Convergence of UK GAAP to IAS: Part 1
| by Steve Lawrence
25 Jul 2002
|This is the first in a series of articles on the current developments in the global
adoption of a harmonised set of accounting regulations. These developments involve
steps in the globalisation of accounting that are essential if accounting is to
continue to have an important role in the business world. ACCA stated recently
in its Review of the year 2001, It is clear that the future development
of the accountancy profession will be at a global level, with global policy makers
and with global standard setters and regulators replacing national ones.
It is important that students have knowledge of the changes that will be required to UK regulations, particularly Statements of Standard Accounting Practice (SSAP) and Financial Reporting Standards (FRS), and to International Accounting Standards (IAS) to harmonise the two sets of regulations into a single set of standards (the new International Financial Reporting Standards (IFRS)). This is the objective of the convergence project. Some of the changes will be to bring UK GAAP into line with current IAS, while other changes will be made to the IAS to bring them into line with UK GAAP. It will not be a one-way process.
We shall be comparing the principles and practices contained in particular standards (or groups of related standards) throughout this series but first it is necessary to consider the background to the convergence project and the convergence of the basic frameworks (principles) that underlie current accounting UK and International Standards.
Two sets of standards were developed which had, and still have, a considerable number of differences. Some of these differences arose because of differing constraints EU Directives in the UK, the need for a 75% majority vote from several national accounting professional bodies at the IASC and / or differing conclusions at different times on regulatory requirements. Recently the two standard setting bodies have developed joint regulations, e.g. FRS 14 and IAS 33 on Earnings Per Share, but even here there are still significant differences.
However, this situation could not be allowed to continue if accounting regulations were to continue to be applicable in a business environment that has become global. There is a need to harmonise and converge the various standards that exist in the world and we shall be reviewing the UK / IAS convergence as an example of this harmonisation process. This need has become a priority in recent years for several reasons including:
The UK Conceptual Framework is the ASB Statement of Principles (SP), published in December 1999, which is based on the IASC Framework for the Preparation and Presentation of Financial Statements (Framework), published in July 1989, which in turn is based on the US Financial Accounting Standards Boards Conceptual Framework (CF) published nearly a decade before that (but recently extended). It might therefore be expected that these CFs would be the same, but unfortunately this is not the case.
The existence of the differences between the SP and the IASC Framework is acknowledged by the ASB who have included an appendix to the SP comparing the two statements.
The principal differences which need to be eliminated as part of the convergence project, as per the ASB commentary, can be summarised as follows:
All of these differences need to be eliminated but perhaps the agreement on
the elements and their definitions should be given priority. Failure to agree
on such fundamentals would clearly undermine the whole convergence project.
Note: Equity could be sub-classified in the balance sheet to cover ownership interests and contributions from / to owners. Both the conceptual frameworks are based primarily on the definitions of assets and liabilities but unfortunately, the definitions are not the same:
Framework - A resource controlled by the entity as a result of past events, and from which future economic benefits are expected to flow to the enterprise.
Note that only the UK definition using the phrase rights or other access clearly indicates that ownership is not required. This is very important when considering substance over form, which is discussed in the next section.
Framework - A present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.
The former appears to be a simplification of the latter but it is confusing to have such a basic item defined differently. This difference has continued into the standards; FRS 12 uses the SP definition while IAS 37 continues to use the more tortuous Framework definition, even though the two standards were supposedly produced as a joint project!
These disagreements give an indication of the amount of work that is needed if a new, converged, framework is to be developed to replace the SP and the IASC Framework. This harmonisation of the basics is however, essential to the whole convergence process and its importance should not be underestimated. This of course assumes that an internationally acceptable conceptual framework is a requirement for internationally acceptable regulations.
Having reviewed the basic conceptual frameworks, we will now proceed to review the individual regulatory standards starting with those concerned with Objectives, Substance and Accounting Policies (as per the ASB Convergence Handbook).
Objectives, Substance and accounting Policies
A comparative review of Accounting Policies indicates that there is a need to remove the option available in IAS 8 to treat adjustments relating to accounting policy changes as current period items. Only the benchmark treatment, where the adjustment is reported as an adjustment to the opening balance of retained earnings, should be retained. This will bring IAS 8 into line with the requirements of FRS 18. It will also be necessary to eliminate a similar choice in IAS 8 for adjustments relating to fundamental errors. Both of these items are clearly not related to current period performance and should not be reported as if they were. It is, however, essential that the adjustments are clearly disclosed and not hidden away in the depths of detailed notes.
Other changes to the performance statement include the removal from UK GAAP of legislation (and some of the requirements of FRS 18) that only permits realised profits to be included in the profit and loss account.
There is currently both a UK project and an international project on the development of a performance statement that will report all gains and losses for the period in a single statement, analysed into their operating, financing and other elements. This will effectively combine the profit and loss account and the statement of total recognised gains and losses in the UK, and extend the income statement content currently described in IAS 1. As a primary statement, the Reporting of Financial Performance is an essential part of the convergence project and its harmonisation will greatly enhance its usefulness to readers comparing such performance on a global scale. The importance of getting this right cannot be overstated.
IAS 1 covers the inclusion of assets and liabilities in the balance sheet, and requires that management should develop policies to ensure that the financial statements provide information that is reliable in that they reflect the economic substance of events and transactions and not merely their form. However, there is no international standard in the nature of FRS 5. This UK standard is the cornerstone of the standard setters battle against off balance sheet financing and other forms of creative accounting practice. In particular, FRS 5 gives essential guidance on transactions that include features such as:
Examples of such transactions are consignment stock, debt factoring and securitised assets, all of which present problems of recognition, derecognition and presentation. While the definitions could be developed as part of the Conceptual Framework convergence, it would seem to be essential to have a specific accounting standard, similar to FRS 5, for use by entities operating in countries with developed economies where such complex transactions arise and whose substance may not be readily apparent.
IAS 18 will need to be changed to reflect the CF focus on the balance sheet elements and should perhaps be linked, or even subsumed, in a new IFRS covering substance over form. This will enable gains on such items as sale and repurchase agreements to be covered in addition to the more obvious revenue generating activities, in a single statement.
IAS 18 gives guidance on the recognition of revenue from the sale of goods, rendering of services and interest, royalties and dividends, but the standard does not provide a basic framework that can be used consistently to address issues arising in different situations. This is one of the objectives of the current ASB Discussion Papers, Revenue recognition, and is perhaps the best way forward to an agreed international standard on this most fundamental issue. There appears to be little point in the ASB proceeding with this project unless it is an integral part of the international accounting convergence process.
Clearly this area of multi-national convergence is not going to be easy as
the following paragraph taken from IAS 18 (in the section covering Sale of Goods)
The other articles in this series will review the particular problems of converging certain accounting practices. Hopefully, then the problems of harmonising on an international scale will become more apparent.
Steve Lawrence MSc FCCA is Senior Lecturer in Accounting, University of East London.
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