounting rules are called the Accounting Standards and are set, in the UK, by the Accounting Standards Board. The accounting rules that were issued before August 1990 are called Statements of Standard Accounting Practice (SSAPs), subsequently they have been called Financial Reporting Standards (FRSs). The UK rules cover things that would be set in law in many other countries. They clarify the way that profit should be measured, assets and liabilities should be valued, and require more information to be disclosed in the notes to the accounts. In addition to those financial statements required by the Companies Act, account- ing standards require the publication of a number of other statements:
● a cash flow statement;
● a note on historical cost profits and losses;
● a statement of total recognised gains and losses.
Historical perspective
The accounting standard-setting regime started in January 1970 with the establishment of the Accounting Standards Committee (the ASC) by the Institute of Chartered Accountants in England and Wales. It was joined by other accounting bodies and was reconstituted in 1976 as a joint committee of the six member bodies. During the 1980s, despite the accounting stan- dards, creative accounting boomed and many accounts plainly did not show a true and fair view. The problem was that the rules only told you what you could not do, not what you could. The standard-setting process was too slow, and, with six accounting bodies represented on the committee, was too often a compromise that satisfied no one. To make matters worse, the ASC had no powers of enforcement, and if companies did not comply, all the auditors could do was to say, ‘The company has not complied with SSAP’. There was no legal sanction.
A committee was appointed in 1987, under the chairmanship of Sir Ron Dearing to review and make recommendations on the standard-setting process. The review resulted in two important changes:
Amendments to the Companies Act
The Companies Act 1989 introduced into the 1985 Act the following changes designed to strengthen the accounting standards:
● A definition of accounting standards was included in the Act.
● Directors, other than those of small and medium-sized private companies, must disclose whether the accounts have been prepared in accordance with applicable accounting stan- dards. Any material departures must be both disclosed and explained.
● Section 245B of the Companies Act requires that when a company does not comply with the Act, the court has the power to order the preparation of revised accounts, with the costs of preparing these accounts being borne by the directors involved in the preparation of the defective ones!
New structure
The recommendations of the commission established a new structure for the setting, and enforcement of accounting standards. This was designed to coincide with the legislative changes.
The current structure
The current structure for the setting and enforcement of accounting standards is shown in Figure 2.1.
The Financial Reporting Council (FRC) has been established to determine the general pol- icy for the standard-setting regime. It guides the ASB on work programmes and issues of pub- lic concern. Its chairman and three deputy chairmen are jointly appointed by the Bank of England and the Secretary of State for Trade and Industry. The balance of the council repre- sent a broad cross-section of senior people who have an interest in the preparation of accounts, or in their use.
There are two bodies that report to the FRC:
The Financial Reporting Review panel
This investigates accounts that have been bought to its attention, where it is felt that the pro- visions of the Companies Act may have been breached. It is empowered under the law to take directors to court for issuing accounts which fail to comply with the law, for example where the accounts fail to give a true and fair view. Various penalties are laid down and the publicity combined with the threat of legal action usually persuades companies to comply with the panel’s recommendations. Probably its most widely publicised success story occurred shortly after its establishment. In its 1991 accounts, Trafalgar House, now part of the Norwegian conglomerate, Kvaerner, had attempted to flatter its profits. It had wrongly classified some of its properties, to avoid a £102.7 million property writedown hitting the profit and loss account, and its policy on accounting for advance corporation tax had led to a £20 million understatement of the tax charge. Following discussions with the Financial Reporting Review Panel, the company agreed to change its accounts.
2 The legal and regulatory framework
THE BODIES RESPONSIBLE FOR ACCOUNTING STANDARDS Figure 2.1
Financial Reporting Council (FRC) Objective: Guidance to the ASB
Financial Reporting Review Panel Objective: Enforcement
Accounting Standards Board (ASB) Objective: Appropriate rule setting
Urgent Issues Task Force (UITF) Objective: Assist the ASB in developing
an interpretation of the rules
The Accounting Standards Board
The ASB replaced the ASC on 1 August 1990 and develops, updates and issues accounting standards. The ASB’s accounting standards are called Financial Reporting Standards(FRSs) and the draft standards are called Financial Reporting Exposure Drafts(FREDs).
Companies now have to conform to accounting standards and so they have become much more important. The ASB has recognised this and tries to involve all interested parties in their development. Before a standard is issued, the ASB will probably issue a discussion paper (these are issued for all important or controversial topics) followed by a FRED to elicit the views of the interested parties.
The Urgent Issues Task Force is a committee of the ASB, whose role is to assist the ASB in maintaining and developing both good standards and accounting practice in financial reporting. It tries to achieve a consensus on the interpretation of existing rules in contro- versial areas and publishes this in an Abstract.
Legal opinion suggests that the status of accounting standards has been strengthened, and that accounting standards and UITF abstracts have to be followed in order to give a true and fair view.
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Statements of recommended practice
Statements of recommended practice (SORPs) are developed by bodies that are recognised by the ASB to provide guidance for the application of accounting standards to specific industries.
For example, the Oil Industry Accounting Committee has issued a number of SORPs relating to the oil industry. These are not mandatory, but companies are encouraged to comply with them.
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International accounting standards
The international accounting standards are set by the International Accounting Standards Committee (IASC). This is an independent body, whose objective is to standardise the accounting principles that are used in financial reporting throughout the world. They were formed in 1973 through an agreement made by the professional accountancy bodies from Australia, Canada, France, Germany, the Netherlands, Japan, Mexico, the United Kingdom, Ireland, and the United States. Since then, the membership has widened and there are now 119 members and six associate members in 88 countries. These members try to persuade national standard setters to publish statements that are in accordance with international standards, and to work for international acceptance and recognition of the international standards. The standard-setting procedure is similar to the UK procedure, with the IASC inviting comment from interested parties at every stage.
Some of the early accounting standards offered a number of options and were felt to be too open to interpretation, and in the late 1980s the IASC embarked on its improvements project. It was hoped that this would encourage securities regulators to accept financial state- ments drawn up in accordance with international accounting standards (IASs) to be accept- able for multinational listings. A new feature of the revised standards is that any allowable options are classified; their preferred treatment is described as the ‘benchmark’ treatment, with the other option being the allowed alternative.
The process of improvement continues and the IASC now has a close relationship with the International Organisation of Securities Commissions. It has suggested a number of changes to IAS to enable them to be acceptable as ‘core standards’ for companies with cross-border listings. International accounting standards often form the basis for accounts prepared in
countries that do not have an established accounting tradition (e.g. eastern Europe), and are becoming increasingly important in developing countries. Many companies overseas, with international markets (for example Anglo American of South Africa), prepare accounts con- forming to international standards. The battle is on to decide whether US or international accounting standards will be those used by companies with cross-border listings.
Up to the end of 1993, any company complying with UK accounting standards would have complied with international accounting standards in all material respects. However, this does not always apply to revised standards of 1993 onwards, and further inconsistencies are likely to emerge over the next few years as the IAS develops its core standards. Most UK standards are broadly in line with the international view, and any points of difference will be discussed throughout this book. Every chapter in Part 2 (the accounts) will discuss any major differences between UK practice and international accounting standards.
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Company size and ownership
Until recently the accounts prepared by small and large companies were broadly similar, although smaller private companies were exempt from some of the accounting standards.
(For example, they do not have to prepare a cash flow statement.)
In 1992 an amendment to the Companies Act introduced substantial disclosure exemp- tions for small companies. We are currently seeing the evolution of two different sets of gen- erally accepted accounting practices, larger companies being required to comply with all statutory provisions and accounting-standard requirements, whereas smaller private com- panies comply with a shorter, more restricted set of rules that reduce the amount of dis- closure in the accounts.
Definition of company size
The size of the company is determined by its turnover, total assets and average number of employees. (A small private company is currently a private company where two out of the three following conditions are met: the turnover must be less than £2.8 million, the total assets less than £1.4 million, and the average number of employees must be below 50. If these conditions are satisfied the company will qualify for the small-company disclosure exemptions under the Companies Act.)
Auditing of small company accounts
The November 1993 budget continued the divergence between small and larger companies’
accounting practices by modifying the audit requirement for smaller companies. Companies with a turnover below £90 000 do not need to have their accounts audited. Those with a turnover between £90 000 and £350 000 only require an independent accountant to verify that the accounts accurately reflect the books.
Financial reporting for smaller entities
In 1997 the ASB issued an accounting standard, Financial Reporting for Smaller Entities (FRSSE).
This standard tries to balance the need for small companies to provide accounting informa- tion that is sufficient to assess their financial performance, but is still simple enough for small companies to prepare. Therefore, it has been designed to ensure that all small compa- nies will be required to prepare accounts that comply with the relevant company legislation and a simplified version of the accounting standards.
2 The legal and regulatory framework
Consequently, most of the accounting standards have been modified, and a number are excluded from the proposed standard. However, most exclusions and simplifications would not normally be relevant for smaller companies anyway. The only major exception is FRS 1, as small companies will still remain exempt from FRS 1, although they have the option to disclose their cash flow.
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A stock exchange listing
Companies listed on a stock exchange must disclose additional information concerned with the company’s status, affairs and activities, directors, shares and shareholders, and loans and interest. This is discussed in more detail in Chapter 3.
UK accounting rules exist within a legal framework. The accounting standards have the backing of the law and since 1989 there are sanctions for non-compliance. The account- ing standards are currently set by the Accounting Standards Board. The older accounting standards are called Statements of Standard Accounting Practice (SSAPs); whereas the newer ones are called Financial Reporting Standards (FRSs). Accounting standards evolve through a period of discussion, and the draft accounting standards are called Financial Reporting Exposure Drafts (FREDs). Sometimes there can be different interpretations of an accounting standard, or point of law. These are resolved by the Urgent Issue Task Force.
Guidance to the application of accounting standards within specific industries may be found in Statements of Recommended Practice (SORPs). These are not issued by the ASB, but by another relevant body that the ASB recognises. Compliance with SORPs is encour- aged, but is not mandatory.
Other countries have their own accounting rules, which may either be incorporated into the law or be in the form of accounting standards. The International Accounting Standards Committee is trying to develop international accounting standards that can be used in any country, and will be acceptable on any stock exchange. This would be parti- cularly useful for companies with multinational listings. Some of the later international standards differ significantly from UK standards. These differences will be discussed in this book.
The amount of detail that you will find in the accounts varies from one type of company to another, depending on size, ownership and whether the company is listed on a stock exchange. Small companies are now exempted from some accounting standards and from some of the more onerous terms and the disclosure requirements of many others.
SUMMARY