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Financial reporting alert - December 2002

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2nd Jan 2003
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Solomon Hare summarises all the main audit and financial reporting practice developments in the six months to December 2002.

Accounting Standards Board ' recent activity
No financial reporting standards have been published since FRS 19 'Deferred Tax'. This extends the transitional arrangements stated in the standard.

On 25 November 2002, ASB published an amendment to FRS 17, Retirement benefits. The requirements of FRS 17 (to be revised at a later date in line with IASB developments) will become mandatory for accounting periods beginning on or after 1 January 2005.

The most recent exposure drafts published are:

  • Exposure draft of an amendment to FRS 17 'Retirement Benefits';
  • FRED 30 'Financial Instruments: Disclosure and presentation; Recognition and measurement';
  • FRED 31 'Share-based Payment';
  • Exposure draft dealing with a revision of the operating and financial review best practice statement.

    Urgent Issues Task Force
    The last Abstract to be issued was UITF 35 'Death-in-service and Incapacity Benefits'. This was issued on 21 May 2002.

    Current ASB projects - Recent developments
    The ASB is proposing, prior to 2005, to replace a number of existing UK standards with new standards based on International Financial Reporting Standards (IFRSs).

    On 7 June 2002, the Council of the European Union adopted the IAS Regulation, which will apply to all EU companies listed on national markets. For accounting periods commencing on or after 1 January 2005, these companies will be required to prepare their consolidated accounts in accordance with International Accounting Standards.

    On 30 August 2002, the Department of Trade and Industry issued a consultation document on the possible extension of the European Regulation on International Accounting Standards beyond consolidated accounts of publicly-traded companies.

    For further information on current ASB projects, consult Inside Track issue 33 (October 2002) on the ASB website. Here is a brief summary:

    Share-based payment -This project considers accounting for goods and services paid for by the issue of shares, share options and similar items. The IASB issued an exposure draft (ED 2) in November 2002 proposing that share-based payment transactions should be recognised in the accounts, resulting in an expense that should be recognised in the profit and loss account. The ASB issued its own exposure draft, FRED 31, identical to the IASB's exposure draft. The intention is that the new requirements should be implemented in the UK for accounts periods beginning on or after 1 January 2004.

    First-time application of International Financial Reporting Standards (IFRSs) - IASB exposure draft ED 1 sets out recommendations for companies adopting IFRSs for the first time. The ASB published the IASB proposals in July 2002 in the form of a consultation paper in order to obtain UK views and explain the implications for UK companies.

    Reporting financial performance (FRED 22) - The ASB and IASB are working in partnership to develop a new standard which will require a single statement of comprehensive income, which would report all recognised gains and losses. As far as the UK is concerned, this will eventually replace the existing profit and loss account and statement of total recognised gains and losses, once the form and content of the performance statement has been agreed. IASB aims to issue an exposure draft in the first half of 2003.

    Business combinations - The IASB issued an exposure draft of an International Financial Reporting Standard in December 2002 covering Phase 1 of the project. The international ED included a number of practices that will differ from present UK GAAP, notably: requiring purchased positive goodwill to be carried on the balance sheet at an unchanged amount, subject to annual impairment review; prohibiting systematic amortisation; requiring negative goodwill to be recognised as a gain in the income statement wherever it arises. It also prohibits merger accounting.

    Basis of consolidation - The ASB has been working at IASB's request on researching world-wide differences on consolidation policy. Future proposals are likely to recommend a substance-based approach based on the principle that control should be the sole criteria justifying consolidation. Control is generally viewed as the entity's ability to direct another entity's policies and the ability to benefit from those policies (similar to the criteria in FRS 5). A control-based approach should be capable of being applied to both simple and complex cases ' an example of the latter being SPEs (special purpose entities).

    Revenue recognition - Following responses to the ASB's July 2001 Discussion Paper, the board is working to convert the paper's general principles into a general standard, and to show how these can be applied to specific industries. The UK and international standards-setters are continuing to discuss a project on this subject, which is now included on the IASB's main work programme.

    Leases: Implementation of a new approach - Following up on a UK discussion paper, the IASB announced in June 2002 that it would embark on active research for lease accounting. A future standard is likely to require a single method of accounting for all leases, irrespective of whether a lease is classified under SSAP 21 as 'finance' or 'operating'. From the viewpoint of the lessee, a standard will have to develop principles for determining what should be recognised as an asset, together with the corresponding obligation.

    Financial instruments ' recognition and measurement - Thye IASB has issued an exposure draft based on IAS 39 as part of its improvement project. The ASB followed up with FRED 30, based on the IASB proposals.

    Derecognition - Derecognition principles are included in FRS 5, but there are a number of differences compared with IAS and US GAAP. The IASB intends to revise its derecognition principles alongside the IAS 39 revisions, but these will not deal with derecognition of assets and liabilities that are not classed as financial instruments. This is another area where ASB's input into the development of international standards is likely to be significant.

    Insurance accounting - The IASB is carrying out extensive work on this subject, and hopes to issue an exposure draft in the first quarter of 2003 dealing with Phase 1 of the project.

    Operating and financial review (OFR) - Following a review of its 1993 Paper, the ASB has issued an exposure draft with proposals for updating its paper.

    Committee on Accounting for Smaller Entities (CASE) -The IASB announced in June 2002 that it proposes to embark on active research in the application of international accounting standards to small and medium-sized entities. The ASB hopes to pass on its experience from developing the FRSSE.

    Statement of Principles for the public and not-for-profit sectors - The ASB hopes to issue a discussion document during 2003.

    SME update

    FRSSE - Companies that currently adopt the FRSSE must move over to FRSSE (effective June 2002) no later than accounts periods ending on or after 22 June 2002.

    As mentioned above, the IASB intends to conduct research on applying international accounting standards to small and medium-sized entities and in emerging economies, known as "the SME project".

    The Committee on Accounting for Smaller Entities (CASE) has been considering the implications of a "one stop shop" FRSSE. This would be a single reference point incorporating the requirements of both accounting standards and legislation, and including issues such as layout and content of balance sheets and profit and loss accounts.

    Company Law Review - The DTI published its Company Law White Paper in July 2002. For SMEs, particular points of note are:

  • The White Paper indicates that the government will not introduce a statutory Independent Professional Review (IPR);
  • There are no immediate proposals to raise the thresholds for audit exemption [earlier indications were that the turnover threshold might be increased from £1m to £4.8m];
  • Simplification of accounts disclosure requirements will be introduced for companies with two out of three of: turnover below £4.8m; gross assets below £2.4m; no more than 50 employees. This will effectively extend the availability of the FRSSE to a greater number of companies;
  • Small companies will no longer be allowed to file abbreviated accounts;
  • The time limit for filing of accounts will be reduced. For private companies, the present limit of 10 months will be reduced to 7 months.

    The above are still proposals and could be changed, although at present this seems unlikely.

    Financial Reporting Review Panel
    Two recent FRRP Press Notices are worth of note:

    FRRP Press Notice 74, Equator Group y/e 31 December 1999
    The company had purchased another company, Equator Films Limited, whose principal assets were film libraries. These assets were individually revalued on acquisition, resulting in negative goodwill.

    The Press Notice quoted FRS 10 which requires intangible assets acquired as part of the acquisition of a business to be capitalised separately from purchased goodwill if their value can be measured reliably on initial recognition.

    FRS 10 requires that they should initially be recorded at fair value, subject to the constraint that, unless the assets have readily ascertainable market values, the fair values should be limited to amounts that do not create or increase negative goodwill arising on the acquisition.

    "Readily ascertainable market values" is defined in FRS 10 by reference to "a homogeneous population" and "an active market". The Panel's view was that:

  • Although the rights attaching to each film were similar, the films themselves were unique and could not, therefore, belong to a homogeneous population of assets that was equivalent in all respects; and
  • The market in which film libraries are bought and sold is not an "active market".

    The revaluation of the films to fair value at the date of purchase should have been limited to an amount that did not give rise to negative goodwill ' a view which was subsequently agreed by the directors.

    A separate issue related to the amortisation policy for intangible assets. The directors agreed with the Panel's view that film libraries should have been amortised.

    The above matters were subsequently corrected by means of a prior year adjustment.

    FRC Press Notice 68, FRRP Group on Proactivity
    Following the report of the DTI's Co-ordinating Group on Audit and Accounting Issues, the Review Panel set up a small group to help develop a pro-active element to the Panel's work and to come forward with specific proposals by the end of the year.

    The aim is to help restore confidence in accounting regulation and thus increase and maintain public and investor confidence.

    Issues to be considered by the group include:

  • Approaches to be taken in selecting company accounts for review;
  • How reviews of accounts might be carried out;
  • What follow-up action might be taken on the reviews that have identified areas of uncertainty.

    It has also been suggested that the Panel should carry out some reviews of company accounts on a sample basis in order to illustrate the implications of any recommendations.

    Audit issues

    Auditing Practices Board ' review of activities - The Auditing Practices Board (APB), a subsidiary of the Accountancy Foundation, was established in April 2002. The "new" APB replaces the previous APB which operated from 1991 to March 2002 under the control of CCAB, the Consultative Committee of Accountancy Bodies.

    The APB's aim is to:

  • Establish high standards of auditing;
  • Meet the developing needs of users of financial information;
  • Ensure public confidence in the auditing process.
    Following the issues associated with Enron, the three main areas of concern are:
  • Financial reporting;
  • Corporate governance;
  • Audit quality.

    On 3 September 2002, APB published a Consultation Paper setting out for comment a summary of its priorities and future work programme for the rest of 2002, as well as 2003 and 2004.

    The International Auditing and Assurance Standards Board (IAASB) - In December 2000, the association of European accountancy bodies, FEE (Federation des Experts Comptables Europeens), recommended that: "By 2005 national auditing standards in the European Union should require auditors of financial statements to:

  • perform audit procedures that comply with International Standards on Auditing (ISAs);
  • report on financial statements in accordance with ISAs; and
  • perform additional audit procedures and report on additional matters in response to specific legal, regulatory or other needs established at a national level".

    APB proposals for adoption of ISAs - The Consultation Paper states that "the likelihood that the ISAs will be adopted by the UK and Republic of Ireland for 2005 audits will have profound impact on APB's work over the next three years'"

    APB aims to adopt ISAs in their entirety on 1 January 2005 (rather than phase them in). As part of the preparations, the APB proposes to:

  • Assist IAASB in its planned revisions to ISAs especially those related to the audit risk model, fraud and aggressive earnings management (materiality and accounting estimates);
  • Prepare a document setting out the main changes to UK and Irish auditing standards resulting from the adoption of ISAs in 2005;
  • Consider what additional standards or guidance, if any, will be needed by UK and Irish auditors in 2005 to supplement ISAs.

    The nature and extent of supplementary standards to be issued by the APB will be influenced by the progress that IAASB has made in incorporating in ISAs those matters where UK standards are in advance of international standards, and additional requirements that may be deemed appropriate in the light of recent experience.

    The APB expects to consult on the need for supplementary standards when it becomes clearer what progress IAASB will have made by 2005.

    APB "igher priority topics"
    The APB has identified the following 'Higher priority topics':

    Aggressive earnings management - The previous APB issued a Consultation Paper in June 2001. Following Enron and related developments, APB regards continuing work in this area as a high priority.

    Apart from monitoring actions proposed by bodies such as ASB, DTI and FSA, APB plans to:

  • Update, in conjunction with IAASB, auditing standards on fraud, materiality and the audit of accounting estimates;
  • Emphasise the importance of the Auditor's Code by updating it and embedding it in a revised statement of the scope and authority of APB pronouncements;
  • Review the impact of its new standard on communications with those charged with corporate governance (SAS 610) and issue guidance for audit committees on the implications of SAS 610;
  • Review other standards, including those relating to related parties and quality control, and assess whether they are sufficiently robust; and
  • Urge the accountancy bodies and accounting firms to give increased emphasis to the need for professional scepticism and to underpin auditing standards with post-qualification training.

    Business empires - This phrase was used in a DTI Inspectors Report published in March 2001 regarding the affairs of Mirror Group Newspapers plc.

    One recommendation from that report was: "We have expressed the view that the auditors would have been able to obtain a somewhat clearer picture if there had been one partner with an overview of the 'empire'. There are and will doubtless continue to be similar 'empires' subject to the effective control of one person, but where it is difficult to have a clear understanding of the overall financial position at a point in time. Such understanding is essential in circumstances such as where there is inter-company trading or financial dependence by companies within the 'empire' on each other or on common sources of funding. In our opinion, auditors should be alert to the pitfalls in acting for such 'empires' and be given guidance in the conduct of such audits."

    APB will raise its concerns with ASB and IASB regarding accounting and disclosure requirements on related party transactions and review SAS 460. APB will also consider the impact of this issue on other auditing standards.

    Developing further Statements of Investment Circular Reporting Standards (SIRs) - APB plans to develop standards or guidance for reporting accountants.

    Responding to changes in legislation - In response to the DTI's company law review, the APB will develop standards and/or guidance for the auditors' review of the Operating and Financial Review (OFR) when legislation is enacted.

    Money laundering - From the summer of 2003, it appears that auditors will have a whistle-blowing responsibility in relation to any crime they suspect a company of having committed. APB will monitor developments and consider whether changes to SAS 120 (Consideration of laws and regulations) or additional guidance is needed.

    Stakeholder pensions - Under the Stakeholder Pensions Regulations 2000, a "reporting accountant" is required to report on the scheme manager's annual declaration. APB expects to be able to issue guidance in the form of a Bulletin later in 2002.

    Directors' remuneration report - APB has issued guidance in the form of Bulletin 2002/2.

    Updating guidance on the audit of regulated industries - A number of Practice Notes were issued in December 2001 covering banks, building societies, insurance companies and investment businesses. Financial Services Practice Notes would need to be updated when a number of FSA initiatives have been finalised. Updates may be expected in 2005 at the earliest.

    A number of lower priority topics are discussed in detail in the APB Paper. For the full range of issues, consult the APB website.

    Assurance engagements - The APB has indicated that it would welcome views as to whether there are existing assurance engagements for which standards and/or guidance are currently needed as a priority.

    The following are suggested as possible areas for work:

  • High level 'umbrella' standards regarding assurance engagements;
  • Review engagements;
  • Reporting on internal control;
  • Environmental and sustainability reporting.

    Internal audit - The APB does not believe that its remit should include internal audit on the grounds that it is for the management of individual companies to decide whether they should have internal audit, and, if so, what its scope and method of operation should be and what standards should apply to it. The guidance issued in 1990 by the former Auditing Practices Committee has not been adopted by APB.

    This Solomon Hare circular provides an overview of the topic. Therefore no responsibility is accepted for any loss arising as a result of any person relying on this summary. Specific advice should be sought before proceeding with any proposed action. For more details of the firm's technical services and seminars, visit the Solomon Hare website.

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