The evolution of an international-based financial reporting framework for the UK has been dragging on for years. Steve Collings looks at what worries practitioners up most – the future of our FRSSE.
After eight years of consultations, debates and draft standards to create an internationally-based framework in the UK, many practitioners would just like to draw a line under this issue as soon as possible.
What we must not forget is moving UK GAAP to an international-based framework, notably the Financial Reporting Standard for Mid-Sized Entities (FRSME), is the biggest change for a generation and is not something the Accounting Standards Board (ASB) can go into lightly. Firms, large and small, need to plan for the changes and such changes come at a cost - though the costs of conversion in the proposal issued by the ASB are unrealistic.
Many critics regard full IFRS (from which FRSME is essentially derived) to be flawed, difficult to apply and cumbersome in many areas. My reply is that current UK GAAP has already converged with IFRS in many areas. Does that mean UK GAAP also suffers from flaws, difficulties in application and a cumbersome structure?
Many GAAPs have their faults and even the ASB admits UK GAAP in its current form has become over-complicated. It is evident that the UK standard-setters are reluctant to maintain it given the lack of new standards over the years; the last one to be issued was FRS 30: ‘Heritage Assets’, in June 2009.
While the ASB sifts through the latest wave of 285 responses to their proposals for the future of UK GAAP, one of the seemingly most controversial of issues surrounds the Financial Reporting Standard for Smaller Entities (FRSSE).
FRSSE has become accepted within the accounting profession because of its easy application, reduced disclosure requirements and the fact that it is a one-stop shop. At lectures to professional accountants and from comments on AccountingWEB, I can see just how protective we have become over the FRSSE.
Since FRSSE was introduced in 1997 it has been updated five times to take account of various changes in the full mainstream UK GAAP as well as the new Companies Act 2006. The current version of FRSSE came into effect in April 2008 and has become established for many smaller practitioner as the firm’s financial reporting bible. It is extremely easy to use, easy to read and runs in conjunction with existing UK GAAP - where a transaction or event is not covered in the FRSSE, we fall back to full mainstream standards to decipher the appropriate accounting treatment.
To recap, the ASB’s current framework proposals suggest a three-tier approach:
| |
Nature of Entity |
Accounting Regime |
Reduced Disclosures For |
| Tier 1 |
Entities that have ‘public accountability’ |
EU-adopted IFRS |
Qualifying subsidiaries |
| Tier 2 |
Entities without public accountability & Small publicly accountable entities that are prudentially regulated |
Financial Reporting Standard for Mid-Sized Entities |
Qualifying subsidiaries |
| Tier 3 |
Small entities without public accountability |
FRSSE |
|
So, under the three-tier approach, we retain FRSSE - I hear lots of accountants breathing sighs of relief.
Of course (and slightly digressing for a moment), the words “public accountability” really could do with being defined in UK legislation because there is the problem of smaller pension schemes and Employee Benefit Trusts (EBTs). Tier 1 of the proposals currently include ALL pension schemes. Consider a small pension scheme with little public interest which only has a few members. These schemes, under the existing proposals would fall into Tier 1, thus having to apply full EU-adopted IFRS – is this really necessary? I am sure I am not alone by saying, definitely not. Smaller schemes have little public interest and in reality are used by companies which would fall into Tiers 2 or 3 under the proposals and whilst such schemes are governed under a SORP, the current SORP may possibly be more appropriate for such schemes.
Arguments against FRSSE
Many critics of FRSSE have suggested that the ASB’ objective in switching to an international-based GAAP should be to improve financial reporting in the UK and to reduce the number of reporting tiers (ie operate two instead of three).
The fact that FRSSE would be based on a redundant framework (current UK GAAP), should the proposals be implemented in the UK, have been addressed to a certain extent by allowing retention of existing accounting policies. Going forward the proposal is that companies would refer to the FRSME, post transition, for additional guidance.
Some critics of the three-tier option argue that applying a two-tier system and dispensing with FRSSE (therefore FRSME applying to smaller companies as well) would be more coherent and less expensive.
Furthermore, FRSSE is completely inconsistent in some fundamental areas to the proposed FRSME. For example, there is no option to revalue tangible fixed assets in FRSME. FRSSE allows this option and so does full EU-adopted IFRS. In addition, FRSSE also permits capitalisation of borrowing costs where relevant criteria are met (this is particularly more common with housing associations). Companies applying FRSME will not be able to capitalise such costs, but EU-adopted IFRS requires it, so there are some quite fundamental inconsistencies between the proposals and current FRSSE.
Borderline companies may also face problems. Companies that cease to become small when they no longer comply with the prescribed criteria will move into tier 2 and report under FRSME. In harder economic conditions such as those we are experiencing now, it is more likely that a business could could fall back into the “small” category. Switching to full EU-adopted IFRS is a one-way step - you cannot go back to UK GAAP should things not work out.
The alternative view is to extend the FRSSE to medium-sized companies, but would this help? Adding in the reporting requirements medium-sized companies must meet would over-complicate FRSSE to the detriment of smaller entities and the practitioners who look after them. Extending FRSSE to medium-sized entities may also discourage many companies from adopting FRSME, in which the ASB has invested so much time and expense.
Arguments for FRSSE
Many smaller practitioners who find FRSSE works well for them and their clients probably think, “If it ain’t broke, don’t fix it!”
My own work in practice and lecturing to accountants has convinced me that dispensing with FRSSE in its entirety and moving everybody in a Big Bang to a two-tier system would be detrimental – especially to practitioners who may have hidden their heads in the sand about such proposals.
At one recent lecture, a practitioner in the audience commented that they would be forced into early retirement if the ASB dispensed with FRSSE. Having to get to grips with a new GAAP for all their small business clients would far outweigh the theoreitical benefits. I am very much doubtful this is an isolated concern.
I do, however, have concerns that some of FRSSE’s current recognition and measurement criteria, particularly with regard to fixed assets, are significantly different than the proposed standard for tier 2 companies. For example, a housing association reporting under FRSSE which builds its own plot of houses may capitalise borrowing costs in accordance with paragraph 6.20 FRSSE (effective April 2008). A similar housing association reporting under FRSME would have to expense borrowing costs, resulting in a distortion in accounting treatment for similar items.
Many commentators have suggested that the ASB perhaps issues a FRSSE based on FRSME – in other words to align FRSSE to FRSME. Given the EU’s proposal to exempt “micro entities” from current financial reporting requirements, the ASB rightly decided to wait and see what happens before making any decisions on FRSSE’s future. This announcement is expected next month (June).
In any instance, the ASB indicated that FRSSE will remain for a time after the introduction of the proposed FRSME and its future will be subject to further consultation. This, I feel, is the best way forward in the short term.
Conclusion
The ASB Board meets today (Thursday 26 May 2011) to consider the responses to its UK framework proposals and to decide what it will do next. After hanging in suspense for so long, what we need at this stage is a “this is the way we are going” decision so firms can plan for any necessary changes. Changes such as these come at a cost and these will have a crucial bearing on those of us working in everyday public practice.
I suspect FRSSE will be with us for the foreseeable future. Indeed it will help firms and their clients for the effects of FRSME to be seen in larger companies first before either dispensing with it in its entirety or modelling FRSSE on FRSME itself. This may offer added comfort to smaller practitioners terrified at the thought of applying an international-based framework.
Steve Collings is the audit and technical partner at Leavitt Walmsley Associates and the author of the ‘The Interpretation and Application of International Standards on Auditing’ (Wiley 2011) and ‘The AccountingWEB.co.uk Guide to IFRS’ (£15 eBook, Sift Media 2011). He also lectures on financial reporting and auditing issues.
