The historical development of accounting standards - part 5
| by Steve Lawrence
01 Aug 2000
This is the final article in the current series covering the history of particular UK accounting standards. This concluding piece considers the development of accounting for fixed assets. There are several accounting standards which regulate the recognition, valuation and disclosure of fixed assets but this article concentrates on the historical developments leading to FRS 15 Tangible Fixed Assets (with special reference to SSAP 12 Accounting for Depreciation and SSAP 19 Accounting for Investment Properties and FRS 10 Goodwill and Intangible Assets (with special reference to SSAP 22 Accounting for Goodwill and SSAP 13 Accounting for Research and Development). Consideration will also be given to FRS 11 Impairment of Fixed Assets and Goodwill.
It is somewhat surprising that it has taken so long to develop standards of accounting principles and practices for something as fundamental as fixed assets. These developments are particularly important because of the Accounting Standards Board’s (ASB) Statement of Principles (SOP) emphasis on a balance sheet approach to financial reporting focusing on assets (and liabilities) and because fixed assets are often the most significant part of an entity’s balance sheet. One would assume that such a fundamental element of financial accounting would have been the subject of a specific accounting standard early on in the standard setting process but this was not the case. It has taken nearly three decades to develop a ‘set’ of standards covering accounting for fixed assets and, as we will see, the progress has not always been smooth nor rapid.
Tangible fixed assetsOur review of the history of accounting for tangible fixed assets starts not with their recognition and valuation, but with their depreciation! The first pronouncement in this area was ED 15 Accounting for Depreciation published in early 1975. This was followed by the original SSAP 12 of the same title in December 1977. The length of time between the ED and the SSAP is quite surprising because the standard is a fairly simple document with only one really contentious requirement — ALL buildings should be depreciated using the same criteria as for other fixed assets (with the exception of freehold land). This presented a problem to many companies but in particular to property companies. Such companies hold fixed asset properties for their investment potential rather than for use and consumption in the company’s business. Initially property companies were allowed a 12 month ‘stay of execution’ in which they could ‘explain’ why depreciation should not be charged on investment properties.
One typical example of the views held by the property companies at the time is given by the chairman of Trafford Park Estates Limited. He stated in his review of the accounts for the year ended 30 June 1978 that “The depreciated value of properties would not show a true picture as in times of inflation values increase and also values vary with every change in interest rates.” The company’s failure to comply with SSAP 12 was not even considered worthy of comment by the auditors.
The 12 month consultation period proved to be hopelessly inadequate and the implementation date was put back until 1 January 1980 (the original SSAP 12 applied in normal cases to periods starting on or after 1 January 1978).
The pressure from the property companies ‘paid off’ because in November 1981 the ASC published SSAP 19 Accounting for Investment Properties exempting such fixed assets from the provisions of SSAP 12. The ASC conceded to the arguments put forward by the property industry representatives agreeing that investment properties were a special case. The change in the ASC’s position is clearly seen in Paragraph 2 of SSAP 19 which states:
A different treatment is required where a significant proportion of the fixed assets of an enterprise is held not for consumption in the business operations but as investments, the disposal of which would not materially affect any manufacturing or trading operations of the enterprise. In such a case the current value of these investments, and changes in that current value, are of prime importance rather than a calculation of systematic annual depreciation. Consequently, for the proper appreciation of the financial position, a different accounting treatment is considered appropriate for fixed assets held as investments.
As a result of this alternative accounting treatment SSAP 12 was amended in November 1981 to incorporate the exemption afforded by the new standard. SSAP 19 has remained largely unchanged for nearly 20 years with only a minor adjustment in 1994 to bring the standard into line with the requirements of FRS 3 Reporting Financial Performance. This amendment was in relation to reserve movements (on revalued investment properties) being usually disclosed in the Statement of Total Recognised Gains and Losses.
However, experience in the early 1980s after the issue of SSAP 12 highlighted certain practical problems with the depreciation of fixed assets that were not specifically addressed in the standard. More importantly companies began to adopt certain ‘creative accounting’ practices that were not considered in the original standard. It soon became very clear that amendments needed to be made and the first step to develop a more robust depreciation standard was taken in December1982 with the issue of a discussion paper. The following are the discussion points of this paper and give a very good indication of the problems encountered with SSAP 12:
This discussion paper was followed by a Statement of Intent (SOI) in 1984 and ED 37 Accounting for Depreciation in March 1985. The major developments in ED 37 incorporated in the revised SSAP 12 (issued January 1987) were:
So throughout the 1970s and 1980s there was no professional pronouncement on accounting for tangible fixed assets other than how to eliminate through depreciation! The ASC in its final period did however try to rectify this obvious shortcoming. In May 1990 the Committee issued ED 51Accounting for Fixed Assets and Revaluations. This was an important development and effectively set the tone for the current accounting standard, FRS 15. ED 51 made some fundamental proposals to change accounting practice in several areas including:
Unfortunately ED 51 was not developed by the new standard setting body (ASB) and accounting for tangible fixed assets continued to be an area unregulated by an accounting standard. Accounting practices were allowed to evolve mostly unchecked, including the practice of not depreciating assets because either, the residual value was expected to exceed the carrying value, and/or, regular maintenance ensured that the life of the asset was considered to be infinite.
This position could not be allowed to continue and in 1996 the ASB issued a discussion paper Measurement of Tangible Fixed Assets. This paper contained proposals covering:
This discussion paper was followed by the issue of FRED 17 Measurement of Tangible Fixed Assets in October 1997. The provisions of the FRED closely followed those of the discussion paper with one significant new proposal — Deathbed Valuations. Under this proposal all assets would be revalued to disposal proceeds immediately prior to disposal. Thus all profits (on disposal) would have been treated as holding gains and be reported in the Statement of Total Recognised Gains and Losses. Fortunately this was not included in the final standard, FRS 15 Tangible Fixed Assets. Other changes to the ED were that Investment Properties to continue to be covered by SSAP 19 and the introduction of a compulsory impairment review for assets with an economic life exceeding 50 years. The FRS continued with the basic objectives of trying to ensure:
Thus FRS 15 sets out the principles for the initial measurement, valuation and depreciation of tangible fixed assets. However, the impairment of fixed assets is covered by FRS 11 and we shall turn to this aspect of accounting for fixed assets after reviewing the historical development of accounting for intangible fixed assets.
Intangible fixed assets (and goodwill)The development of the standards covering intangible fixed assets starts in February 1975 with the publication of ED 14 Accounting for Research and Development, which was followed in October 1977 by the original SSAP 13 of the same name.
This standard established the differentiation between research (both pure and applied) expenditure which was to be expensed as incurred, and development expenditure which can be deferred if certain criteria are met. There were however continuing problems with determining exactly what expenditure should be classified as costs incurred on research and development activities. In addition there was dissatisfaction with the standard’s disclosure requirements. In order to improve the information about R & D and provide more guidance on how to distinguish R & D expenditure the ASC reviewed the original SSAP 13. This review resulted in the publication of ED 41 in June 1987.
The ED made minor adjustments to the basic definitions and gave a number of specific examples of expenditure likely to be included in R & D, and a similar list of expenditure normally excluded. The main change however, was the new requirement to disclose ‘The total amount of R & D expenditure charged in the profit and loss account, analysed between the current year’s expenditure and amounts from deferred expenditure’. These changes were incorporated in the revised SSAP 13 issued in January 1989 and brought the UK standard into line with IAS 9 Accounting for Research and Development Activities. These revisions were considered important to the need to encourage investors to take a longer term view of a company’s performance.
The other significant development by the ASC in the standardisation of accounting for fixed assets was the issue of pronouncements relating to accounting for goodwill. Although not treated as an intangible fixed asset in FRS 10 it is included under that heading in the 1985 Companies Act Balance Sheet Formats and should therefore be included in any discussion on accounting for intangibles.
In June 1980 the ASC published Accounting for Goodwill: A Discussion Paper. It contained a description of the possible accounting treatments of goodwill, and concluded in favour of the elimination of purchased goodwill by amortisation through the profit and loss account. There was however a dichotomy of views on the discussion paper recommendations, which reflected the varying practices at the time, and the subsequent Exposure Draft (ED 31 was issued in November 1982) recommended allowing two different methods. The options to be permitted were:
SSAP 22 Accounting for Goodwill was issued in December 1984 and while permitting both the options advocated in ED 31, selected immediate write-off as the ‘normal’ method of eliminating goodwill.
The first revision of SSAP 22 took place in 1988 with the issue of ED 44.This ED merely introduced some additional disclosure requirements in an effort to improve the overall financial reporting of business combinations. The revised SSAP 22 was issued the following year but contained only the disclosure revisions advocated in ED 44, with nothing on the major problem at the time Accounting for Brands.
The revised standard was only ever seen as a short-term solution and the ASC immediately undertook a more extensive review of accounting for goodwill, with specific reference to dealing with the ‘brands’ problem. This work resulted in more radical changes, which were originally put forward in ED 47 (Issued February 1990).
The major change was the move back to compulsory capitalisation and amortisation of purchased goodwill. The ‘about-turn’ by the ASC (See original discussion paper) was fiercely criticised, with the CBI (for example) telling the standard setters to:
take its badly thought out proposal back to the drawing board and come up with something in line with commercial reality.
This was a typical response by the business community who basically wanted things to remain as per the revised SSAP 22. One particular reason for this was the perceived advantage the standard gave to UK companies when competing for business combinations with American companies who, under US GAAP, had to capitalise and amortise goodwill in their group profit and loss accounts.
At the same time as the ASC was trying to deal with the goodwill problem, it was developing for the first time a pronouncement on accounting for intangible fixed assets. (ED 52). This ED included the following fairly controversial proposals:
Neither ED 47 nor ED 52 were developed by the ASB into full accounting standards but the new standard setting body did return to the thorny problems presented by goodwill and intangible assets in the mid-1990s.
Several working and discussion papers were issued and were finally developed into FRED 12 Goodwill and Intangible Assets. With very little amendment the full standard, FRS 10, was issued 18 months later in December 1997. This new standard now regulates accounting for goodwill and intangible assets with the capitalisation/amortisation method the norm. However, the transitional arrangements allow for goodwill previously written off to reserves to remain eliminated against such reserves until the relevant business is disposed of. Thus the old write-off method will continue to have a significant effect on financial reporting in consolidated accounts.
FRS 10 also includes provisions requiring that under certain conditions goodwill and intangible assets are to be the subject of an impairment review. It is this last area in the review of accounting for fixed assets that we now turn.
Impairment of fixed assets and goodwillInitially the 1996 ASB Discussion Paper on impairment only covered tangible fixed assets but when FRED 15 was issued the following year its scope had been extended to include intangible fixed assets and goodwill. It thus provided the necessary guidance required by FRS 10 to deal with goodwill and intangible fixed assets that were either not amortised or had an amortisation period exceeding the recommended 20 years.
The overall objective of FRED 15 was however to deal with the possible impairment of all fixed assets and the exposure draft was designed to ensure that:
These objectives are also adopted by the final standard, FRS 11 which was issued in July 1998. This standard provides detailed guidance on the writing down of assets when they are impaired (that is when the recoverable amount of the fixed asset or goodwill is below its carrying value). This will help considerably in clarifying the confusing position that has existed for many years in attempting to comply with the legal requirement to write down fixed assets for diminution in value that is regarded as permanent rather than temporary. The subjectivity involved in deciding on the permanence of a fall in value has been significantly reduced.
FRS 11 gives detailed guidance on how to determine the ‘net realisable value’ of an asset, and in determining its ‘value in use’, which are the essential elements in deciding on the recoverable amount of an asset. The standard also deals with discounted cash values and the concept of an ‘income generating unit’, and is in line with IAS 36 thus contributing to the harmonisation programme.
SummaryThe UK has developed over the last three decades a ‘set’ of standards covering accounting for fixed assets. SSAP 13 covers Research and Development, with the remainder of the set being made of more recent pronouncements, FRSs 10, 11 and 15. Together they provide detailed rules on what costs to recognise, how to deal with the asset values once recognised, and how to assess them for impairment. Overall they constitute a fairly robust framework for fixed asset accounting but one must continue to wonder:
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