Comparatie Ias - Ukgaap-Us Gaap

Global accounting
Global accounting UK, IAS and US compared
UK, IAS and US compared
9557
Global Assurance
KPMG
is
the
professional
advisory
firm
w h o s e a i m i s to tu rn k n ow l e d ge i n to va l u e for the benefit of its clients, its people and i t s c o m m u n i t i e s . W i t h m o re t h a n 10 0 , 0 0 0 p e o p l e c o l l a b o ra t i n g wo rl d - w i d e , t h e f i rm provides assurance, tax and legal and financial advisory services from more than 8 0 0 l o c a t i o n s i n 1 6 0 c o u n t ri e s . Fo r f u rt h e r i n fo rm a t i o n a b o u t o u r s e r v i c e s please speak to your usual contact or call a ny o f o u r o ff i c e s . h t t p : / / w w w. k p m g . c o m
Global accounting
UK, IAS and US compared
Contents
1. 2. 3. Executive summary .............................................................................................. Introduction........................................................................................................... Regulatory background ........................................................................................ 3.1 Generally accepted accounting principles ................................................. 3.2 Legal and listing requirements ................................................................... Financial statement requirements ...................................................................... 4.1 Form of the financial statements ................................................................ 4.2 Comparatives................................................................................................ 4.3 Audit reports ................................................................................................. 4.4 Accompanying financial and other information........................................ General issues....................................................................................................... 5.1 Classification and presentation within the financial statements ............. 5.2 Prior period adjustments and other accounting changes ........................ 5.3 Statement of cash flows .............................................................................. 5.4 Basis of accounting ...................................................................................... 5.5 Reporting the substance of transactions.................................................... 5.6 Consolidation................................................................................................ 5.7 Business combinations ................................................................................ 5.8 Foreign currency translation ....................................................................... 5.9 Hedging ......................................................................................................... 5.10 Interim financial reporting ........................................................................... Specific balance sheet items ............................................................................... 6.1 Intangible assets........................................................................................... 6.2 Fixed tangible assets.................................................................................... 6.3 Capitalisation of interest.............................................................................. 6.4 Impairment of fixed assets other than investments ................................. 6.5 Investments in associates and joint ventures............................................ 6.6 Other investments and financial instruments............................................ 6.7 Stock .............................................................................................................. 6.8 Debt instruments .......................................................................................... 6.9 Leases............................................................................................................ 6.10 Product financing arrangements................................................................. 6.11 Tax provisions............................................................................................... 6.12 Other provisions ........................................................................................... 6.13 Contingencies ............................................................................................... 6.14 Capital & reserves, or shareholders funds ............................................... Specific profit and loss account items ............................................................... 7.1 Revenue......................................................................................................... 7.2 Advertising costs .......................................................................................... 7.3 Non-monetary transactions......................................................................... 7.4 Holiday pay ................................................................................................... 7.5 Pensions and other post-retirement benefits ............................................ 7.6 Other post-employment benefits................................................................ 7.7 Other long-term employee benefits ........................................................... 7.8 Employee share purchase and option schemes ........................................ 7.9 Exceptional items ......................................................................................... 7.10 Sale or termination of an operation & discontinued operations ............. 7.11 Sales of property .......................................................................................... 7.12 Imputation of an interest cost ..................................................................... 1 8 10 10 11 14 14 15 15 16 18 18 22 24 27 29 33 36 46 51 58 60 60 66 69 71 76 80 87 88 93 96 97 103 108 111 116 116 118 119 120 121 126 128 129 134 136 139 141
4.
5.
6.
This book has been prepared to assist clients and others in understanding the differences of principle between accounting standards and the accounting requirements of company law in the United Kingdom, generally accepted accounting principles in the United States and accounting standards and other pronouncements of the International Accounting Standards Committee. Whilst care has been taken in its preparation, reference to the standards, statutes and other authoritative material should be made, and specific advice sought, in respect of any particular transaction. No responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication can be accepted by any member of KPMG International. 7. ISBN 1 85061 2560 2000 KPMG International, a Swiss association. All rights reserved. Printed in the Netherlands. KPMG and the KPMG logo are trademarks of KPMG International. No part of this publication may be reproduced, stored in any retrieval system or transmitted in any form by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of the publisher. Designed and produced by Mattmo concept & design, Amsterdam. Printed by Drukkerij Dombosch, Raamsdonklsveer
1. Executive summary
8. 7.13 Extraordinary items...................................................................................... 7.14 Dividends ...................................................................................................... 7.15 Earnings per share (EPS) ............................................................................. Specific major disclosure items .......................................................................... 8.1 Segmental reporting .................................................................................... 8.2 Disclosures about financial instruments .................................................... 8.3 Related party transactions .......................................................................... 142 143 144 148 148 151 158
Introduction
Despite having a great deal of common purpose and common concepts, the accounting principles in the UK and the US and under International Accounting Standards (IASs) can lead to markedly different financial statements. This is not merely of academic interest. In the global market for capital, the differences need to be understood and, eventually, eliminated. This book examines, but not exhaustively, those areas of UK, IAS and US requirements most frequently encountered where principles, or their application, differ.
Appendices I Common differences in accounting terminology...................................... II Common accounting abbreviations ...........................................................
160 164
Regulatory background
The overriding requirements for a UK companys financial statements is that they give a true and fair view. Accounting standards are an authoritative source as to what is and is not a true and fair view, but do not define it unequivocally. Ad hoc adaptations to specific circumstances may be required. Moreover, if, rarely, following the requirements of standards would fail to give a true and fair view, those requirements must be departed from to the extent necessary to give a true and fair view. Under IAS the situation is very similar. In the US however, financial statements are more closely tied into the rule-book by the requirement that they be prepared in accordance with GAAP.
General issues
Substance The true and fair approach is typified by the UK standard that requires transactions to be accounted for in accordance with their substance. Whilst the real targets of this requirement were the (now defunct) off balance sheet finance schemes, it is significant that the way in which this has been achieved is by a highly conceptual standard. Assets and liabilities are defined and attention is directed toward analysing probable changes in benefits, risks and obligations in order to determine the substance - the so called risk-and-rewards approach. In contrast, the US deals with similar issues by detailed prescription for each type of transaction, eg leasing, product financing, sale of properties or transfers of financial assets and those prescriptions do not necessarily follow a risks-and-rewards approach, for example transfers of financial assets are on the so-called financial components basis (see below). As a general principle IASs follow the risk-and-rewards approach but have rather less guidance as to how this might be carried out; and in the case of transfers of financial assets they follow the American components approach. Revaluation Having established that an asset exists, the IAS and British bases of measurement can be fundamentally different from that of America. In Britain and under IASs certain classes of assets, principally but not solely property, may be revalued provided that this is done consistently and the valuations are kept up to date. In America the historical basis must be retained (aside from certain financial instruments). Business combinations Business combinations are often a source of accounting issues. A few, important differences remain between the three GAAPs. Both IAS and the UK include a size test in their uniting/ pooling-of-interests (merger) criteria; the US does not. As a result, pooling-of-interests accounting is comparatively common in the US but not in the UK or under IAS. When
acquisition accounting applies the UK requires any restructuring of the acquired entity to be charged in the post-acquisition profit and loss account. Under IAS and US requirements some such restructurings may increase the goodwill. In addition, where the fair value of the acquired assets and liabilities is greater than the price paid - negative goodwill - the US rules require the non-current asset fair values to be reduced to eliminate the difference and thereafter a deferred credit arises for any remaining difference and is amortised over up to 40 years. The UK records negative goodwill as a separately disclosed deduction from positive goodwill and amortises it in line with depreciation and sale of the acquired non-monetary assets. Any remainder is taken to the profit and loss account in the periods expected to benefit. The IAS approach involves a similar presentation but the release to the profit and loss account is as follows: first, to match any costs that it has been identified with; then to match and to the extent of the depreciation of acquired non-monetary assets; and any balance thereafter is taken immediately to income. Foreign currency translation The translation of foreign currency financial statements of foreign operations throw up some important differences. All use the closing rate/ net investment method but in the UK the profit and loss account may be translated at either the average or the closing rate. Some companies do choose the latter. Under IASs and in the US the actual, or an average rate, must be used. Moreover, under IASs it is a matter of choice as to whether to include capitalised goodwill and fair value adjustments as part of the retranslated net investment, whereas in the UK and US they are always included. Lastly, under IASs and US GAAP the cumulative translation adjustment on a net investment is recycled through the profit and loss account on disposal of the net investment. In the UK there is no recycling. Hedging Both IASs and US GAAP have comprehensive standards on hedging; the UK does not. Some of the differences in approach here are typified by the case of a hedge of a future transaction, which can be either a contracted future transaction or a forecast one. In the UK the hedge would usually be held off balance sheet until the transaction occurs, the transaction then being stated on the hedged basis. Under IASs the cash flow hedging model is applied to this hedge: the hedge is stated at fair value with the resulting adjustment, so far as it is an effective hedge, taken directly to equity; it is held there until the transaction occurs when it is then recycled out to adjust the transaction (either affecting the profit and loss account immediately or adjusting the cost of the purchased asset as appropriate). The US uses the cash flow hedging model for hedges of forecast transactions; however, the gains and losses initially taken to equity are not recycled into the cost of the hedged purchased asset (if that is the case) but are instead recycled into the profit and loss account to match the cost of the asset as it flows through, eg as it is depreciated. Where the future transaction is a contracted one the US uses the fair value model: the hedge is stated at fair value with the resulting adjustment flowing through the profit and loss account; the hedged item, in this case the contract, is stated at fair value to the extent hedged with the resulting adjustment flowing through the profit and loss account. (IASs also use the fair value model for some hedges.) Cash flow The statement of cash flows of a British company is markedly different. It is based on pure cash - cash deposits and overdrafts both of which are repayable on demand. Both the IAS and US GAAP statements are based not only on cash but also on cash equivalents, ie short-term highly liquid investments. In addition, the US excludes overdrafts and IASs may in some cases include them.
Specific balance sheet items

Intangibles For many years perhaps the most significant differences between the three approaches lay in the area of intangibles. In the US, the long standing treatment of (positive) goodwill is the same as for any other acquired intangible. Such assets must be capitalised and subsequently amortised over their expected useful lives which may not exceed 40 years (although there are some proposals to modify this). Before 1998 in the UK and before 1995 under IASs, (positive) goodwill could be written off directly to shareholders funds and usually was. This has now changed and (positive) goodwill must be capitalised in both regimes. However, it should not be overlooked that both sets of transitional rules permit the old goodwill to remain in shareholders funds. A new set of differences now arises in respect of amortisation of (positive) goodwill and intangibles. Under IASs the life is usually limited to 20 years but this may be rebutted and a longer, but finite period may be used. In such a case annual impairment testing of the (positive) goodwill or intangible is required. The UK approach is very similar save that it is permitted for the life even to be indefinite. In addition, the US rules prohibit the carrying of development costs as an asset. In the UK they may, at the companys option, be carried as an asset if certain conditions are satisfied. Under IASs they must be carried as an asset, again if certain conditions are met. Fixed tangible assets (property, plant and equipment) As mentioned above, this is the principal category of assets subject to optional revaluation in Britain and under IASs. However, in Britain one category of asset - investment properties - must be revalued. Moreover, these investment properties must not be depreciated because of their special purpose. IASs take a different approach to investment properties. From 2001 they need not be depreciated, in which case they must instead be stated at market value with changes therein flowing through the profit and loss account. In the US all property other than land must be depreciated but not be revalued. The US also requires interest to be capitalised during the period of an assets being made ready for use. Under IASs and in the UK this is optional. Impairment The existence of an impairment is judged differently by the US on the one hand and the UK and IASs on the other. The US considers that an asset is impaired only if its book value exceeds the undiscounted cash flows expected to be obtained from its use. If that is the case then it is written down to its fair value, which may be the present value of those cash flows (if fair value cannot be determined in other ways). Under both IAS and UK principles recognition and measurement are consistent: an impairment occurs when and to the extent that the book value exceeds the higher of the net realisable value and the present value of the cash flows expected to arise from the continued use of the asset. The US does not permit any subsequent reversal of the impairment. Both IASs and the UK do permit reversal but in respect of goodwill (IAS) and goodwill and intangibles (UK). There are some restrictions on this. Associates and joint ventures Under US GAAP there is no accounting distinction between associates and joint ventures: both are equity accounted. Under IASs certain types of joint venture may, optionally, be proportionately consolidated. In the UK joint ventures may not be proportionately consolidated,
although the equity accounting is expanded somewhat to give a similar effect in the profit and loss account. It is also worth noting that the US and IASs presume a 20% investee to be an associate whereas the UK has no such presumption but more closely defines significant influence. In addition, IASs distinguish between types of joint venture on the basis of legal form, whereas the UK uses substance. Financial instruments Comprehensive standards in this area are a recent innovation. IASs and US GAAP have them; the UK does not. The IAS and US standards are very similar. They have three different treatments for financial instruments (other than hedges, for which see above). One is amortised cost. This is reserved firstly for a very restricted class of assets for which there is the positive intention and ability to hold it to maturity. It also applies under IAS to any loan or receivable originated by the company, or in the US to any non-marketable equity securities and any debts that are not securities. Next, any financial instrument (IAS) or security (US) held for trading purposes, and all derivatives other than those held as certain hedges, are stated at fair value with the resulting adjustments taken to the profit and loss account. Lastly, any asset (US a security) not fitting in the other categories is known as available-for-sale. These are stated at fair value also. In the US the fair value adjustments are taken to shareholders funds (through other comprehensive income) and are recycled into the profit and loss account when the item is sold. Under IASs a company may choose to use the US treatment for the fair value adjustments or to take them immediately to the profit and loss account. In the UK market-makers, for example, mark their financial instruments to market through the profit and loss account but otherwise investments are usually held at amortised cost. Investments may be revalued but the resulting adjustment goes directly to shareholders funds and is not recycled. The UK does, however, have a standard dealing with transfers of financial assets. An asset is derecognised on a substance basis, ie only if all significant risks and rewards of the assets are transferred. If credit risk is retained then the asset remains on the balance sheet. Under the US and IAS financial components approach, however, a credit risk component would be retained to portray the credit risk but the rest of the asset would be taken off the balance sheet. Stock (inventory) In Britain the LIFO method of establishing the cost of stock would rarely be appropriate; in America and under IASs it is acceptable. Debt Where a companys own shares contain an obligation, as for example some preference shares do, IASs classify them as debt. In the UK they would be classed as shareholders funds, albeit the non-equity element thereof. Under US GAAP there is mezzanine level shown separately from both debt and shareholders funds; preference shares whose redemption is not controlled by the company are reported at this level. Where an instrument contains both debt and equity-share characteristics, for example convertible debt, IASs split the two elements and report them as debt and shareholders funds respectively. In the UK and US this is only done if the equity element is actually separable. There are also differing treatments for the maturity classification of debt. Under IASs and US GAAP a short-term debt can be reclassified as long-term on the basis of a post-balance sheet long-term refinancing. This is not possible in the UK. The US rules provide copious guidance on the extinguishment of debt and in many cases any
gain or loss is required to be treated as an extraordinary item. The IAS guidance is somewhat more brief, and the UK guidance very much so, but for all practical purposes neither permits classification as extraordinary. Deferred tax Under UK principles deferred tax is provided in respect of timing differences - differences between the timing of inclusion of items in accounting and in taxable profit. The IAS and US provisions are in respect of the rather different, wider concept of temporary differences. These are the differences between the balance sheet carrying amounts of assets and liabilities and those carried in the tax computation. The purpose is to provide for the tax arising on the recovery of each asset (or settlement of each liability) at book value whether that recovery is through use, realisation or whatever. Furthermore, in the US and under IAS, provision is made in full for all liabilities (and for assets but subject to a recoverability test). In the UK the provision is only for that element of the full potential liability that will probably crystallise. In determining this partial provision, account is taken of the effect of future transactions (eg, capital expenditure) on the deferral, perhaps indefinitely, of crystallisation of the tax relating to past timing differences. However, the UKs partial provision approach looks set to change towards full provision. Other provisions The UK and IASC standards on provisions are virtually identical, as IASC based its standard on the UK one. They provide comprehensive frameworks for provisions, whereas the US does not. One of the main UK and IASC principles is that all restructuring costs are provided on the basis only of a commitment resulting from some form of external action; the same applies in the US as regards redundancy costs, but other costs are still provided on a decision-basis. On the other hand, the US prohibits provision for voluntary redundancies until an employee has accepted the invitation. Under UK and IAS standards provision is made for the expected take up once the terms have been announced. Decommissioning costs are another specific area of difference. In the UK and under IAS the cost of necessary decommissioning of a plant or facility is made, on a discounted basis, when the plant is constructed and is charged as part of its cost (and then depreciated). In practice in the US such costs are usually spread over the plants life on an undiscounted basis. A further specific area is repairs and maintenance. The UK and IAS prohibit provision for the maintenance of own assets, but the US does not. Purchase of own shares It is a permitted, and not uncommon practice, for US companies to hold their own shares as treasury stock. Such shares are shown as a deduction from stockholders equity (shareholders funds); IASs require the same treatment. Under UK law a company cannot formally hold its own shares without cancelling them. Nevertheless companies may hold such shares in substance in connection with employee share option schemes. Such shares are shown as an asset in the balance sheet (usually a fixed asset).
Specific profit and loss account items

Defined benefit pensions and similar The current UK standard is quite different from those of the US and IAS. The UK approach could be termed actuarial: it uses valuation assumptions, for both assets and liabilities, that look to the long-term outcome. The US and IASs use current market rates for high quality corporate bonds to discount the obligation and use market values for the assets (although in the US certain
de minimis fluctuations may be ignored and some averaging of asset market values is permitted). Moreover, the US and IAS rules prescribe particular actuarial methods and assumptions. The UK standard does not. The differences may sound trivial but in the field of pensions a small change in an assumption can be magnified to a large monetary amount. In the UK all variations from the regular costs are spread over the remaining working lives of the employees. In the US there is an option not to account for any variation if it falls within certain limits known as the corridor. Under IASs any vested past service costs are booked immediately; all other variations are either spread forward if they fall outside a similar corridor, or instead any faster, systematic recognition method may be used. The cost of employee share schemes Where an employee is awarded a share option the cost to the company is based, in the UK, on the intrinsic value (the difference between the option exercise price and the shares market price) at the grant date. In the US the cost may be based either on intrinsic value at a measurement date that may be later than the grant date, or on the fair value of the option itself. (It should be noted that in both countries, if certain conditions are met, no intrinsic value-based cost at all is accrued.) IASs have no rules on share-based remuneration. Sale or termination of an operation and discontinued operations The US definition of a discontinued operation is more narrowly drawn than that of the UK; that of IASs is between the two. In addition, a major difference arises in the presentation of discontinued operations. In the US the post-tax results are presented as a single line item positioned immediately before extraordinary items. Furthermore, the assets and liabilities of the operation are presented as a single net amount in the balance sheet. In the UK the revenues, expenses, assets and liabilities remain in their normal locations in the accounts. The results of the discontinued operation are separately identified but only by analysis, on the face of the profit and loss account, of the turnover and operating profit of the whole group into continuing and discontinued elements. The assets and liabilities are not identified. The IAS requirements are similar to those of the US insofar as they require all profit and loss account items down to profit after tax, and assets and liabilities, to be attributed to discontinued operations. However, it is not clear whether the US single line item presentation is possible under IAS; and, in contrast to the UK, amounts so attributed may be given in the notes rather than on the face. So far as provisions for sales or terminations of operations are concerned the US rules require provision for a discontinued operation to be made on a decision-basis. IAS and the UK require a commitment basis, whether the sold or terminated operation is a discontinued one or not. When provision is made the UK and US approaches include certain operating losses in that provision, but under IAS they may not be included. Dividends In the UK a dividend declared after the year end, but in respect of the year just ended, is accounted for in that previous year. In the US and under IAS such a dividend would be dealt with in the year of declaration.
amounts reported internally irrespective of whether they are on the same basis as the external financial statements. (A reconciliation must, of course, be included.) Under IASs, broadly speaking, the management approach is used to identify the segments but the UK approach is used to report figures for them. In addition, under IAS the amounts disclosed include gross assets and liabilities, depreciation and cash flow information; none of these is given in the UK; in the US gross assets are required and other items may be required depending upon the internal reporting. Financial instruments All three GAAPs have plentiful disclosure requirements for financial instruments. However, there are a number of differences between them. First of all, the UK has a wide requirement to make qualitative disclosure of the objectives, policies and strategies for holding or issuing financial instruments. The SEC requirement in the US is very similar. Under IASs the equivalent disclosure is in relation only to instruments held for risk management. IASs require disclosure for all financial instruments of the terms and conditions, which may include notional principals, maturities, amount and timing of future cash payments etc. In the UK there are no general terms and conditions disclosures at all. In the US this sort of disclosure is similar to the tabular options for dealing with market risk (the other two options are sensitivity analysis and valueat-risk). Further, the US requires separate disclosure about four components of market risk: interest, currency, commodity and other market risk, such as equity price risk. The UK has requirements for interest and currency but only encourages other market price risk disclosures. IAS has specific requirements only for interest risk and otherwise other market risks are dealt with only by the general terms and conditions disclosures (which would have some similarities with the US tabular option). The UK does not require any disclosure of credit risk. On the other hand US GAAP calls for disclosure of concentrations of credit risk. IASs go further and require all credit risk, as well as all concentrations thereof, to be disclosed. Lastly on financial instruments, the UK requires disclosures about unrecognised or deferred gains and losses on all hedges other than of net investments in foreign entities. Under US GAAP and IASs the equivalent requirements apply only to cash flow hedges, which are used, for example, for hedges of future transactions whether contracted or uncontracted in the case of IAS and, for example, for hedges of forecast (eg, future uncontracted) transactions in the US. Future developments In all three GAAPs a number of areas of accounting practice are under review, although having emerged from a period of intense standard setting there is perhaps less just over the horizon than is usual. Those that are under review are quite major areas. In some instances the UK proposals would, if carried through to future standards, narrow but not eliminate some areas of difference with the US and IASs. First, it is proposed that deferred tax will remain on the timing differences basis but will move towards full provision. Second, after drawn out debate it looks as though the measurement principles for pensions will be aligned with IASs; however there will be no spreading at all - the whole change in value will go onto the balance sheet immediately but with the other entry split between the profit and loss account and the statement of total recognised gains and losses (other comprehensive income). In the US also, some of the proposals would also narrow the differences. At present it is fairly common for US business combinations to use pooling/ uniting-of-interests (merger) accounting, whereas it is comparatively rare under UK and IAS principles. The FASB proposes to prohibit the method entirely. The IASC is monitoring US developments and may re-examine this area. The FASB has also proposed that the maximum life of goodwill should be reduced to 20 years. However, other intangibles might in some cases have longer lives, even indefinite lives if there is an observable market price for the intangible.
Specific major disclosure items

Segmental reporting Rather different approaches are taken by the three for segmental reporting. In the UK segments are distinguished from one another by their differing risks and returns and the amounts reported therefor are analyses of the relevant figures as stated in the financial statements. By contrast, the US uses the management approach whereby the company is split into segments in line with the internal reporting structure, whatever that may be. Moreover, the amounts reported are the
2. Introduction
As this book rolls off the presses, the course of international accounting harmonisation has reached a defining but as yet unclosed chapter in its history. There will soon crystallise into reality the international relationship between different standards, and their standard setters, for many years to come. Before looking forward to that, the progress to date should not be overlooked. The force that drove it, and continues to do so, can be stated in three words: global capital markets. Both Britain and America have long histories of exchange traded equity investment by the public and their accounting has developed to report companies activities from this perspective. As the capital markets become increasingly global other countries that have hitherto used, say, the perspective of the tax authorities or lenders as their accounting model, have found that to participate in the market they need to adopt its perspective. At the same time globalisation demands that the various versions of that perspective come closer together, if not become replaced by a single version. Here International Accounting Standards, IASs, join the story. IASs are another version of that Anglo-Saxon model. But with the world as their constituency they have the potential to achieve more widespread acceptability than other versions. In so saying, one cannot but recognise that these three are indeed different versions of the same basic model. The apparently common language of the capital markets has marked differences when put into effect by these three proponents. Why should this be so? There are probably many factors at work. On the cultural side, the US puts the emphasis on consistency between companies and, combined with a traditionally litigious environment, this tends toward the formulation of accounting rules for almost all conceivable circumstances. In the UK and under IASs the drive has been towards a few principles (although the detailed rule approach has made a modest showing of late) and a more pragmatic approach. Moreover, the British and IAS standard setting processes started only in the 1970s - America had something like a 30 year head start. The result is that in the US there is very little scope for alternative treatments, whilst a range of detailed adaptations of the principles to specific cases is often possible in the UK. On the academic side there are the intractable accounting problems, such as deferred tax - is it really a liability and if so how much should be recognised? There are various solutions to the intractables but no one solution is without its drawbacks. The result is that different nations opt for different drawbacks just as much as they opt for different solutions. IASs are perhaps mid-Atlantic. In some areas the UK approach is favoured, for example the true and fair view and, usually, substance; in others the US approach is adopted, for example the components approach to financial asset transactions. However, the gap between the GAAPs has narrowed of late. IASs have undergone a period of overhaul, eliminating many of the optional treatments; the UK has changed to deal with some of the intractables, for example goodwill, by accepting largely the same drawbacks as others do; and in the US there has even been recognition that its standards are not the most rigorous when it comes to the availability of pooling (merger) accounting. Moreover, the standard setters in different countries have co-operated on issues such as the overhaul of earnings-per-share standards. So there is cause to hope that there might be less divergence in the use of the common concepts. Looking forward, whilst IASs have received endorsement, albeit somewhat qualified, from the International Organisation of Securities Commissions (IOSCO), significantly they await the results of a review by the US Securities and Exchange Commission that may bring about a good degree of endorsement for their use in the US by non-US registrants. And lately, new
constitutional arrangements for setting IASs have been put in place in order to improve both that process and the relationship with national standard setters and others. Where these reviews and new arrangements will in practice leave the balance between IASs and national standards, such as those of the UK and US, is difficult to predict. If US endorsement is slow in coming then IASs may be marginalised. But there might then develop a powerful IAS-bloc, perhaps centred on the European Union, including the UK, to rival the other standard setters powerbases. The European Commission is already proposing, again with some qualification, that IASs become mandatory for listed European companies. On the other hand, the IAS table might become the place where national standard setters thrash out agreed treatments to be put into their own national standards and into IASs. Or IASs might even become the single global supercode replacing national standards altogether indeed, this is the only rational long-term objective. Notwithstanding this hurly-burly, none of UK, IAS or US standards will disappear overnight. Important differences between them, and the need to cope with them, will remain for some years to come. This book describes the significant differences between accounting principles followed in the UK, under IASs and in the US. It is not a complete listing; rather it is a summary of those areas most frequently encountered where the principles differ or where there is a difference in emphasis between the three. Furthermore, it does not address accounting in specialised industries, for example banking and insurance. It looks first at the regulatory background and at general requirements and issues before turning to specific matters affecting the balance sheet, the profit and loss account and finally major disclosure matters. The comparison is effected by examining the UK principles in the left-hand column, those of IASs in the middle and those of the US on the right. As far as possible then, the requirements of the three frameworks dealing with the same circumstances are set out side-by-side. The narratives use the terminology of the UK, IASs or the US as appropriate. A table of common differences in terminology is provided in Appendix I. In addition, the narratives usually refer to the reporting entity, for the sake of convenience, as being a company. However, the terms entity, enterprise or undertaking are used where the context requires it (eg, where an entity is a quasi-subsidiary). References to the sources of the accounting requirements or practices are included in the headings or subheadings as appropriate. The key to these and other abbreviations is set out in Appendix II. US references which comprise a letter followed by a number (eg, B50 for business combinations) are to the section of the Current text (a condensed version of the requirements of the standards ordered by subject and issued by the FASB) with that same reference. The last standards which were taken into consideration in writing this book were FRS 16 (Current taxation) in the UK, IAS 40 (Investment property) and the USs SFAS 138 (Accounting for certain derivative instruments and certain hedging activities - an amendment of FASB Statement No 133); the text reflects the latest standards even though some of them are not yet mandatory. The matters referred to in this book are complex. Legislation, accounting standards and other authoritative material are, of course, subject to change. Accordingly, professional advice should be sought before acting on, or refraining from acting on, any material in this book.
2. Introduction
2. Introduction
UK
I AS
US
10
3. Regulatory background
3.1
Generally accepted accounting principles
3.1

(IAS 1, SIC 18)
3.1
The term generally accepted accounting principles has no formal meaning in the UK. The term generally accepted accounting practices (GAAP) is used informally in the UK to denote the corpus of practices forming the basis for determining what constitutes a true and fair view: that is, broadly, accounting standards and, where relevant, the accounting requirements of company law and The Listing Rules of the Financial Services Authority. Accounting standards are applicable to the accounts of a reporting entity that are intended to give a true and fair view (see 3.2 below) of its state of affairs at the balance sheet date and of its profit or loss for the financial period ending on that date. The development of such standards is overseen by the Financial Reporting Council (FRC), a body representing a wide constituency of interests. Its function is primarily to guide the Accounting Standards Board (ASB), its subsidiary body, on its work programmes and issues of public concern. The ASB does the work of developing, issuing and withdrawing accounting standards. Such standards developed and issued by the ASB are known as Financial Reporting Standards (FRSs); the standards issued by the ASBs predecessor body, and which
Under IASs there is no formal term generally accepted accounting principles (or practices), although GAAP may occasionally be used to signify the whole body of IASC authoritative literature. The sources of such accounting requirements are the International Accounting Standards (IASs) themselves and interpretations thereof made by the IASCs Standing Interpretations Committee (such pronouncements being known as SICs). When these sources do not cover a particular issue then the IASCs conceptual framework, Framework for the preparation and presentation of financial statements (the Framework), should be consulted. If that does not provide guidance then it is permitted to look to the pronouncements of other standard setting bodies (eg, the UKs ASB and the USs FASB) and to accepted industry practice, provided that conflicts with neither IASs, SICs nor the Framework. IASs sometimes include optional treatments. One is designated the Benchmark Treatment and the other is designated the Allowed Alternative Treatment. For each such choice a company should
The principal sources of generally accepted accounting principles (GAAP) are Statements of Financial Accounting Standards (SFASs) issued by the Financial Accounting Standards Board (FASB) together with Accounting Research Bulletins (ARBs) and Accounting Principles Board Opinions (APBs) which were issued by predecessor bodies of the FASB. The FASB is the designated organisation in the private sector for establishing financial accounting and reporting standards. Its board is composed entirely of full time members. It also issues Interpretations (to clarify, explain, or elaborate on existing SFASs, ARBs or APBs) and Technical Bulletins (to address issues not directly covered by existing standards). US pronouncements are issued sequentially. They are not withdrawn but may be revised or superseded by subsequent pronouncements. The FASB publishes each year the updated Original pronouncements and the Current text. The former contains the original text of all FASB pronouncements, Interpretations and Technical Bulletins presented in sequential order. The latter is a reorganised version of the Original pronouncements categorised by subject. As
have been adopted or amended by the ASB, are known as Statements of Standard Accounting Practice (SSAPs). The ASB is composed of two fulltime and eight part-time members. A committee of the ASB, known as the Urgent Issues Task Force (UITF), assists the ASB in areas where an accounting standard (or a Companies Act provision) exists, but where unsatisfactory or conflicting interpretations have developed or seem likely to develop. In these circumstances the UITF will seek a consensus as to the appropriate accounting treatment. The ASB publishes abstracts of the UITFs consensuses (known informally as UITFs) which are considered to be part of the body of practices forming the basis for determining what constitutes a true and fair view.
apply the Benchmark or Allowed Alternative consistently. IASs are developed and issued by the board of the IASC, which was hitherto composed entirely of part-time members. The board has now being reconstituted to become composed of twelve fulltime members and two part-time members, all of whom will be appointed by the trustees of an IASC, itself newly constituted as an independent foundation. SICs are developed by the Standing Interpretations Committee, a sub-committee of the IASC, and are approved by that committee and by the board. SICs are intended to give guidance in cases when IASs are unclear or silent.
pronouncements are not withdrawn nor (necessarily) revised as they are affected by subsequent publications, it is usually advisable to consult the Current text rather than the Original pronouncements. The Original pronouncements do, however, contain background information and the basis for the FASBs conclusions which may be valuable to a reader unfamiliar with the related concepts or accounting treatments. Further accounting guidance is provided by consensuses of the FASB Emerging Issues Task Force (EITF) and Statements of Position, Issues Papers and Industry Audit and Accounting Guides issued by the American Institute of Certified Public Accountants (AICPA).
3.2
Legal and listing requirements

(CA 85, UITF 7, The Listing Rules)
3.2

(IAS 1)
3.2

(Securities Act 1933, Securities Act 1934)
Significant difference
The overriding requirement is for the financial statements to give a true and fair view.
The overriding requirement is for the financial statements to give a fair presentation.
The main requirement is for (domestic companies) financial statements to be prepared in accordance with US GAAP.
The Companies Act 1985 sets out the accounting requirements for companies. The overriding requirement is for the accounts to give a true and fair view of the companys (or groups) state of affairs as at the balance sheet date and of the profit or loss for the financial period ending on that date.
There is no legal framework under which IASC standards operate. The IASC is an international foundation representing a wide constituency of interests. Its objective is to develop, in the public interest, accounting standards, promote their world-wide use and rigorous application and to
In general, only those companies which are registered with the Securities and Exchange Commission (SEC) are under any legal obligation to publish audited financial statements. Certain other companies may publish audited financial statements due to other regulatory requirements (for example
11
UK I AS US
UK
I AS
US
12
A true and fair view is not defined but for a combination of reasons, including the authorisation of the ASB to issue accounting standards under the Act, it is generally accepted as requiring compliance with applicable accounting standards - indeed the ASB has received, and published, legal opinion to this effect. However, since the true and fair requirement is an overriding one, companies must depart from any specific accounting practices prescribed by law or by standards if those practices would fail to give a true and fair view in the particular circumstances and to adopt some alternative that does give such a view. Such circumstances are expected to occur only rarely and when they do a company is required to disclose the particulars of the departure (the prescribed treatment that would fail to give a true and fair view and the alternative adopted), the reasons for it (why the prescribed treatment would so fail) and its effect. The Act sets out the detailed requirements for all companies to prepare accounts, prescribes their form and content, prescribes the requirements for audit and requires publication of the accounts to shareholders and others including their filing on public record with the Registrar of Companies. There are some derogations of the rules for accounting disclosure and for filing by small and medium sized companies (as defined) and, for certain very small companies (as defined), there is an exemption from the requirement for audit. Significantly, the Act provides for the Secretary of State (for Trade and Industry) to enquire into accounts where it appears that the requirements of the Act - including the true and fair requirement and thus requirements of accounting standards might have been breached. Where such accounts do work to bring about convergence of IASs and national accounting standards. The IASC itself has no power to require companies to adopt its standards, although some countries may permit their companies to do so (as an alternative to national standards) or may require it by importing the standards wholesale. However, any company claiming compliance with IASC standards must comply with all IASs and all SICs. Similarly to the UK, the overriding requirement is for a fair presentation, which is not defined. Thus companies must depart from the specific provisions of standards in order to give such a view when to do otherwise would not. In these extremely rare cases, disclosures similar to those required in the UK are to be given. The IASC does not carry out any inquiry or enforcement role regarding the application of its standards. In addition, accounts prepared under IASC standards often contain supplementary information required by local statute or listing requirements. banks). The financial statements of domestic SEC registrants must be prepared in accordance with US GAAP and in conformity with other SEC regulations regarding accounting and disclosures, and form part of the Annual Report on Form 10-K filed on public record with the SEC. Foreign registrants are required to prepare and file their Annual Report on Form 20-F, in accordance either with US GAAP or with foreign GAAP including reconciliations to US GAAP, and which is similar to Form 10-K. In addition to 10-K and 20-F filings, SEC registrants must make regular filings of additional financial information. Many companies which are not required to register with the SEC include the additional accounting and disclosure requirements imposed on SEC registrants. In addition to the SEC various other regulatory organisations, such as the Governmental Accounting Standards Board and the Office of Thrift Supervision, issue accounting and reporting requirements relevant to entities within their jurisdictions. Forms 10-K and 20-F are periodically reviewed by the SEC for compliance with GAAP (including the local GAAP of a foreign registrant) and other relevant regulations. The review findings are communicated by private comment-letters to the company. Significant inadequacies can lead to reissue of prior year financial statements. Lesser problems may be dealt with by amended current year filings or improved disclosures in future financial statements.
appear to be defective he may require the directors to revise the accounts, applying to the Courts if necessary to enforce this. The Secretary of State has, under the Act, authorised the Financial Reporting Review Panel (FRRP) - a subsidiary body of the FRC - to carry out this enquiry and enforcement role in respect of large companies (as defined). To date the FRRP has not found it necessary to apply to the Courts in order to enforce its will. The Financial Services Authority (a regulatory body) imposes some additional disclosure requirements on companies whose securities are listed. The requirements are contained in its rule book, The Listing Rules.
13
UK I AS US
UK
I AS
US
14
4. Financial statement requirements
4.1
Form of the financial statements

(CA 85, FRS 1, FRS 3)
4.1

(Framework, IAS 1, IAS 27)
4.1

(SFAS 130, ARB 43, F43, Regulation S-X)
The following are normally presented: balance sheet; profit and loss account; statement of total recognised gains and losses, known informally as the STRGL (see 5.1); note of historical cost profits and losses (see 5.1); cash flow statement; and notes to the accounts (including the reconciliation of movements in shareholders funds). The reconciliation of movements in shareholders funds (equivalent to the IAS or US statements of changes in shareholders equity) may also be shown as a primary statement but may not be combined with the STRGL. A parent company must present consolidated accounts, subject to three exemptions. The first, and major, exemption is that, broadly speaking, if the company is itself a wholly owned subsidiary of another European Union (EU) company in whose consolidated accounts it is included then it need not prepare consolidated accounts itself. The second exemption is similar to this but applies where the company is only majority owned by another EU parent (but subject to certain minority protection procedures). Lastly, certain medium and small sized
The following are normally presented: balance sheet; income statement; a statement of changes in equity, or a statement of recognised gains and losses (see 5.1); cash flow statement; and notes to the accounts. A parent company must present consolidated financial statements unless it is itself a wholly owned subsidiary or, subject to the minoritys consent, is virtually wholly owned (usually 90% or more of the voting power). Usually only consolidated financial statements are presented as international standards do not contain a requirement to present the parent companys financial statements. However, if such statements are prepared, all relevant standards would apply equally to the individual financial statements.
The following are normally presented: balance sheet (or statement of financial position); income statement (also known as statement of earnings or statement of operations); statement of changes in stockholders equity (sometimes combined with the income statement, occasionally included in the notes); statement of cash flows; and notes to the financial statements (including the statement of comprehensive income - see 5.1). Usually consolidated financial statements only are presented.
companies (as defined) may opt not to prepare consolidated accounts. Where consolidated accounts are required, the parent companys balance sheet (but not its other statements), and related notes, and certain other disclosures are nevertheless required to be given. A cash flow statement is not required for a company that is a 90% or more owned subsidiary of another company in whose publicly available consolidated accounts it is included. In addition, a cash flow statement is not required of a small company (as defined).
4.2
Comparatives
(CA 85)
4.2
Comparatives
(Framework, IAS 1)
4.2
Comparatives
(ARB 43, F43, Regulation S-X)
Financial statements are presented for the current and the preceding periods only.
The financial statements cover the current and preceding periods only.
Except for SEC registrants, financial statements are usually presented for the current and the preceding years. SEC registrants are generally required to present income statements, statements of changes in stockholders equity and statements of cash flows for each of the most recent three years and balance sheets for each of the most recent two years.
4.3
Audit reports
(CA 85, SAS 600)
4.3
Audit reports
(ISA 700, ISA 710)
4.3
Audit reports
(SAS 58, SAS 64)
The audit report refers to the current year only (although a mis-statement in the comparatives would probably lead to a qualification since those comparatives would not have been properly prepared in accordance with the Companies Act 1985 - see below).
The IASC does not issue auditing standards. Audits of IAS financial statements would usually be carried out under local standards, or, often, International Standards on Auditing (ISAs) issued by the International Auditing Practices Committee of the International Federation of
The audit report refers to all years presented. Statements on Auditing Standards (issued by the Auditing Standards Board of the AICPA) prescribe the form of the report, which usually states that the audit has been conducted in accordance with generally accepted auditing standards and whether
15
UK I AS US
UK
I AS
US
16
The Companies Act 1985 requires auditors to report whether or not the accounts give a true and fair view and whether they have been properly prepared in accordance with that Act; Statements of Auditing Standards (SASs), issued by the Auditing Practices Board (APB), prescribe the form of that report. The report distinguishes the respective responsibilities of company directors and of auditors; describes in general terms the audit process (confirming that it has been carried out in accordance with Auditing Standards) as the basis of the audit opinion; and states the auditors opinion. The report would be qualified if the scope of the audit was limited or if the auditor disagreed with an accounting treatment or disclosure (including the comparatives). In addition, where proper accounting records had not been maintained or where all necessary information and explanation had not been received by the auditor, this would be stated in the report. Uncertainties, if properly disclosed in the accounts, would not result in a qualified audit report but if fundamental would be mentioned in the report. Accountants, a private sector international professional body. Under ISAs the audit report refers to the current year and/ or the prior year depending on whether the comparatives are seen as a sub-set of the current year financial statements or as a separate set of financial statements. (Even if not ordinarily referred to, a misstatement in the comparatives would probably lead to a qualification if the misstatement was considered material in the current year comparison). The report states whether the financial statements present fairly in all material respects (or give a true and fair view of) the financial position, performance and cash flows. The format of the report is similar to that of the UK: respective responsibilities are explained; the audit process is described; and the opinion is stated. The report would be qualified if the scope of the audit was limited, there was a disagreement over an accounting treatment or information could not be obtained. In some situations it will be appropriate to include an emphasis of matter referring to an uncertainty; such emphasis is not a qualification. or not the financial statements are presented fairly in conformity with GAAP. Certain situations must be disclosed in the audit report, such as when the financial statements are not in accordance with GAAP, significant uncertainties exist, the scope of the audit was limited or necessary information could not be obtained. SEC regulations (where applicable) are also relevant to the form of report given. For example, the report may have to be extended to cover certain schedules required by the SEC.
4.4
Accompanying financial and other information

(CA 85, The Listing Rules, SAS 600)
4.4

(IAS 1)
4.4

(Regulation S-K, Regulation S-X)
The accounts must be accompanied by a Directors Report containing certain information specified by the Companies Act 1985. That Directors Report is usually rather brief and it must be filed, with the accounts, on public record with the Registrar of Companies, except for the case of small companies (as defined) which need not file the report.
In the UK and US the accompanying information arises out of legal and listing requirements. Since IASs do not relate to any particular legal or listing framework, there are no such requirements, although, of course, the particular company using IASs will be subject to its own such requirements. However, IAS 1 does encourage but does not
The annual financial statements filed on Form 10-K or 20-F must be accompanied by a number of additional SEC disclosures including managements discussion and analysis of financial conditions and results of operations (MD&A), selected financial data, supplementary financial information and certain prescribed financial schedules.
The accounts will in practice be accompanied by a statement acknowledging the directors responsibilities, principally for the preparation of the accounts. (The audit report refers readers to this statement and, if the statement is not present, the auditors would give the equivalent information in their report). The directors of a company often use the annual report and accounts as an opportunity to include information for shareholders on selected operating and financial matters. The ASB has sought to regularise the completeness and content of such information. It has issued a non-mandatory statement setting out its recommendations for a thorough Operating and Financial Review. In addition to this, listed companies are required to include in their annual report and accounts a statement as to the extent to which they have complied with a code of corporate governance best practice (known as the Combined Code), a statement dealing with how the Combined Codes principles have been applied and certain details of directors emoluments (over and above that required by law). The code covers the proceedings and composition of the board - including the need for and role of non-executives - directors remuneration, relations with shareholders and certain board responsibilities in connection with financial reporting and internal controls. Furthermore, the directors of all listed companies are required in all cases to make a statement as to whether the business is a going concern with supporting assumptions and qualifications as necessary.
require, a financial review by management which describes and explains the main features of the companys financial performance and position and the principal uncertainties it faces.
17
UK I AS US
UK
I AS
US
18
5. General issues
5.1
Classification and presentation within the financial statements
5.1

(IAS 1)
5.1

(SFAS 130, ARB 43, B05, C49, Regulation S-X)
Balance sheet (CA 85, UITF 4, FRS 4) The Companies Act 1985 prescribes the available balance sheet formats. The format usually adopted is one where total assets less liabilities balances with capital and reserves (shareholders funds) plus minority interests. Assets are generally presented in ascending order of liquidity (least liquid first) and liabilities in descending order (most liquid first). The Act prescribes minimum standards of balance sheet disclosure, specifying certain balance sheet captions and the allocation of items between those captions. Current assets and current liabilities are separately presented from other assets and liabilities. Current assets are those which are not intended for use on a continuing basis in the companys activities. However, an anomaly arises in that current assets could include amounts receivable after more than one year. If the amount concerned is sufficiently material (in the context of total net current assets) then that amount must be disclosed on the face of the balance sheet. Current liabilities comprise creditors falling due within one year. Short-term obligations are included
Balance sheet Whilst certain items are, as a minimum, required to be shown on the face of the balance sheet, there is no prescribed format in which they should be presented. However, there is a general requirement to present the balance sheet either on the basis of distinguishing current from non-current assets and liabilities, or broadly in order of liquidity. Current assets are those assets that are: either expected to be realised in, or are held for sale or consumption in, the normal course of the companys operating cycle; or are held primarily for trading purposes or for the short-term and are expected to be realised within twelve months of the balance sheet date. Current liabilities are those liabilities that are expected to be settled in the normal course of the companys operating cycle, or are due to be settled within twelve months of the balance sheet date. The current portion of long-term debt (but not shortterm debt itself) should be classified as non-current if there is an intention and supporting agreement to refinance on a long-term basis (see 6.8).
Balance sheet The balance sheet is generally presented as total assets balancing with total liabilities and stockholders equity. Assets and liabilities are generally presented in descending order of liquidity (most liquid first). SEC regulations prescribe the format and certain minimum balance sheet disclosures for public companies. Otherwise, balance sheet detail should generally be sufficient to enable material components to be identified. The balance sheet usually presents current assets and current liabilities separately from other assets and liabilities (known as a classified balance sheet). The current classification applies to those assets which will be realised in cash, sold or consumed within one year (or within one operating cycle, if longer), and those liabilities that will be discharged by the use of current assets or the creation of other current liabilities within one year (or operating cycle, if longer). The current liability classification includes obligations that, by their terms, are due on demand or will be due within one year (or operating cycle, if longer) from the balance sheet date, even though
5. General issues
within current liabilities regardless of anticipated re-financing subject to one narrow exception. Where a committed back-up facility is effectively an integral part of the related debt (according to narrowly defined conditions), then that debt may be classified according to the maturity of the back-up facility (see 6.8). Shareholders funds and minority interests are each required to be analysed into equity and non-equity elements (as defined - see 6.14). If the non-equity element is immaterial then the analysis may be given in the notes. Profit and loss account (CA 85, FRS 3) The Companies Act 1985 specifies four acceptable formats for the profit and loss account (of which only two are often used in practice), prescribes minimum standards of disclosure and specifies how certain items should be allocated in the profit and loss account. Both of the commonly used formats reconcile turnover to the profit for the financial year, from which dividends are then deducted. Format 1, the more common of the two, analyses expenses by function (cost of sales, distribution costs, administrative expenses) and requires gross profit to be disclosed. Format 2 analyses expenses by type, such as salaries and wages, and does not show gross profit. FRS 3 supplements the statutory formats with an operating profit sub-total and three additional, or supplementary, format items which appear after operating profit but before interest: profits or losses on sale or termination of an operation (paragraph 20(a) FRS 3); costs of a fundamental restructuring (paragraph 20(b) FRS 3); and profits or losses on the disposal of fixed assets (paragraph 20(c) FRS 3). Income statement Certain items are required, as a minimum, to be presented on the face of the income statement. Appropriate additional line items, headings and sub-totals must also be given where this is necessary to achieve a fair presentation. In addition, an analysis of expenses by either their type or function should be disclosed on the face of the income statement or in the notes.
they may not be expected to be discharged within that period. Short-term obligations expected to be refinanced on a long-term basis can be excluded from current liabilities only if the company intends to refinance the obligation on a long-term basis and has demonstrated the ability to accomplish that refinancing (see 6.8).
Income statement The income statement is usually presented in one of two formats as follows: either in a single-step format where all expenses, classified by function, are deducted from total income to give a subtotal of income before income taxes, from which income taxes and extraordinary items are then deducted; or in a multiple-step format where the cost of sales is deducted from sales to show gross profit, then other income or expenses are added or deducted to show income from operations and income before and after income taxes. SEC regulations also prescribe the format and certain minimum income statement disclosures for registrants. Otherwise, income statement disclosures should generally be sufficient to enable material components to be identified.
5. General issues
19
UK I AS US
UK
I AS
US
20
The second of the three items is intended to be used very rarely (that is, when the restructuring has a material effect on the nature and focus of the companys operations). The formats do not provide a line for exceptional items and companies are prevented from including a separate line for them - they must be subsumed into the format item to which they relate (see 7.9). Typically, however, companies manage to isolate exceptionals on the face of the profit and loss account by a columnar analysis. Companies are also required to analyse the format items, from turnover down to operating profit, between operations acquired in the year (as a component of continuing operations), continuing operations and discontinued operations (as defined - see 7.10). As a general principle, the Companies Act 1985 requires that only realised profits be recognised in the profit and loss account. Statement of cash flows See 5.3 for a separate discussion of statements of cash flows. STRGL (FRS 3, Statement of Principles) The components of this statement are the gains and losses of the period attributable to shareholders, that is, increases and decreases in net assets other than contributions from, or distributions to, owners. Thus it includes, inter alia, the profit for the financial year, any revaluation of assets or exchange differences dealt with in reserves. Statement of cash flows See section 5.3 for a separate discussion on statements of cash flows. Statement of recognised gains and losses There is a choice of presenting as a primary statement either a statement of recognised gains and losses (like the UK) or a statement of changes in equity (see below). Statement of cash flows See 5.3 for a separate discussion of statements of cash flows. Other comprehensive income (OCI) A statement of comprehensive income, on the same basis as the UKs STRGL, is required to be presented either as a separate primary statement or together with the income statement or statement of changes in stockholders equity. Comprehensive income other than net income reported in the income statement is known as other comprehensive income (OCI) and should be separately reported as such in the statement. In addition, items reported
5. General issues
therein should be accumulated in a separate accumulated OCI component of stockholders equity and the balance thereon should be analysed on the face of the balance sheet, in the statement of changes in stockholders equity or in the notes. Reconciliation of movements in shareholders funds (FRS 3) This reconciliation deals with the movements in the total shareholders funds and is very often presented with the primary statements rather than as a note. Movements on individual items of capital and reserves are usually dealt with separately in other notes to the accounts (although the two may be combined in some suitable format). The components of the reconciliation are the profit for the financial year, dividends, other recognised gains and losses (usually as a single aggregate figure) and each other movement individually. Note of historical cost profits and losses
(FRS 3)
Statement of changes in equity A statement of changes in equity (similar to those of the UK and US) must be presented either as a primary statement (if there is no statement of recognised gains and losses) or as a note (if there is a statement of recognised gains and losses).
Statement of changes in stockholders equity The statement of changes in stockholders equity is usually presented as a separate statement showing, for each category of equity, the opening and closing balances and movements during the period. Alternatively, a separate statement may be omitted if the information is shown in the notes to the financial statements or combined with the income statement.
5. General issues
Note of historical cost profits and losses There is no equivalent of the UK statement.
Note of historical cost profits and losses There is no equivalent of the UK statement.
The note of historical cost profits and losses, whilst not strictly a primary statement, is presented together with the primary statements where there is a material difference between the result as disclosed in the profit and loss account and the result as if an unmodified historical cost basis had been adopted (ie, if no revaluations had been made - see 5.4). Its basic format is that of a reconciliation of the reported profit before tax to that which would have been shown on the unmodified basis.
21
UK I AS US
UK
I AS
US
22
5.2
Prior period adjustments and other accounting changes
5.2
5.2
Most accounting policy changes are dealt with by restatement of all periods presented.
Most accounting policy changes may be dealt with by restatement or by passing the cumulative adjustment through the current year.
Many accounting policy changes are dealt with by passing the cumulative adjustment through the current year.
Prior period adjustments (FRS 3) Prior period adjustments, as defined below, are dealt with by restatement of the opening position and of the comparatives for prior periods. The cumulative effect of the change - as at the start of the year in which the change is made - should be shown as a separate item in the current years STRGL. Prior period adjustments are defined as material adjustments applicable to prior periods arising from: changes in accounting policies (see below); or the correction of fundamental errors. They do not include normal recurring adjustments or corrections of estimates made in prior periods. In addition, prior periods are restated when using merger accounting (see 5.7).
Prior period adjustments (IAS 8) Where a prior period adjustment is applicable the opening balance of retained earnings and the comparatives are restated. Prior period adjustment is the Benchmark Treatment for: certain changes in accounting policy (see below); and the correction of fundamental errors. In both cases the Allowed Alternative Treatment is to put the adjustment through in the current year and no restatement occurs. However, in both the Benchmark and Allowed Alternative Treatments for a change in accounting policy, if the adjustment to opening retained earnings cannot be determined the change should be made prospectively. In addition, prior periods are restated when applying uniting-of-interests accounting (see 5.7).
Prior period adjustments (APB 9, SFAS 16, A35) In single period financial statements, prior period adjustments are reflected as adjustments of the opening balance of retained earnings. When comparative statements are presented, corresponding adjustments are made of the amounts of net income, its components, the balances of retained earnings, and other affected balances for all of the periods presented to reflect the retrospective application of the prior period adjustments. Such prior period adjustments may only be made: to correct errors in prior period financial statements; for certain changes in accounting principles (see below); for certain adjustments related to prior interim periods of the current fiscal year; or to reflect accounting changes that are in effect the statements of a different reporting entity (eg, pooling-of-interests - see 5.7). Changes in accounting principle and method
(APB 20, A06)
5. General issues
Changes in accounting policy and method

(FRS 3, FRS 10, FRS 15, CA 85, SSAP 2, UITF 14)
Changes in accounting policy and method

(IAS 8, IAS 16, IAS 38, SIC 8)
A change in accounting policy must be justified as preferable and should be accounted for as a prior period adjustment, as discussed above. The effect of the policy changes on the preceding and current
A change in accounting policy should be made where required to adopt a new IAS or in any case where the change will result in a more appropriate presentation of events or transactions in the
A change in accounting principle must be explained and justified as preferable. The term accounting principle also includes the methods of applying principles. In most instances prior periods are not
years should be disclosed where practicable. Changes resulting from the introduction of new accounting standards are, in general, not treated differently from other changes in accounting policy; prior years are restated, although many recent standards have had different transitional provisions. Accounting methods give effect to accounting policies. Only changes in policy qualify as prior period adjustments. For example, a change from one method of computing depreciation/ amortisation to another is not treated as a change in accounting policy; the unamortised cost should be written off over the remaining useful life beginning in the period in which the change is made. A change in estimated useful life or residual value should also be treated in this way.
financial statements. In either case if the company chooses the current period adjustment method of effecting the change it should give pro forma information on the prior year adjustment basis. In all cases the effect of the change on all periods presented should be disclosed, together with the reason for the change. All new IASs either have their own transitional rules (many recent IASs fall into this category) or, failing that, are by default effected as a change of accounting policy. A change in depreciation/ amortisation method, useful life or residual value does not qualify as a change in accounting policy. When a company prepares IAS financial statements for the first time, this is dealt with as a change in policy, but one that is required to be effected by the prior period adjustment method save to the extent that the adjustment relating to prior periods cannot be reasonably determined.
adjusted. Instead the cumulative effect (net of tax) of the change should be shown in the income statement, after extraordinary items and before net income, in the year in which the change occurs. Income before extraordinary items and net income should be shown on a pro forma basis on the face of the income statement for all periods presented as if the newly adopted accounting principle had been applied during all periods presented. The effect of adopting the new principle on income before extraordinary items and on net income (and on other related per share amounts) in the period of the change should also be disclosed. In the following cases, however, the financial statements of prior periods should be restated: a change from LIFO to another method of inventory valuation; a change in the method of accounting for longterm construction-type contracts (see 7.1); and a change to or from the full cost method of accounting that is used in the extractive industries (the details of which are outside the scope of this book). These general rules do not apply to a change which results from the initial adoption of a new accounting pronouncement. Initial adoption rules are included in each new pronouncement; restatement may either be prohibited, required or optional. A change from one method of computing depreciation to another (for example, from the sumof-the-years-digits to the straight-line method) is a change in accounting principle and should be accounted for accordingly. A change in estimated useful life or residual value, however, is a change in an accounting estimate and should be accounted for prospectively.
5. General issues
23
UK I AS US
UK
I AS
US
24
Changes in accounting estimate (FRS 3) Changes in accounting estimates should be accounted for in the period of the change, and if material, their nature and size should be disclosed. Changes in accounting estimate (IAS 8) Changes in accounting estimate are included in the net profit or loss for the period in which the change occurs (or the period of the change and future periods if the change affects both). Where material, the effect should be disclosed. Changes in accounting estimate (APB 20, A06) Changes in accounting estimates should be accounted for in the period of the change as if only that period is affected by the change, or in the period of the change and future periods if those periods are affected. A change in estimate should not be accounted for by restating prior periods or by reporting pro forma amounts for prior periods.
5.3
Statement of cash flows

(FRS 1)
5.3

(IAS 7)
5.3

(SFAS 95, C25)
Significant differences
The statement is based on cash; there are no cash equivalents. Cash includes overdrafts repayable on demand. Interest, dividends and tax are presented as separate classes of items.
5. General issues
The statement is based on cash and cash equivalents, the latter including short-term highly liquid investments. Cash and cash equivalents may include overdrafts repayable on demand in some cases. Interest and dividends can be classified as operating, investing (if received) or financing (if paid); tax is usually classed as operating.
The statement is based on cash and cash equivalents, the latter including short-term highly liquid investment. Cash and cash equivalents do not include any overdrafts. Dividends paid are classed within financing; other dividends, tax and (most) interest are classed within operating.
Cash A cash flow is an increase or decrease in cash resulting from a transaction. It therefore excludes the effect of exchange rate changes on cash. Cash is defined as cash in hand and deposits with qualifying financial institutions repayable on demand, less overdrafts from such institutions repayable on demand. There is no concept of cash equivalents. Items that would fall into that category in the US or under IASs would probably be regarded as liquid
Cash and cash equivalents Cash flows are inflows and outflows of cash and cash equivalents; they therefore exclude the effects of exchange rate changes on cash and cash equivalents as this involves no inflow or outflow. Cash comprises cash on hand and demand deposits. Cash equivalents are short-term highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value. Short-term is not defined but the standard suggests a cut-off of
Cash and cash equivalents A cash flow is an increase or decrease in cash and cash equivalents resulting from a transaction. It therefore excludes the effect of exchange rate changes on cash and cash equivalents. Cash and cash equivalents include currency on hand, demand deposits, and short-term highly liquid investments (with original maturities of three months or less, or with remaining maturities of three months or less at the time of acquisition).
resources in the UK. Liquid resources are defined as current asset investments that are disposable without curtailing or disrupting the business and are either readily convertible into known amounts of cash at or close to book value or are traded in an active market. It should be noted that current asset investments is wider than the three months maturity referred to in the US and IAS. Cash flows in respect of liquid resources are classified separately. Classification and presentation of cash flows Cash flows are classified and reported under the following headings: operating activities; dividends from joint ventures and associates; returns on investments and servicing of finance; taxation; capital expenditure and financial investment; acquisitions and disposals; equity dividends paid; management of liquid resources; and financing. All interest paid, including that capitalised, is classed as servicing of finance. The statement should be reconciled to the movement in net debt, which is the net of debt, liquid resources and cash. Cash flows from transactions undertaken to hedge another transaction should be reported under the same heading as that other transaction. Cash flow from operating activities may be reported on a gross basis (ie, the direct method reporting cash received from customers, paid to suppliers etc) or as
three months maturity (on acquisition by the company). Bank overdrafts repayable on demand are dealt with as cash and cash equivalents where they form an integral part of the companys cash management.
Classification and presentation of cash flows The cash flow statement should split cash flows during the period between operating, investing and financing activities. A company should choose its own policy for classifying each of interest and dividends paid as operating or financing activities and each of interest and dividends received as operating or investing activities. Taxes paid should be classified as operating activities unless any particular tax cash flow (not merely the related expense in the income statement) can be specifically identified with, and therefore classified as, financing or investing activities. Net cash flows from all three categories are totalled to show the change in cash and cash equivalents during the period, which is then reconciled to opening and closing cash and cash equivalents. The company should disclose the components of cash and cash equivalents and reconcile these to the equivalent figures presented in the balance sheet. When a hedging instrument is accounted for as a hedge of an identifiable position, the cash flows of the hedging instrument are classified in the same
Classification and presentation of cash flows The statement of cash flows classifies cash receipts and payments as follows: operating activities; investing activities; and financing activities. Interest received and paid (net of interest capitalised, which is classed as investing), dividends received and all taxes are included under operating activities. Dividends paid are classed as financing activities. Net cash flows from all three activities are totalled to show the change in cash and cash equivalents during the period, which is then reconciled to the opening and closing cash and cash equivalents. Cash flows resulting from certain contracts that are hedges of identifiable transactions should be classified in the same cash flow category as the cash flows from the hedged items. While companies are encouraged to report gross operating cash flows by major classes of operating cash receipts and payments (the direct method), presenting such items net (the indirect method) is
5. General issues
25
UK I AS US
UK
I AS
US
26
a single net amount (the indirect method). In both cases a reconciliation must be provided separately to show the derivation of net operating cash flow from operating profit (whereas the IAS and US reconciliations start with net profit/ income). With the following exception, all other sections of the cash flow statement are to be presented on the gross basis: in the liquid resources and financing sections, inflows and outflows may be netted off where they occur due to rollover or re-issue of short maturity, high turnover items. manner as the cash flows of the position being hedged. Cash flows from operating activities may be presented either by the direct method (gross receipts from customers etc) or the indirect method (net profit and loss for the period with adjustments to arrive at the total net cash flow from operating activities). Although the standard encourages the use of the direct method, in practice the indirect method is usually used. All financing and investing cash flows should be reported gross, save for the following exception. Receipts and payments may be netted where the items concerned (eg, sale and purchase of investments) are turned over quickly, the amounts are large and the maturities are short. allowable in respect of operating activities. Under the direct method, the statement begins with cash from operations by source (eg, amounts received from/ paid to customers, suppliers and employees). The indirect method starts with net income and reconciles it to net cash flows from operating activities by adjusting for non-cash items (such as depreciation) and the net change in most working capital items. If the indirect method is used, amounts of interest paid (net of amounts capitalised) and income taxes paid during the period are disclosed. Under both the direct and the indirect method, cash inflows and outflows from investing and from financing activities should be reported on a gross basis. Other matters Information about all investing and financing activities of a company during a period that affect recognised assets or liabilities but do not result in cash receipts or payments are also disclosed. For example, the initial recording of a capital (finance) lease results in the recognition of a leased asset and a corresponding liability in the balance sheet without affecting cash flows. Cash flows denominated in foreign currencies are translated into the reporting currency using the exchange rates in effect at the time of the cash flows (although a weighted average exchange rate for the period may be used). Exchange rate effects on cash balances held in foreign currencies must be reported as a single line item in the statement of cash flows. Banks, savings institutions and credit unions are permitted to report net cash receipts and payments for deposits placed with and withdrawn from other
5. General issues
Other matters Material non-cash transactions should be disclosed where this is necessary for an understanding of the transaction (eg, vendor placing or the inception of a finance lease). Foreign currency cash flows arising in a company as a result of its own transactions are translated at the rate at the date of the transaction. The cash flows of foreign companies included in group accounts are translated by the same method used to translate the profit and loss account of that company. The effect of exchange rate changes on the balance of cash (and other elements of net debt) is reported as a single line item in the note reconciling opening and closing net debt with the net cash flow for the year. In common with other companies, banks and insurance companies may report their operating cash flow on a net basis.
Other matters Non-cash investing or financing transactions (eg, share-for-share acquisition, debt-to-equity conversion) should be disclosed in order to provide relevant information about investing and financing activities. Cash flows arising from a companys foreign currency transactions should be translated into the reporting currency at the exchange rate at the date of the cash flow (where exchange rates have been relatively stable a weighted average can be used). Cash flows of foreign subsidiaries are translated also at actual rates (or appropriate averages). The effect of exchange rate changes on the balances of cash and cash equivalents are presented as part of the reconciliation of movements therein. Financial institutions may report on a net basis certain advances, deposits and repayments thereof.
financial institutions, for time deposits accepted and repaid and for loans made to and collected from customers.
5.4
Basis of accounting
5.4
Basis of accounting
5.4
Basis of accounting
The modified historical cost basis may be used to revalue certain assets, usually property. There are no special requirements when the reporting companys functional currency is hyper-inflationary.
The modified historical cost basis may be used to revalue certain assets. If the company reports in a hyper-inflationary currency it must make current purchasing power adjustments.
The historical cost basis is adopted for property (and most other items). If the reporting companys functional currency is highly inflationary then it must instead use US dollars as the functional currency.
5. General issues
Conceptual framework (Statement of Principles,

SSAP 2)
The ASB has recently published its conceptual framework, the Statement of principles for financial reporting. Its purpose is to guide the development of new standards. It is similar to the IAS and US frameworks, save that the emphasis is on substance. Although the framework has been in gestation for many years, nevertheless during that time it influenced many of the later UK standards: for instance, FRS 5 Reporting the substance of transactions (see 5.5) uses its definitions of assets and liabilities and its criteria for recognition of these items in the accounts; and FRS 12 Provisions, contingent liabilities and contingent assets (see 6.12) uses its definition of a liability for the critical issue of provision timing.
Conceptual framework (Framework) The IASC uses its conceptual framework, the Framework, as an aid to drafting new or revised IASs. The Framework also provides a point of reference for preparers of financial statements in the absence of any specific standards on a particular subject (see 3.1). The Framework is similar to the US conceptual framework, though less practical emphasis is placed on consistency (eg, there are some optional treatments in IASs).
Conceptual framework (CON 1, CON 2, CON 3, CON

4, CON 5, CON 6)
The FASB works within a formal conceptual framework. That framework defines the objectives of financial reporting (essentially economicdecision making) and the qualities necessary to achieve this. In practice the main quality which is sought by standards is consistency. The framework goes on to define the elements of financial statements, which are built up from definitions of assets and liabilities, their recognition and measurement, and finally the presentation of a complete set of financial statements.
27
UK I AS US
UK
I AS
US
28
The modified historical cost convention
(CA 85, FRS 15)
The modified historical cost convention

(IAS16, IAS 38, IAS 39)
The accounts are prepared under the historical cost convention although it is permissible to modify that basis to include the revaluation of certain assets (usually property). Where revaluations, other than of investments, are carried out they must be done on a class-by-class basis and must be kept up to date (see 6.1 and 6.2); investments may be occasionally and selectively revalued. In addition, mark-tomarket accounting is sometimes used in the financial sector (eg, see 6.6).
Save in respect of certain financial assets and liabilities, financial statements are prepared under either the historical or modified historical cost convention. In the latter case whole classes of property, plant and equipment and of certain intangible assets may be revalued (with the revaluations being kept up-to-date). In addition, all derivatives, all financial assets and liabilities held for trading and all financial assets that are classed as available-for-sale are carried at fair value (see 6.6). Financial reporting and hanging prices
(IAS 15, IAS 29)
The modified historical cost convention The basic financial statements are generally prepared under the historical cost convention; upward revaluation occurs only in connection with purchase accounting (see 5.7) and certain other specific situations (eg, trading and available-for-sale securities and derivatives - see 6.6).
Financial reporting and changing prices If a companys subsidiary reports in a hyperinflationary currency then adjustments are required when it is consolidated (see 5.8). Where the company itself reports in a hyper-inflationary currency there are no similar requirements. The UK standard on current cost accounting, SSAP 16, was suspended in 1985 and finally withdrawn in 1988. At the time of its withdrawal the ASBs predecessor, the ASC, re-affirmed its view that where historical cost accounts were materially effected by changing prices it was correct in principle to give information about those effects. However, it did not mandate this; it merely encouraged companies to do so. In practice very few companies give such information. The ASCs publication Accounting for the effects of changing prices remains the most authoritative source of guidance for measurement and presentation under the current cost (and the current purchasing power) accounting convention(s).
Financial reporting and changing prices

(SFAS 89, C28)
Companies are encouraged, but not required, to disclose on the current cost basis certain information about the effects of changing prices. Where a company has a subsidiary reporting in a hyper-inflationary currency, its financial statements must be adjusted before being translated and consolidated (see 5.8). Moreover, where the company itself reports in a hyper-inflationary currency its own financial statements must be adjusted to state all items in the measuring unit current at the balance sheet date, ie it must adopt the current purchasing power concept. There is no absolute numerical test for hyper-inflation, but a three year cumulative inflation rate approaching, or exceeding, 100% is an indication of hyperinflation.
A business entity that prepares its financial statements in US dollars and in accordance with US generally accepted accounting principles is encouraged, but not required, to disclose supplementary information on the effects of changing prices. Appendix A of SFAS 89 provides measurement and presentation guidelines for the disclosure of supplementary information on the effects of changing prices. If a foreign registrant has a highly inflationary functional currency it is, in most instances, required instead to adopt the US dollar as its functional currency. Similar procedures are required for the consolidation of subsidiaries in highly-inflationary economies (see 5.8).
5. General issues
5.5
Reporting the substance of transactions

(FRS 5)
5.5

(Framework, IAS 1, IAS 17 IAS 18, IAS 39, SIC 12) ,
5.5
All transactions should be reported in accordance with their substance on a risksand-rewards basis. There is comprehensive guidance on this.
Financial asset transactions are reported on a financial components basis; otherwise substance on a risks-and-rewards basis is used. There is less guidance on substance than in the UK.
Financial asset transactions are on a financial components basis; there is no general requirement to report substance. There is no standard on substance.
FRS 5 Reporting the substance of transactions looks at some of the concepts underlying accounting rather than addressing a particular area. (However, it does scope out certain arrangements such as forward contracts, swaps and purchase commitments unless they are part of a wider arrangement that falls within its scope.) Its concept is that the commercial effect of a companys transactions, and any resulting assets, liabilities, gains or losses, should be faithfully represented in its financial statements. For most transactions the substance, and thus the accounting, are clear. The difficult areas are the more complex transactions, whose commercial effect may not be readily apparent - the real target is so-called off balance sheet finance. This principle does not take precedence over other more specific standards, but those other standards should be applied to the substance of the transactions and not merely to their legal form. For example, although SSAP 21 contains the more specific provisions for most leases, FRS 5 will be relevant in ensuring that they are classified in accordance with their substance (see 6.9).
There is no IAS that deals with the whole of this broad area. The Framework requires reporting to be in accordance with substance rather than legal form and sets out, very briefly, a risk-and-rewards approach to assessing the substance. The leasing and revenue recognition standards (IASs 17 and 18) and an SIC on special purpose entities (SPEs) (SIC 12) put that into practice in three particular areas. However, in its financial instruments standard, IAS 39, the IASC has moved to a financial components approach (see 6.6).
There is no overall conceptual standard in US GAAP. However, there are a number of specific pronouncements which deal with some of the issues encompassed by FRS 5. The specific US GAAP accounting standards, such as those for leases or for sales of financial assets, need to be consulted when transactions are being considered for off balance sheet treatment.
5. General issues
29
UK I AS US
UK
I AS
US
30
Assets and liabilities FRS 5 adopts definitions of assets and liabilities as follows: Assets are rights or other access to future economic benefits controlled ... as a result of past transactions or events. The FRS highlights risk as evidence of whether or not a company has an asset. Risk, for this purpose, includes the upside potential for gain as well as the downside potential for loss. Liabilities are obligations to transfer economic benefits as a result of past transactions or events. A company will have a liability whenever there is some circumstance in which it is unable to avoid, legally or commercially, an outflow of benefit. For example, the prospect of a commercial or economic penalty if a certain action is not taken may negate a legal right to refrain from taking that action. When assessing the risks, benefits and obligations that might provide evidence of the existence of an asset or liability, it is important to give greater weight to those which are likely to have a commercial effect in practice. The effect of applying these definitions is that socalled off balance sheet finance is brought onto the balance sheet. Commercial effect in practice - lenders return Whatever the substance of a transaction, it should have commercial logic for each of the parties entering into it. Thus, in assessing the commercial effect of a transaction, it is important to consider the position of all of the parties. In particular, where a transaction involves only two Commercial effect in practice - lenders return A form of lenders return test is applied to a purported transfer of a financial asset; if such a return is involved and the transferor has both the right and the obligation to repurchase it, then it remains on the transferors balance sheet. This might be termed a two way test and differs from that of the UK where a lenders return is sufficient Commercial effect in practice - lenders return There is no lenders return concept under US GAAP. The US GAAP leasing criteria are discussed in 6.9. Assets and liabilities The Framework uses similar definitions to those of the UK and US: An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity. A liability is a present obligation arising from past events, the settlement of which is expected to result in an outflow of resources embodying economic benefits. Once again the Framework requires substance rather than form to be looked to when determining whether an item meets these definitions. Assets and liabilities (CON 6) CON 6 defines assets and liabilities in a similar fashion to FRS 5, as follows: Assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. Liabilities are probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.
5. General issues
parties, one of which receives a lenders return but no more, this indicates that the substance of the transaction is that of a secured loan. The main reason for this is that the lender is not compensated for assuming any significant exposure to loss other than that associated with the creditworthiness of the other party. This guidance on lenders return is fundamental, and for many transactions it will not be necessary to look any further in determining their substance.
even if it is only a transferors call option that ensures the transferee of this (a one way test). However, where an SPE is involved a lenders return to the SPEs capital providers is sufficient to bring in the SPE on consolidation. This version of the lenders return test is not specifically required to be a two-way test and so is much more in line with the UK approach. Moreover, given that this one-way test is part of a risk-and-rewards approach to SPEs it is arguable that it is applicable by analogy to all situations to which a risk-andrewards approach is applicable, ie other than to financial instruments. The linked presentation There is no linked presentation concept under IASs. Arrangements qualifying for that presentation in the UK would be either derecognised or, more likely, on consolidation continue to be fully recognised separately from the finance (see 6.6). The linked presentation There is no linked presentation concept under US GAAP.
The linked presentation However, there is a special linked presentation where the finance is non-recourse and is repayable only from benefits generated by the assets being financed, or by transfer of the assets themselves. Where detailed conditions are met, this linked presentation is required, whereby the nonreturnable finance is shown deducted from the related gross asset on the face of the balance sheet, for example: Securitised mortgages Less non-returnable proceeds
X (Y) Z
5. General issues
This shows both that the company retains significant benefits associated with the gross asset and that the claim of the provider of the finance is limited strictly to the funds generated by that asset. Options Off balance sheet finance schemes often make use of options. There is detailed guidance on when an Options There is no general guidance on options under IASs, save where they are separate financial Options There is no broad concept similar to that in the UK. However, a transferors call option to re-acquire an
31
UK I AS US
UK
I AS
US
32
option should be regarded as genuinely conditional and when it should not. All the features that are likely to be relevant during the exercise period of the option should be taken into account, assuming that each of the parties will act in accordance with its economic interests. Transactions in previously recognised assets An asset should cease to be recognised only if all significant rights or other access to benefits related to that asset, and all significant exposure to risks inherent in those benefits, have been transferred to others. However there are special cases where the original asset has been sold but an interest in the asset and/ or an obligation has been retained. In such cases the amount and/ or description of the asset may need to be changed and any liability recognised in accordance with the substance. Offset of assets and liabilities There has been a long standing principle (which is also embedded in the Companies Act 1985) that assets and liabilities must not be offset. FRS 5 confirms this and enlarges upon it by determining when debit and credit balances are separate assets and liabilities, which must not be offset, and when they are components of a single asset or liability, as follows. Debit and credit balances must be offset when all of the following conditions are met: Two parties owe each other known monetary amounts. The reporting company can insist on net settlement, although this may be just a contingent right provided it can be enforced in all situations of default by the other party. Its ability so to insist is assured beyond doubt Offset of assets and liabilities A financial asset must be offset against a financial liability when: there is a legally enforceable right to set off the amounts; and the entity expects to settle net or to settle both amounts simultaneously. Offset of assets and liabilities (FIN 39, FIN 41) It is a general principle of US GAAP (as discussed by FINs 39 and 41) that the offsetting of assets and liabilities is improper except where a right of set-off exists. A right of set-off exists when all of the following conditions are met: Each of two parties owes the other determinable amounts. The reporting party has the right to set-off its amount owed with the amount owed by the other party. The reporting party intends to set-off. The right of set-off is enforceable at law. A debtor having the valid right of set-off may offset the related asset and liability and report the net amount. instruments (see 6.6), other than the overall requirement to account for the substance. asset, or a transferees put option, will generally preclude a sale of that asset from being recognised. (Put options pursuant to recourse provisions do not, of themselves, preclude sales treatment.) Transactions in previously recognised assets IASs do not have detailed requirements in this area, other than for transfers of financial assets which are dealt with on a financial components basis (see 6.6). The general requirement to account for the substance would apply. Transactions in previously recognised assets US GAAP does not have any general rules in this area. Specific areas of difficulty are dealt with by specific standards, eg transfers of financial assets which are on the financial components basis (see 6.6).
5. General issues
(for instance, its ability must be able to survive the insolvency of the other party, however remote that insolvency may seem). Note that IAS and US GAAP on this issue use the companys intention or expectation to settle net, whereas in the UK it is the companys ability to do so that matters.
5.6
Consolidation
(CA 85, FRS 2, FRS 5)
5.6
Consolidation
(IAS 22, IAS 27, SIC 12)
5.6
Consolidation
(ARB 51, APB 18, SFAS 94, SFAS 125, EITF 9620, C51)
Consolidation is based on control. Minorities must be on the consolidated value basis.
5. General issues
Consolidation is based on control. Minorities may be on the subsidiary or the consolidated value basis.
Consolidation is based largely on ownership. Minorities must be on the subsidiary value basis.
Entities included in the consolidation Consolidated accounts include all of the parent companys subsidiary undertakings (as defined) and its quasi-subsidiaries (as defined), except that certain of those undertakings should be excluded in very restricted circumstances (as detailed below). The accounting concept that underlies the parent~subsidiary relationship can be summarised as control of one undertaking by another. Control, in this context, means the ability of one undertaking to direct the financial and operating policies of another undertaking with a view to gaining economic benefits from its activities; nevertheless, the actual exercise of such dominant influence is enough to satisfy this concept without needing to look for any
Entities included in the consolidation Consolidated financial statements should include all subsidiaries (as defined) of the parent except in certain restricted circumstances (as explained below) where some subsidiaries must be excluded. The definition of a subsidiary focuses directly on the concept of control, that is, the parents power to govern the financial and operating policies of an entity so as to obtain benefits from its activities. Thus it is possible for a company that has less than a 50% interest in another still to be considered its parent so long as it controls that other entity. Moreover, since IASs focus directly on control they do not need a concept of a quasi-subsidiary; such entities would simply be subsidiaries. The
Entities included in the consolidation Consolidated financial statements must include those companies over which the parent company has a controlling financial interest through a direct or indirect ownership of a majority voting interest (over 50% of the outstanding voting shares). Certain transactions with SPEs raise questions about whether the SPEs should be consolidated (notwithstanding the lack of majority ownership) and whether transfers of assets to the SPE should be recognised as sales. In respect of an SPE holding a non-financial asset, for non-consolidation and sales recognition by the sponsor or transferor to be appropriate, the majority owners of the SPE must be independent third parties who have made a
33
UK I AS US
UK
I AS
US
34
formal power or ability through which it arises. The concept is put into effect by numerous provisions of company law and of standards. The law uses a series of tests, widely drawn but essentially based on interests in ownership (including options), rather than using the concept of control directly. However, the effect in practice is very similar. Moreover, any undertaking which is controlled as described above, but fails the legal tests, would fall under the definition of a quasi-subsidiary. Some subsidiaries are required to be excluded from consolidation. The main such exclusion is where there are severe long-term restrictions that have the effect in practice of substantially hindering the exercise of the rights of the parent company over the assets or management of that undertaking. Broadly speaking, this means that where an undertaking meets one of the subsidiary undertaking definitions (which are not directly based on control) but it is not actually controlled by the (apparent) parent, then ipso facto it must be excluded. If significant influence was nevertheless still exerted on the subsidiary it would be treated like an associate and be equity accounted. The second required exclusion is where the interest of the parent company is held exclusively with a view to subsequent resale within approximately one year of its acquisition and the undertaking has not previously been included in the parents consolidation. Subsidiaries accounting periods and policies Wherever practicable, the accounts of subsidiary undertakings which are used for the purpose of consolidation should be prepared to the same yearend and cover the same accounting period as the parent (even if this means preparing accounts specially for this purpose). Where, rarely, this is not principles are no different for SPEs. However, in that particular case there is additional guidance on determining whether in substance the SPE is controlled. For example, control would usually exist if the parent has the right to the majority of benefits of the SPEs activities, however these are conveyed; the same applies if the parent retains the risks of the SPEs assets by, for instance, the other investors receiving mainly a lenders return. A subsidiary should be excluded from consolidation in two cases. The first is where the subsidiary operates under severe long-term restrictions which significantly impair its ability to transfer funds to the parent. This differs from that of the UK which looks simply at the restrictions effect on control. The second exclusion is where control is intended to be temporary because the subsidiary is acquired and held exclusively with a view to its subsequent disposal in the near future. Temporary is not defined, but in our view one year, following the UK approach, is generally considered the limit. Such excluded subsidiaries are instead treated as investments (see 6.6), ie there is no possibility of their being treated as associates. substantive capital investment in the SPE, have control of the SPE, and have substantive risks and rewards of ownership of the assets of the SPE including residuals. Where SPEs asset is a financial one then a different approach applies: the majority owners must be able to sell or pledge their interests; the SPE must be legally separate from the transferor; and the SPEs activities are limited at law to, broadly, holding the asset in question. If these conditions are not met, transfer or nonconsolidation still apply if the non-financial asset tests are met. A majority owned subsidiary is not consolidated if control is likely to be temporary or does not rest with the majority owner (because of bankruptcy, reorganisation, foreign exchange restrictions, governmental controls, etc).
5. General issues
Subsidiaries accounting periods and policies Where practical, a subsidiarys accounting period, for the purposes of consolidation, should be the same as that of the parent. Where different periods are used the gap must be no more than three months either way and adjustments should be made for significant transactions in the intervening period.
Subsidiaries accounting periods and policies If the difference in fiscal periods of a parent and subsidiary is not more than three months, it is usually acceptable to use, for consolidation purposes, the subsidiarys statements for its fiscal period. Material events in the intervening period should be disclosed.
practicable, it is permitted to use a subsidiary undertakings non-coterminous accounts provided that its period end is not more than three months before that of the parent and adjustments are made for material events in the intervening period. Assets and liabilities of subsidiary undertakings should generally be included in the consolidation on the basis of uniform accounting policies. Where the policies followed in any particular subsidiarys individual financial statements differ from those of the group then appropriate adjustments must be made on consolidation. Where, exceptionally, the directors of the parent consider that there are special reasons for departing from this procedure, and the policies so adopted are acceptable in themselves, then disclosure of the reasons must be given; in practice this is rare indeed. Minority interests Minority interests are calculated as the minority share of the assets and liabilities as included in the balance sheet (other than goodwill). This means that minority interests are based on fair values at the time of acquisition plus post-acquisition profits under the parents policies. Losses in a subsidiary are required to produce a negative minority interest save to the extent that the group has any commercial obligation (whether formal or implied) to provide finance that may not be recoverable in respect of the accumulated losses attributable to the minority. Thus a negative balance is more likely than under the IAS and US approach.
Where practical, uniform accounting policies should be used throughout the group. If, because of impracticability, uniform accounting policies are not used then this fact should be disclosed together with the proportions of the items in the financial statements to which different accounting policies have been applied.
While accounting policies throughout the group must be in accordance with US GAAP, uniformity of accounting policies is not required. Disclosure should generally be made where accounting policies followed by various divisions, subsidiaries, etc, of the company are not consistent.
5. General issues
Minority interests The Benchmark Treatment for minority interests is for them to be based on the book values of the assets and liabilities as reported by the subsidiary itself, ie the US treatment. The Allowed Alternative Treatment follows the UK approach. Losses in a subsidiary may create a debit balance on minority interests only if the minority has an obligation to make good the losses.
Minority interests Minority interests are generally based on the minority share of the book values of the assets and liabilities as reported by the subsidiary itself. Losses in a subsidiary may only create a debit balance on minority interests if the minority has an obligation to make good the losses. Future developments A current FASB exposure draft proposes to change the basis of inclusion in the consolidation to one of control rather than ownership. An exemption for temporary control would remain.
35
UK I AS US
UK
I AS
US
36
5.7
Business combinations
(CA 85, FRS 6, FRS 7, FRS 10)
5.7
(IAS 7, IAS 22, IAS 27, SIC 9, SIC 17)
5.7
(APB 16, SFAS 79, SFAS 109, EITF 95-3, EITF 95-19, B50)
A merger is more simply defined than in the US, including a size test; it is rare. Costs of restructuring the acquired entity are always charged to the profit and loss account. Post-1997 positive goodwill is capitalised and amortised over up to 20 years but optionally longer, even an indefinite period. Negative goodwill is shown as a negative asset and is taken to the profit and loss account in the amount of the acquired non-monetary assets as they are depreciated or sold and the balance in the periods expected to benefit. There are special rules governing group reconstructions.
A uniting-of-interests is more simply defined than in the US, and includes a size test. Unitings-of-interests are rare in practice. Some restructuring costs are included in he purchase price where the acquirer has announced certain details at the date of acquisition. Post-1994 positive goodwill must be capitalised and amortised over a finite life, usually not more than 20 years. Negative goodwill is presented as a negative asset and is taken to income, first, to match any costs that it has been identified with, then to match and to the extent of the depreciation of acquired non-monetary assets and any balance thereafter is taken immediately to income. There are no rules dealing with transactions between companies under common control.
A pooling-of-interest is defined at length but does not include a size test; it is comparatively common. Certain costs of restructuring the purchased entity can be recorded as part of the purchase price. Positive goodwill must be capitalised and amortised over up to 40 years. Negative goodwill on a purchase is credited first against acquired non-current assets and the balance to a deferred credit thereafter released over up to 40 years. There are special rules for transactions between companies under common control.
5. General issues
Applicability of merger or acquisition accounting Accounting standards and company law set out certain criteria which, if met, require a business combination to be accounted for as a merger. This is a rare occurrence. In all other cases acquisition accounting must be used. They are not alternatives. The criteria are designed to determine whether a business combination meets the conceptual definition of a merger as one that results in the creation of a new reporting entity formed from the combining parties, in which the shareholders of the
Applicability of uniting-of-interests or purchase accounting Uniting-of-interests accounting must be used for a business combination where, rarely, no acquirer can be identified; purchase accounting applies in all other cases (ie, the vast majority). Although the principle by which a uniting-of-interests is defined is that no acquirer can be identified - that is, the shareholders of one party do not obtain control over the combined entity - the standard gives guidance on characteristics that must be present in such a uniting-of-interests, as set out below.
Applicability of pooling-of-interests or purchase accounting While both purchase and pooling-of-interests accounting are used in the US, they are not alternatives. Pooling must be used if certain criteria are met. These criteria relate to the attributes of the combining entities before the combination, the manner of combining the entities, and the absence of certain planned transactions but do not include a size test. In outline, they are as follows:
combining entities come together in a substantially equal partnership for the mutual sharing of the risks and benefits of the combined entity, and in which no party to the combination in substance obtains control over any other, or is otherwise seen to be dominant. The reporting entity formed by a merger must be regarded as a new entity rather than the continuation of one of the combining entities, enlarged by its having obtained control over the others. An acquisition is a business combination which is not a merger. The merger accounting criteria (re-arranged to effect comparison with IAS) are set out below. They are much more conceptual than those of the US and are perhaps more sharply delineated than those of IAS. Autonomy of each party: Merger accounting is not appropriate where one of the parties results from a recent divestment by a larger entity since, until it has established its own track record, it will not have been independent for a sufficient period to establish itself as a party separate from its previous owner. Portrayal: No party to the combination is portrayed as either acquirer or acquired, by its own board or management or by that of another party to the combination. Management: All parties to the combination, as represented by the boards of directors or their appointees, participate in establishing the management structure for the combined entity and in selecting the management personnel, and such decisions are made on the basis of a consensus between the parties to the combination rather than purely by exercise of voting rights.
Management: The management of one party should not be able to dominate the selection of the management team of the enlarged entity. Share-for-share: The substantial majority, if not all, of the voting common shares of the combining entities are pooled, ie exchanged for shares rather than for, say, cash. One party must not pool equity shares in return for combinedentity equity shares with reduced rights. Relative size: The fair value of one party is not significantly different from that of the other. No change in interests: The shareholders of each party maintain substantially the same voting rights and interests in the combined entity, relative to each other, after the combination as before. For example, the share exchange ratio cannot give a premium to one party. No other financial arrangements: The financial arrangements do not otherwise provide a relative advantage to one group of shareholders over the other. For example, one partys share of the combined equity should not depend on the post-combination performance of the business that it previously controlled. Such arrangements may take effect prior to or after the business combination itself. Transactions among companies under common control, eg some group reconstructions, and business combinations in the accounts of a jointly controlled entity are not dealt with by IASs.
Attributes of the entities - autonomy: Each of the combining entities is autonomous and has not been a subsidiary or division of another entity within two years before the plan of combination is initiated. Attributes of the entities - independent of each other: Each of the combining entities is independent of the other combining entities (ie, inter-corporate investments do not exceed 10% of the outstanding voting common stock of any combining entity). Manner of combining - single transaction: The combination is effected in a single transaction or is completed in accordance with a specific plan within one year after the plan is initiated. Manner of combining - share-for-share exchange: An entity offers and issues only common stock with rights identical to those of the majority of its outstanding voting common stock in exchange for substantially all (90% or more) of the voting common stock interest of another entity at the date the plan of combination is consummated. Manner of combining - no prior changes to equity: None of the combining entities changes the equity interest of its voting common stock in contemplation of effecting the combination (such as distributions to stockholders, new issues, exchanges and retirements of securities) either within two years before the plan of combination is initiated or between the dates the combination is initiated and consummated.
5. General issues
37
UK I AS US
UK
I AS
US
38
Share-for-share: Under the terms of the combination, equity shareholders of each party to the combination receive, in relation to their equity shareholdings, no consideration other than equity shares in the combined entity, with the following exception. They are, however, permitted also to receive non-equity consideration (or equity shares with reduced rights) provided that this represents an immaterial proportion of the fair value of the consideration received. In addition, at least 90% of the new subsidiary must be obtained. Relative size: The relative sizes of the combining entities are not so disparate that one party dominates the combined entity by virtue of its relative size. A party would be presumed (subject to rebuttal) to dominate if it is more than 50% larger than each of the other parties to the combination, judged by reference to the ownership interests; that is, by considering the proportion of the equity of the combined entity attributable to the shareholders of each of the combining parties. Thus in a two-party combination the limiting ratio, subject to rebuttal, is 60% : 40%. No change in interests: Where the pricing of the combination puts a bid premium on one partys shares - ie, the post-combination relative interests are not in the same proportions as the pre-combination ones - then unless there is a clear explanation to the contrary this portrays the combination as an acquisition and merger accounting is prevented. No other financial arrangements: No equity shareholders of any of the combining entities retain any material Manner of combining - no stock repurchases: Each of the combining entities re-acquires shares of voting common stock only for purposes other than the business combination (such as stock option and compensation plans) and no entity re-acquires more than the normal number of shares between the dates the plan of combination is initiated and consummated. Stock repurchases in the two years before initiation are presumed to be for the purpose of the combination, known as tainted stock and are also counted as non-share consideration for the purposes of the share-for-share condition above. Manner of combining - no change to stockholders proportionate interests: The ratio of the interest of an individual common stockholder to those of other common stockholders in a combining entity remains the same as a result of the exchange of stock to effect the combination. Manner of combining - no restrictions on stockholders rights: The voting rights to which the common stock ownership interests in the resulting combined entity are entitled are exercisable by the stockholders; the stockholders are neither deprived of nor restricted in exercising those rights for a period. Manner of combining - no contingent consideration: The combination is resolved at the date the plan is consummated and no provisions of the plan relating to the issue of securities or other consideration are pending. Absence of planned transactions - no future stock repurchases: The combined entity does
5. General issues
interest in the future performance of only part of the combined entity. For example the existence of a material minority would prevent merger accounting. A minority of 10% is acknowledged by the law and standards as being too much. However, this should not be applied as an arithmetic test. Some lesser figures would also be judged material. In assessing the consideration received by all parties (see above), any related arrangements should also be considered. In particular, where one of the combining entities has, within a period of two years before the combination, acquired equity shares in another of the combining entities, the consideration for this acquisition should be taken into account in determining whether this criterion has been met. There are special rules governing group reconstructions. These permit merger accounting where the definition of a merger is not met, provided certain conditions are fulfilled.
not agree directly or indirectly to retire or reacquire all or part of the common stock issued to effect the combination. Absence of planned transactions - no other financial arrangements: The combined entity does not enter into other financial arrangements for the benefit of the former stockholders of a combining entity, such as a guarantee of loans secured by stock issued in the combination, that in effect negates the exchange of equity securities. Absence of planned transactions - no disposals: The combined entity does not intend or plan to dispose of a significant part of the assets of the combining entities within two years after the combination other than disposals in the ordinary course of business of the formerly separate entities and to eliminate duplicate facilities or excess capacity. Subsequent transactions - no short-term stock sales: A controlling shareholder of any party to the combination does not sell his stock in the combined entity until financial results of the combined entity are published (covering at least 30 days post-combination). In practice poolings-of-interest are fairly common; as a result the FASB is minded to prohibit them altogether (see Future developments below). In addition, transactions between companies under common control are ordinarily accounted for in a manner similar to pooling-of-interests. The above rules also apply to business combinations in the financial statements of equity method investees.
5. General issues
39
UK I AS US
UK
I AS
US
40
Acquisition accounting Fair value of assets and liabilities acquired general rules Under acquisition accounting, the identifiable assets and liabilities of an acquired entity that existed at the date of acquisition - including any separable intangibles - are recorded at fair values (as defined) which reflect the conditions at the date of acquisition and the accounting polices of the acquirer. The difference between those fair values and the cost of the acquisition is goodwill: positive goodwill is capitalised and amortised usually over no more than 20 years, although longer or even indefinite periods are permitted (see 6.1); positive goodwill from before 1998 may be set off directly against shareholders funds (see 6.1); the treatment of negative goodwill is described later in this section. Based on the identifiable principle the following must be treated as post-acquisition items: changes resulting from the acquirers intentions or future actions; impairments, or other changes resulting from events subsequent to the acquisition; and future operating losses as well as reorganisation and integration costs expected to be incurred as a result of the acquisition, whether they relate to the acquired entity or to the acquirer. There are rules governing the application of these principles to specific classes of asset and liability, as follows: The fair value of acquired monetary assets and liabilities must reflect the timing of receipt or payment (ie, by discounting). Fair values of tangible fixed assets and investments are normally based on market value or depreciated replacement cost. Fair value of an intangible asset is normally market value. Purchase accounting Fair value of assets and liabilities acquired general rules Under purchase accounting, the identifiable assets and liabilities of the acquired entity that existed at the date of acquisition, plus certain restructuring provisions, are brought in at fair value. The identifiable assets include any intangibles that can be reliably measured (see 6.1). The difference between the aggregate of the fair values and the cost of acquisition is goodwill. Goodwill is dealt with at more length later on (see 6.1), but broadly that arising after 1994 is capitalised and amortised over a finite life usually, although not necessarily always, of less than 20 years; positive goodwill from before 1995 may be set off directly against equity. Negative goodwill is dealt with below. The restructuring provisions that must be recognised, even though they are not a liability of the acquired entity, are in respect of the acquirers restructuring of the acquired entity, the main features of which have been planned and announced by the date of acquisition; a detailed formal plan is then required within three months of acquisition or by the date of approval of the financial statements (whichever is the earlier). Developments-in-progress must be capitalised and amortised. In other respects the rules for determining the fair values of particular classes of assets and liabilities are broadly similar to those of the UK. Where less than the whole of an entity is acquired the gross asset and liability values and minority interest may be determined on the US fair-and-book mixed basis Purchase accounting Fair value of assets and liabilities acquired general rules The purchase method accounts for a business combination as the acquisition of one entity by another. The acquirer records the acquired assets, less liabilities assumed, at cost to the acquirer. The difference between the cost of an acquired entity and the sum of the fair values of tangible and identifiable intangible assets, less liabilities assumed, is recorded as goodwill and, if positive, is capitalised and amortised (over a period not to exceed 40 years - see 6.1). Negative goodwill is dealt with as set out below. In the US, redundancy and reorganisation acquisition-accruals are generally not allowed; only the direct costs of an acquisition should be included in the cost of a purchased entity. Indirect expenses of the acquiring company, including costs associated with the closing of duplicate facilities, should be charged to expense when incurred. Costs of a plan to exit an activity of an acquired company, or terminate involuntarily employees of an acquired company, or relocate employees of an acquired company, should be recognised as liabilities assumed in the purchase if specified conditions (in EITF 95-3) are met. Those conditions are similar to the normal rules for restructuring provisions (see 6.12), save that at the time of acquisition management needs only to begin to assess the restructuring plan and within one year to finalise that plan and communicate it to relevant employees. In other respects the rules for determining the fair values of particular classes of assets and liabilities are broadly similar to those of the UK. However, the
5. General issues
Fair value of stock (inventory) and work-inprogress allows for the subsequent realisation of a trading profit. Fair value of subsidiaries or businesses subsequently sold or held exclusively for resale (and consequently not consolidated) is equal to net sale proceeds. Pension surpluses (to the extent recoverable) and deficits are recognised in full. Deferred tax is assessed from the perspective of the new group (see below for further details). Any developments of the acquired entity which are separable and measurable - in practice this probably means those that meet the SSAP 13 criteria (see 6.1) must be recognised as an acquired intangible asset (otherwise goodwill would be mis-stated). The fair value of such a development would be its replacement cost (normally its estimated market value). The identifiable assets and liabilities recognised in this way could include items that were not previously recognised in the financial statements of the acquired entity because other accounting standards precluded their recognition. For example, it may be appropriate to assign a value to contingent assets (the recognition of which is normally prohibited by FRS 12). Even if the acquired entity is not wholly owned the assets and liabilities, and minority interests therein, are stated at fair value. The period allowed for determining and adjusting the fair values as at the date of acquisition, and thus goodwill, must not go beyond the end of the first full financial (ie, reporting) year following the acquisition.
(Benchmark Treatment) or the UK full fair value basis (Allowed Alternative). As in the UK, the period for determining and adjusting the fair values of the assets and liabilities, against goodwill, must not go beyond the end of the first annual accounting period commencing after the acquisition, but with one exception. The acquirers restructuring provision cannot be increased against goodwill after the earlier of three months from the date of acquisition and the approval of the first financial statements including the acquisition; and any reversals of the provision are always adjusted against goodwill. Push down accounting per se is not permitted under IASs. However, some fair value adjustments could be reflected in the acquired entity as revaluations of property, plant and equipment (but this would require the valuations to be kept up-todate) or as accounting policy changes (provided it results in a more appropriate presentation).
fair values of intangibles, property and nonmarketable investments are to be determined in the manner most appropriate to the circumstances. Moreover, whilst the purchase price allocation must include intangible assets in respect of research and development activities (in-process R&D), unless these have any alternative future benefits they must be written off to the income statement immediately after the date of acquisition; this is a highly contentious issue, and the propriety of the amount allocated to in-process R&D is a hot topic with the SEC. Where the acquired entity is not wholly owned the assets and liabilities are stated at fair value to the extent acquired with the remainder, and the minority interest caption itself, at the acquired entitys book value. The period allowed for determining and adjusting the fair values as at the date of acquisition, and thus goodwill, must not go beyond one year from the date of acquisition, subject to one exception. Downward adjustments to (allowable) reorganisation provisions (see above) are always adjusted against goodwill. Under certain circumstances, SEC registrants may be required to reflect the purchase price of assets and liabilities acquired in the separate financial statements of the acquired company. Additionally, if the acquiring company is to issue either debt or mezzanine (see 6.8) financing and the acquired company (if it becomes wholly owned) either assumes, guarantees or will offer its own debt or equity to retire any of the debt of the acquirer, the debt and related interest cost should be reflected in the separate financial statements of the acquired company. Such accounting is known as push-down accounting.
5. General issues
41
UK I AS US
UK
I AS
US
42
Push-down accounting is not permitted in the UK. However, certain fair value adjustments (eg, fixed asset revaluations provided they were carried out regularly thereafter) and accounting policy alignments may be reflected in the financial statements of the acquired entity. Fair value of assets and liabilities acquired negative goodwill Negative goodwill is presented as a separately identified deduction from positive goodwill on the face of the balance sheet. Its amount, up to the fair value of the acquired non-monetary assets, is credited to the profit and loss account as those assets are recovered through depreciation or sale. The remaining amount is taken to the profit and loss account in the periods expected to benefit; the FRS gives no further guidance on that period save to say that the credit should not be linked to future costs and losses that do not constitute identifiable liabilities, such as restructuring costs. Fair value of assets and liabilities acquired negative goodwill Unamortised negative goodwill is presented as a deduction from the asset category containing positive goodwill - effectively as a negative asset. It is amortised, that is, credited to the income statement, as follows: first, to the extent that it relates to certain postacquisition costs (explained below), at the same time as those costs; the balance, up to an amount of the fair value of the non-monetary assets acquired, over the life of the depreciable assets; and then any remaining balance, immediately. The post-acquisition costs referred to above are those expected losses and expenses, not being acquired entity liabilities or permitted restructuring provisions, that are identified in the acquirers plans for the acquisition. This would seem to include, for example, a period of operating losses that the acquirer foresees that the acquired entity will sustain before a turnaround can be effected. Fair value of assets and liabilities acquired deferred tax Fair value adjustments may give rise to timing differences for which deferred tax assets and liabilities should be recognised on acquisition. Any such assets and liabilities should be recognised only to the extent that it is probable than an asset or liability will crystallise in accordance with the Fair value of assets and liabilities acquired deferred tax Since deferred tax liabilities (and assets to the extent that it is probable that they will be recovered) arise whenever there is a difference between the book and tax values of assets and liabilities (see 6.11), it follows that deferred tax is provided on all fair value adjustments (but not on Fair value of assets and liabilities acquired deferred tax SFAS 109 (see 6.11) requires a deferred tax liability or asset to be recognised for book-vs-tax basis differences arising in purchase accounting (eg, fair value adjustments to the acquired entitys assets) except for non-tax-deductible goodwill, allocated negative goodwill and leveraged leases. In Fair value of assets and liabilities acquired negative goodwill Negative goodwill is allocated proportionately to reduce the values assigned to non-current assets (except long-term investments in marketable securities). If these non-current assets are thereby reduced to a zero value, any remaining negative goodwill is treated as a deferred credit and is amortised systematically to income over the period estimated to benefit, not exceeding 40 years.
5. General issues
normal SSAP 15 partial provision rules (see 6.11). The crystallisation should be determined by considering the enlarged group as a whole (in order to avoid the post-acquisition profit and loss account reflecting a change in assumptions). Thus, where an acquired entity has accumulated losses for tax purposes, the fair value of such losses, where recoverable from an enlarged group point of view, is recognised as a deferred tax asset (and setoff against any deferred tax liability). Subsequent recovery (or re-assessment) in excess of the initially recognised amount would give rise to a reduced tax charge if the recovery (or re-assessment) occurred after the end of the period allowed for adjusting fair values (see above). Cost of acquisition The cost of an acquisition is determined as the amount of cash paid and the fair value of any other purchase consideration given by the acquirer, together with the expenses of acquisition (as defined). This is measured at the effective date of the acquisition (see below). Thus, the cost of acquisition includes contingent consideration and it is to be provided for at acquisition on a best estimate basis. Revised estimates would be made in subsequent years, with the cost of acquisition and goodwill being adjusted, until the ultimate outcome is known. Where contingent consideration is to be satisfied by the issue of shares, there is no obligation to transfer future economic benefits and thus no liability. Instead the contingent amount would be reported within shareholders funds as a separate (non-statutory) item usually called shares to be issued.
5. General issues
non-tax deductible goodwill itself). In doing so the recoverability of deferred tax assets is considered from the enlarged groups perspective. If a deferred tax asset of the acquired entity is subsequently recovered in excess of the amount recognised on acquisition then the whole such amount is taken to the income statement. However, at the same time and largely off-setting this, the original goodwill, and its accumulated amortisation, are adjusted through the income statement with the benefit of this hindsight. There is no time limit for these adjustments. The goodwill adjustment, nevertheless, is subject to the proviso that it must not create or increase negative goodwill. Cost of acquisition The cost of an acquisition is the amount of cash or cash equivalents paid, or the fair value of the other purchase consideration given, plus any costs directly attributable to the acquisition. In our view this is measured at the date of acquisition (see below). Contingent consideration is provided for at the outset where it is probable that it will be paid. It is subsequently adjusted against goodwill, as the estimate of the amount payable is revised. In addition, any payments made by the acquirer under a guarantee of the value of its shares or debt given as consideration are not themselves consideration but are debited to shareholders equity or against the debt as the case may be. Costs directly attributable to the acquisition include the usual professional fees as well as the costs of
accordance with the normal deferred tax rules, a deferred tax asset (net of a valuation allowance) is recognised to the extent that it is more likely than not that it will be recovered. If a valuation allowance is recognised for a deferred tax asset at the acquisition date but the asset is subsequently recovered, then goodwill is adjusted. The tax benefits recovered (that is, by elimination of that valuation allowance) are applied: first, to reduce to zero any goodwill related to the acquisition; second, to reduce to zero other noncurrent intangible assets related to the acquisition; and, third, to reduce income tax expense.
Cost of acquisition The cost of acquisition is generally measured by the fair value of the consideration or, in rare cases, the fair value of the acquired company, if that is more clearly evident. It is measured at the date on which the parties reach agreement and announce the transaction. Contingent consideration (eg, possible future cash payments or stock issues) forms part of the cost of acquisition (and thus goodwill) and is recognised when the contingency is resolved and the consideration becomes payable (or issuable). This may result in later recognition than under UK GAAP. As in the UK, any payments made under guarantees of the value of its shares or debt issued as consideration, would themselves be additional consideration for the acquisition.
43
UK I AS US
UK
I AS
US
44
Any payments made under guarantees of the value of its shares or debt issued as consideration, would themselves be additional consideration for the acquisition. Fees and similar incremental costs incurred directly in making an acquisition should be included in the cost of acquisition, except for the expenses of issuing shares or other securities that are issue costs under FRS 4 (see 6.8) and which are required by that standard to be accounted for as a reduction in the proceeds of the capital instrument. Internal costs, and other expenses that cannot be directly attributed to the acquisition, should be charged to the profit and loss account. Effective date of acquisition The effective date of an acquisition is the date at which control - the direction of the financial and operating policies with a view to gaining economic benefits - passes to the purchaser. Effective date of acquisition The date of acquisition is the date on which control is effectively transferred to the acquirer. Effective date of acquisition The effective date for an acquisition is ordinarily the date assets are received and other assets are given up or securities are issued. However, another date, such as the end of an accounting period, between the date of initiation and consummation of the transaction may be used as the effective date if certain conditions are met. The conditions are that: the purchase agreement specifies the date; effective control (ie, all risks and rewards of ownership) pass to the acquirer at that date; and the time between this date and the closing date is relatively short (delays due to obtaining any regulatory approval excepted). Where the effective date for an acquisition is other than the date the consideration passes, the cost of the acquired company and net income for the period should be reduced by imputed interest at an appropriate current rate. issuing equity securities but exclude the costs of issuing debt, which are deducted from the debts carrying value. Internal costs cannot be included. The cost of acquisition also includes those direct costs that would not have been incurred had the acquisition not been initiated. However, the registration and issue costs of equity securities are dealt with as a reduction of equity.
5. General issues
Merger accounting The fundamental principle of merger accounting is that the consolidated financial statements of the combined entity (that is, the parent company of the enlarged group) are prepared as if the merger had always been in existence. The accounts of the parties to the combination are aggregated and the accounts of the combined entity therefore reflect the history of all combining parties. Adjustments are, of course, made in the aggregation process; items have to be included on the basis of uniform accounting policies. Furthermore, one of the combining entities will have issued shares, and perhaps given other consideration, in order to acquire the merging subsidiary undertaking. As part of the mechanics of consolidation, the amount at which the parents investment in the subsidiary undertaking is stated in its individual accounts (which would normally be the nominal value of the shares issued together with the fair value of the other consideration given) is set off against the share capital and reserves (of the other group). The difference between this amount and the nominal value of the shares received in exchange is shown as a deduction from, or addition to, consolidated reserves (it is not goodwill). Merger expenses must not be included as part of this difference, but should be charged through the profit and loss account of the combined entity at the effective date of the merger, as fundamental reorganisation or restructuring expenses, falling under paragraph 20(b) of FRS 3 (see 5.1), that is, as a separate item on the face of the profit and loss account after operating profit and before interest. Merger expenses are not defined but the natural interpretation would seem to be those costs which
Uniting-of-interests accounting Since a uniting-of-interests involves no acquisition but a continuation of the businesses that existed before, the financial statements of the combining parties are simply added together for the current and all prior periods. An adjustment, similar to the UKs merger difference, arises and is taken to equity. In the process of combination uniform accounting policies are adopted to the normal extent (see 5.6).
Pooling-of-interests accounting The pooling-of-interests method accounts for a business combination as the uniting of the ownership interests of two or more companies by exchange of equity securities. No acquisition is recognised because the combination is accomplished without disbursing resources of the constituents. Ownership interests continue and the former bases of accounting are retained. The recorded assets and liabilities of the constituents are carried forward to the combined entity at their previously recorded amounts. Income of the combined entity includes income of the constituents for the entire fiscal period in which the combination occurs. Prior periods are restated as if the companies had been combined throughout each period. This prior period restatement includes aligning of the accounting policies of the smaller combining entity with those of the larger. (Any change in policy of the larger combining entity is dealt with in the normal way.) An amount analogous to the UKs merger difference is dealt with as additional paid-in capital. Future developments The FASB has issued proposals for a new business combinations standard. Pooling-of-interests accounting would not be permitted in any circumstances. The maximum life of goodwill would drop to 20 years. For other intangible assets there would be a presumed maximum life of 20 years but, if certain conditions are met longer, longer periods may apply (without annual impairment testing); moreover, in particular amortisation will not be required if the life is indefinite and there is an observable market price for the intangible.
5. General issues
45
UK I AS US
UK
I AS
US
46
would fall within expenses of acquisition under FRS 7 (see above). The fact that the standard requires merger expenses to be presented as costs of a fundamental reorganisation might suggest that it has a wider class of costs in mind. However, in our view, any rationalisation and reorganisation costs consequent upon the merger should be treated in accordance with the normal rules as applied to the enlarged entity as if it had always existed.
5.8
Foreign currency translation

(SSAP 20, UITF 9)
5.8

(IAS 21, IAS 29, SIC 11)
5.8

(SFAS 52, F60)
The concept of a functional currency is used. For translating foreign entities (other than extensions of the parents own trade), either the closing or an average rate may be used for the profit and loss account. Fair value adjustments and capitalised goodwill on such a foreign entity must be retranslated. The cumulative exchange adjustment is not taken into account on a sale or termination of a foreign entity. Foreign entities in hyper-inflationary economies may be remeasured in a stable currency or dealt with by constant purchasing power adjustments.
5. General issues
There is no definition, or explicit mention, of functional currency. For translating foreign entities (ie, those not integral to the parents operations) the actual, or an average, rate must be used for the income statement. Goodwill and fair value adjustments in respect of such a foreign entity may be either included within or excluded from the translation of the entitys financial statements. On a sale or liquidation of such a foreign entity the cumulative translation adjustment is taken through the income statement (as part of the gain or loss on sale). Foreign entities in hyper-inflationary economies are dealt with by constant purchasing power adjustments or, subject to SIC deliberations, by remeasurement into a stable currency.
The concept of functional currency is used. For translating foreign enterprises (other than extensions of the parent company), the actual, or an average, rate must be used for the profit and loss account. Fair value adjustments and goodwill arising on such a foreign entity must be retranslated. On the sale or liquidation of a foreign enterprise the cumulative translation adjustment is taken into the income statement as part of the gain or loss. Foreign entities in highly-inflationary economies must be measured in the groups reporting currency.
Functional currency A companys functional currency is defined as the currency of the primary economic environment in which it operates and generates net cash flows. There is little guidance on interpreting this definition but it is generally thought to be broadly equivalent to that of the US. SSAP 20 does not include a specific requirement to prepare accounts in the functional currency, although this is almost always done. Occasionally, however, a non-Sterling functional currency company (perhaps an international crude oil producer) will for the convenience of the reader report in Sterling (by a net investment method translation - see below - from the functional currency).
Functional currency IASs have no explicit concept of functional currency. Whatever currency the accounts are presented in is simply known as the reporting currency (all other currencies are foreign currencies) and its role in the translation processes is similar to that of the US and UK functional currency. There are no rules governing the selection of the reporting currency although the standard observes that it would usually be the currency of the country in which the company is domiciled. So in most cases this reporting currency will probably be the same as the US and UK functional currency. In cases where the company intends to present accounts in a currency that has no relevance for its operations it may be necessary to take the view that its operations are in effect a foreign entity (dealt with further below) so far as that reporting currency is concerned. Thus the apparent free choice of the underlying functional-like currency may not exist in practice. The SIC proposes to clarify this issue along the lines set out above. Foreign currency transactions Each foreign currency transaction, ie the assets, liabilities, gain or loss arising therefrom, is recorded in the reporting currency at the rate of exchange at the date of the transaction. At each balance sheet date the monetary assets and liabilities (ie, those to be received or paid in fixed or determinable amounts of money) are translated at the exchange rate at the balance sheet date. In general the resulting exchange gains and losses are dealt with in the income statement. Where an asset has been purchased in the last year, it was invoiced in a foreign currency, a liability arising on its acquisition cannot yet be settled and
Functional currency A companys functional currency is defined as the currency of the primary economic environment in which the company operates. Normally this is the currency of the environment in which the company generates and expends cash. The functional currency of a foreign operation is, in most cases, a matter of fact. In some situations, however, the facts may not identify clearly the functional currency, and managements judgment is required to determine the functional currency that best achieves the objectives of translation.
5. General issues
Foreign currency transactions In general each asset, liability, revenue or cost arising from a foreign currency transaction should be translated into the functional currency at the exchange rate in effect on the date of the transaction. At each balance sheet date monetary assets and liabilities (ie, amounts to be received or paid in money) denominated in a foreign currency are translated using the exchange rate at that balance sheet date. The resulting exchange gains or losses are reported in the profit and loss account. Equity investments in foreign entities (ie, subsidiaries, associates, joint ventures and branches) are non-monetary assets and are not
Foreign currency transactions Foreign currency transactions are transactions denominated in a currency other than the companys functional currency. At the date the transaction is recognised, each asset, liability, revenue, expense, gain or loss arising from the transaction is measured and recorded in the functional currency of the reporting company using the exchange rate in effect at that date. At each balance sheet date, monetary items that are denominated in a currency other than the functional currency of the reporting company are adjusted to reflect the current exchange rate. Resulting gains and losses (except for those items which qualify for hedge accounting), are included in the determination of net income for that period.
47
UK I AS US
UK
I AS
US
48
normally retranslated (but see 5.9 for hedging of such investments). Intra-group loans and other deferred balances which are, for all practical purposes, as permanent as an equity investment should be considered to be part of a companys equity investment. there is a severe devaluation of the currency of that liability against which there is no means of hedging then an Allowed Alternative Treatment is available. The devaluation exchange losses on that liability may be capitalised into the related asset (provided that it does not exceed its recoverable amount, or replacement cost if lower). These circumstances are expected to be rare. Equity investments in foreign entities (subsidiaries, associates, joint ventures or branches) are not monetary assets and so are not retranslated. However, monetary items that in substance form part of the net investment in the foreign entity, ie receivables and payables (other than trade items) for which settlement is neither planned nor likely for the foreseeable future, are retranslated but with the exchange differences taken directly to equity. Translation of foreign currency financial statements Where, exceptionally, the trade of the foreign entity is more dependent upon the economic environment of the investor companys currency (eg, the investees functional currency is the same as that of the investor) then its accounts should be translated as if the investor company had entered into the investees transactions itself (ie, as described above). This is known as the temporal method. More normally, this is not the case. Rather, the normal method of translation is known as the closing rate or net investment method: assets and liabilities are translated from the foreign entitys functional currency balance sheet at the rate on the balance sheet date; the profit and loss account may be translated at either that closing rate or at an average rate for the year; and the resulting exchange gains and losses are excluded from the profit and Translation of foreign currency financial statements Where a foreign operation is an integral part of the operations of the reporting company, its financial statements should be translated as if its transactions were those of the reporting company (ie, as above). However, in most practical cases the operations are not integral, and are termed foreign entities. In these cases the assets and liabilities are translated at the rate on the balance sheet date; items in the income statement are translated at rates as at the dates of the relevant transactions, although an appropriate average rate may be used; exchange differences so arising are taken directly to equity. The cumulative amount of this translation adjustment must be disclosed. In performing this last mentioned translation, goodwill and fair value adjustments in respect of Translation of foreign currency financial statements The functional currency of a foreign entity will not always be the currency of the country in which it is located or the currency in which its records are maintained. Such a situation will occur, for example, when the entity is merely an extension of the parent company. In that case, the functional currency would be the reporting currency of the parent company (and it would be translated as if its transactions were those of the parent, ie as above). For subsidiaries for which the local currency is the functional currency, the exchange rate at the balance sheet date is used to convert the assets and liabilities at the balance sheet date from the functional currency to the reporting currency. Revenues, expenses, gains and losses are translated at the exchange rate in effect when these items were recognised. In practice, an appropriately weighted average rate may be used. Gains and losses on intra-group foreign currency transactions that are of a long-term investment nature (that is, settlement is not planned or anticipated in the foreseeable future, and this is reassessed at every year end) are included in OCI, provided that the transacting entities are consolidated, combined, or accounted for by the equity method in the reporting companys financial statements.
5. General issues
loss account and instead are reported in the STRGL and as a movement on shareholders funds. There is no requirement to report the cumulative amount of such gains and losses. The closing rate method is applied to the assets and liabilities of the foreign entity as measured in the group accounts, that is after any fair value adjustments arising on the acquisition of that entity. In addition, capitalised acquisition goodwill on a foreign enterprise, recognised in the group accounts, would be retranslated. However, any pre1998 goodwill set off against reserves (see 5.7) need not be retranslated as it is not recognised as an asset in the accounts. (These treatments do not arise from any specific provision of standards but from their underlying principles.)
5. General issues
the foreign entity concerned may either be included as part of the re-translated assets and liabilities or be excluded (and therefore never retranslated). If a foreign entity reports in a currency that has no relevance for its operations it may be necessary to take the view that the accounts must first be translated into a currency of relevance to the operation, as if that currency were its reporting currency (ie, like the US remeasurement process). The SIC is currently considering this point.
Translation adjustments arising from the process of translating an entitys financial statements from the functional currency into the reporting currency are included in OCI, rather than in net income, and are accumulated and disclosed as a separate component of consolidated stockholders equity. If an investor accounts for an investment in a foreign entity using the equity method, the investors financial statements should report a translation adjustment in OCI; that is, the investors share of the adjustment resulting from translation of the investees financial statements. Goodwill and other fair value purchase-accounting adjustments of an acquired foreign entity represent assets of the acquired foreign entity. Accordingly, goodwill and other fair value purchase adjustments and the related accretion and amortisation should be translated at current exchange rates in a similar manner to the other assets and liabilities of the foreign entity. If the accounting records of an entity are maintained in a currency other than its functional currency, they must be converted into its functional currency, by a process called remeasurement, before translation into the reporting currency. The remeasurement process is intended to produce the same accounting result as if the entitys books of record had been maintained in its functional currency. Consequently, historical exchange rates are used for non-monetary items (and related revenues and expenses) denominated in currency other than the functional currency and current exchange rates are used to measure monetary items. Exchange gains and losses that arise from the remeasurement process are reported in determining net income.
If a closing rate method entity does not keep its records in its functional currency then, before translation to the groups reporting currency, they must first be translated to their own functional currency by the temporal method, ie the same as the US remeasurement process.
49
UK I AS US
UK
I AS
US
50
Translation of foreign currency financial statements - hyper-inflation Adjustments are required where the distortions caused by very high inflation (hyper-inflation) in a foreign entity are such as to affect materially the consolidated accounts and in any event are required where the cumulative inflation rate over three years approaches or exceeds 100% and that foreign entity is material. Adjustments are made in one of two ways: adjusting the hyper-inflationary currency financial statements to reflect current price levels (ie, adopting the current purchasing power concept); or by deeming the real functional currency to be a relatively stable currency and thus translating from the hyper-inflationary currency to that relatively stable functional currency using the temporal method. The relatively stable functional currency need not be the functional currency of the parent, that is, a Sterling parent with a hyper-inflationary Latin-American subsidiary might translate its results into US dollars under the temporal method and then translate that to Sterling using the closing rate method. Sale or liquidation of a foreign entity The attributable proportion of the cumulative exchange differences is not included in the calculation of profit or loss on the full or partial sale or termination of a foreign investee. This is because these gains and losses have already been recognised once (through the STRGL) and cannot be taken a second time. Translation of foreign currency financial statements - hyper-inflation IASs do not specify an absolute rate of inflation that is considered to be hyper-inflation. However, they consider that a cumulative inflation rate over three years approaching, or exceeding, 100% is an indication of a hyper-inflationary economy. Before the financial statements of a subsidiary reporting in such a hyper-inflationary currency are translated into the reporting currency they are restated in terms of the measuring unit current at the balance sheet date (ie, the current purchasing power concept is used). The SIC is considering whether it is also acceptable for the financial statements of the subsidiary concerned instead to be reported in a non-hyper-inflationary currency, provided that currency has relevance for the subsidiarys operations, before being translated in the normal way to the groups reporting currency. Translation of foreign currency financial statements - high inflation Highly inflationary economies include those with cumulative inflation of 100% or more over a three year period. The financial statements of a foreign entity in such an economy must be remeasured as if the functional currency were the reporting currency (as discussed above).
5. General issues
Sale or liquidation of a foreign entity The cumulative exchange differences, relating to a foreign entity, that have previously been included directly in equity, should be recognised in the income statement when the foreign entity is disposed (or proportionately so if it is partly disposed of). The standard does not specify whereabouts in the income statement this item is included; in practice it is included as part of the gain or loss on the disposal.
Sale or liquidation of a foreign entity The amount attributable to a foreign entity included in the translation component of stockholders equity should be reported as part of the gain or loss upon sale or upon complete or substantially complete liquidation of that entity. Accordingly, accounting records should be maintained in a manner that will allow the identification of that portion of the separate component of equity that relates to each investment operation. If a company sells part of its ownership interest in a foreign entity, a pro rata amount of the accumulated translation component of equity attributable to that investment should be recognised in measuring the gain or loss on sale.
5.9
Hedging
(SSAP 20, UITF 19)
5.9
Hedging
(IAS 21, IAS 39)
5.9
Hedging
(SFAS 52, SFAS 133, SFAS 137, SFAS 138, D50, F60)
There is no comprehensive standard on hedging. There is no explicit rule on the degree of probability of a hedged future transaction. A hedge of any future transaction is usually held off balance sheet. A non-derivative cannot be used to hedge a future transaction but may hedge a recognised asset or liability or net investment. Hedge gains and losses are never taken to shareholders funds for later recycling. The ineffective portion of a net investment hedge is reported in the profit and loss account.
The requirements are comprehensive and complex. In order to be hedged a future transaction must be highly probable. The cash flow hedging model is applied to all future transaction hedges whether committed or otherwise. A non-derivative may be used to hedge the foreign currency exposure in a recognised asset or liability, a forecast transaction or a net investment. Where a cash flow hedged transaction results in an asset, the hedge gain or loss is recycled out of equity to adjust the assets cost. The ineffective portion of a net investment hedge is nevertheless reported in equity.
The requirements are comprehensive and even more complex than those of IASs. In order to be hedged a future transaction must be probable. Either the fair value or the cash flow model may be used where a derivative hedges the foreign currency exposure in a firmly committed transaction; all other hedges of firmly committed transactions use the fair value model; all other hedges of forecast transactions use the cash flow model. A non-derivative may be used only as a hedge of foreign currency exposure in a firmly committed transaction or in a net investment. Where a cash flow hedged transaction results in an asset, the hedge gain or loss is recycled out of equity as and when the assets cost passes through the income statement. The ineffective portion of a net investment hedge is reported in the income statement.
5. General issues
General Since UK practice does not classify hedges in a way similar to IAS or the US, the layout of this UK section is not comparable with those of the corresponding IAS and US sections. There is a shortage of formal guidance on hedge accounting in the UK. What guidance exists is contained in SSAP 20 which deals with the hedging
General Since the IAS (and US) requirements classify hedges in a different way from that of UK practice, this IAS section, though comparable to the layout of the corresponding US section, is not comparable with the layout of the corresponding UK section. The standard on hedging, IAS 39, is mandatory for years beginning on or after 1 January 2001;
General Since the US (and IAS) requirements classify hedges in a different way from that of UK practice, this US section, though comparable to the layout of the corresponding IAS section, is not comparable with the layout of the corresponding UK section. For years beginning after 15 June 2000 hedging is governed by SFAS 133, the requirements of which
51
UK I AS US
UK
I AS
US
52
of foreign equity investments with borrowings and with limited aspects of forward foreign exchange contracts. What follows summarises this guidance together with common practice in this area. Hedging in the UK might for convenience be classified into three types: existing asset/ liability: eg, a hedge of a foreign currency debtor or of the currency or interest basis of a borrowing (including a floating-tofixed swap); future transaction: eg, a hedge of a contracted, or an uncontracted but probable, sale or purchase; and net investment: a hedge of a net investment in a foreign entity. One would expect a certain degree of documentation in advance for anything to be classed as a hedge but, save for net investment hedges, there is no quantified rule for hedge effectiveness. Thus it would be possible for the hedge to be in a different currency from the hedged position provided that the two were expected to move reasonably in tandem. For net investment hedges the post-tax cash expected to be generated by the investment must cover the after tax exposure created by the hedge. There are few restrictions as to what can be hedges or hedged items. One restriction is that a nonmonetary item cannot be a hedged item (though in such a case one might question whether the asset was part of a foreign currency branch forming a net investment); another is that an anticipated transaction cannot be hedged with a non-derivative (as exchange on this must go through the profit and loss account). There is no explicit requirement that in consolidated accounts the hedge and the hedged item must be in the same group member; however,
5. General issues
hitherto there was no standard on the subject. IAS 39 is a complex and detailed standard. The IASC has formed an IAS 39 Implementation Guidance Committee (IGC) that is currently addressing over 100 interpretation issues. What follows here is necessarily highly summarised. Some general conditions apply to all types of hedge: The main requirement for qualification as a hedge is for the hedge to be, and be expected to continue to be, highly effective. That is, the offsetting changes in fair values or cash flows of the hedge and hedged item must normally be within 80% to 125% of each other. This must be reliably measurable. The effectiveness of the hedge must be based on changes in fair value or cash flows of all of the risk components of a hedging instrument, save that the time value of an option may be excluded (leaving just the intrinsic value component) and the forward points on a forward may be excluded. The excluded components flow through the income statement. In addition, the hedge must be documented as such from the outset, including the hedge objective, strategy and how its effectiveness will be measured. Under IAS 39 hedges fall into three types, each discussed below.
are dealt with below. The previous rules, themselves detailed but much less so that those of SFAS 133, were rather different but are not included in this book. SFAS 133 is a very complex and detailed standard, even more so than IAS 39, so much so that the FASB has put in place a Derivatives Implementation Group (the DIG) that has or is addressing over 100 specific application issues. What follows here is necessarily highly summarised. As under IASs some general conditions apply to all types of hedge: The main one is for the hedge to be, and be expected to continue to be, highly effective. Although SFAS 133 does not quantify this, in our view it means that the correlation must be within 80% to 125% as these were the limits of high correlation in the predecessor standard and SFAS 133 refers to that phrase and standard. In addition, there must be reasonable basis for measuring effectiveness. The effectiveness of the hedge must be based on changes in fair value or cash flows of all of the risk components of a hedging instrument, save that the time value of an option may be excluded, leaving just the intrinsic value component, and the forward points on a forward may be excluded. The excluded components flow through the income statement. The hedge must be documented as such from the outset, including the hedge objective, strategy and how its effectiveness will be measured. Three hedge accounting models are used and each is discussed below.
in our view it is not possible that, eg for a foreign currency liability hedging a foreign currency asset, the two are in different functional currency entities. It is accepted that an anticipated transaction must be probable before it can be hedged, but there is no explicit degree of probability attached to that. Existing asset/ liability hedge Where the hedge is an on-balance sheet instrument, such as a borrowing hedging a foreign currency debtor, then it must be retranslated with the exchange taken to the profit and loss account. The hedged item would be treated similarly. Where the hedge is derivative, such as a forward or a swap, then it is usually kept off balance sheet and instead the hedged item is dealt with on the hedged basis, eg as if it were a synthetic Sterling debtor, floating rate borrowing or whatever else is the effect of the hedge. This is sometimes called accrual accounting because, for example with an interest rate swap, all that is accounted for is the accrual of interest-exchange payments. Where a forward is used the forward points would be spread. Where an option is used, which is not common, the time and intrinsic values may sometimes be split. As an alternative, a derivative might be separately recognised in the balance sheet with gains and losses thereon taken to the profit and loss account, and the same applied to the hedged item. However, this is much less common than leaving the derivative off-balance sheet. An interest rate swap is never dealt with in such an alternative way, instead being accrual accounted, as own debt (or debt investments) are not usually marked-to-market for interest rate risk.
Fair value hedges A fair value hedge is where: a derivative is used to hedge changes in fair value (other than for currency risk) of a recognised asset or liability; or a derivative or non-derivative is used to hedge foreign currency risk on a recognised asset or liability. It does not include hedges of any form of future transaction, whether firmly committed or otherwise (these are cash flow hedges). A financial item may be hedged with respect to any one or more of its individual risks whereas a nonfinancial item must be hedged with respect to all of its risks or solely currency risk. The hedged risk must be one that could affect the income statement such that, for example, share issues and repurchases cannot be hedged. There is no equivalent of the US rule that the hedged item must not be one that is remeasured to fair value through the income statement. As in the US the hedged item cannot be a held-to-maturity asset except as regards credit or foreign currency risk. Note that under IASs held-to-maturity assets is potentially a wider category than the US held-tomaturity securities; however, IASs include an originated-loans-and-receivables category of asset and this is not subject to any similar hedging restriction. There is no explicit requirement that in consolidated accounts the hedge and the hedged item must be in the same group member. However, in our view it is not possible for the hedge and the hedged item to be in different currency entities.
Fair value model This model is used for the following types of hedge: fair value hedges: a derivative used to hedge changes in fair value (other than for currency risk) of a recognised asset or liability; a derivative used to hedge changes in fair value (other than for currency risk) of an unrecognised firmly-committed future transaction; certain foreign currency hedges: a derivative used to hedge the foreign currency exposure on a recognised asset or liability; a non-derivative used to hedge the foreign currency exposure in an unrecognised firmly-committed future transaction; or a derivative used to hedge the foreign currency exposure in an unrecognised firmly-committed future transaction may be accounted for using the fair value model (the alternative is the cash flow model). In a fair value hedge the hedged item, if financial, need not be all of the risks affecting the items fair value. It could instead be solely interest rate risk or credit risk (or both). In a fair value hedge of a nonfinancial item all of the items risks must be hedged. In addition, there are other rules on what can be hedged in a fair value hedge. First, it must be something which can affect the income statement. Thus stock issues and repurchases and certain stock issues for stock option plans cannot be hedged. Next, it must not be an item that is already remeasured to fair value through the income
5. General issues
53
UK I AS US
UK
I AS
US
54
Future transaction hedge The usual accounting here is to leave the derivative off-balance sheet until the hedged transaction affects the profit and loss account, when the effect of the hedge is taken there too, or results in an asset when the cost thereof is adjusted by the effect of the hedge. Alternatively, the derivative could be stated at market value in the balance sheet but with the adjustment thereby thrown up deferred elsewhere in the balance sheet until such time as the hedged transaction occurs or results in an asset the cost of which can be adjusted. This is very much less common in practice as all it achieves is a grossingup of the balance sheet. Net investment hedge The after-tax exchange differences on the net investment are reported in the STRGL immediately that they arise. The after-tax exchange differences on the hedge, to the extent that they match those on the net investment, are reported in the STRGL when they arise. There is no subsequent recycling of these amounts through the profit and loss account. Unmatched exchange differences are taken to the profit and loss account in the first instance. Future developments The ASB is examining the subject of hedge accounting as part of its project on financial instruments. Accounting The hedge is stated at fair value with changes therein flowing through the income statement. The hedged item is marked-to-market for the hedged risk (even if its normal basis is cost, eg a fixed rate borrowing), with the result taken through the income statement. Cash flow hedges A cash flow hedge is where: a derivative is used to hedge the future cash flows (other than for currency risk) on a recognised asset or liability, for example of the interest cash flows on a floating rate liability; a derivative is used to hedge future cash flows (other than for currency risk) on a future contracted, or uncontracted but highly probable transaction; a derivative or non-derivative is used to a hedge foreign currency risk of future cash flows on a recognised asset or liability; or
5. General issues
statement, for example a trading security, although there would be no advantage in fair value hedge accounting here anyway. Normal exchange adjustments under SFAS 52 (see 5.8) are not considered to be remeasurement to fair value for this purpose. Lastly, the hedged item cannot be a held-to-maturity security except as regards credit or foreign currency risk. Foreign currency hedges are not permitted in consolidated accounts unless the group member holding the exposure also holds the hedge; thus a group treasury company that buys the hedge in the market must write a back-to-back instrument with the group member holding the exposure. Accounting The hedge is stated at fair value with changes therein flowing through the income statement. The change in the fair value of the hedged item, so far as attributable to the hedged risk, is reflected in the items carrying value and in the income statement.
Cash flow model This model is used for the following types of hedge: cash flow hedges: a derivative used to hedge the future cash flows (other than for currency risk) on a recognised asset or liability, for example of the interest cash flows on a floating rate liability; a derivative used to hedge the future cash flows (other than for currency risk) of a forecast, ie probable but not firmly committed, transaction;
a derivative or non-derivative is used to a hedge foreign currency risk of future cash flows on a future contracted, or uncontracted but highly probable transaction. A financial item may be hedged with respect to any one or more of its individual risks whereas a hedge relating to a non-financial item must be with respect to all of its risks or solely currency risk. The hedged risk must be one that would affect the income statement such that, for example, forecast share issues or repurchases cannot be hedged. There is no equivalent of the US rule that the hedged item must not be one that is remeasured to fair value through the income statement. The IGC proposes to clarify that the interest rate risk on a floating rate held-to-maturity asset may not be hedged. There is no explicit requirement that in consolidated accounts the hedge and the hedged item must be in the same group member. However, in our view it is not possible for the hedge and the hedged item to be in different currency entities.
certain foreign currency hedges: a derivative used to hedge the foreign currency exposure of the cash flows on a recognised asset or liability; a derivative used to hedge the foreign currency exposure of a forecast, ie probable but not firmly committed, transaction; or a derivative used to hedge the foreign currency exposure in an unrecognised firmly-committed future transaction may be accounted for using the cash flow model (the alternative is the fair value model). It is possible that a hedged future transaction may first be dealt with under the cash flow model as a forecast transaction but subsequently fall under the fair value model when it becomes a firmly committed transaction. In a cash flow hedge the hedged item, if financial, need not be all of the risks affecting the items cash flow. It could instead be the effect on cash flows solely of interest rate risk or credit risk (or both). In a cash flow hedge relating to a non-financial item, ie the forecast purchase or sale of a non-financial asset, all of the items cash flow risks must be hedged. In addition, there are other rules on what can be hedged in a cash flow hedge. First, the risk of variation in cash flows must be something which can affect the income statement. Thus forecast stock issues and repurchases cannot be hedged. Next, the forecast transaction must not be one that, on occurrence, will give rise to an asset or a liability that will be remeasured to fair value through the income statement, for example the purchase of a trading security. Similarly, if the cash flows relate to
5. General issues
55
UK I AS US
UK
I AS
US
56
an existing recognised asset or liability that item must not be remeasured to fair value through the income statement. Normal exchange adjustments under SFAS 52 (see 5.8) are not considered to be remeasurement to fair value for this purpose. Lastly, the hedge cannot be of cash flows arising on a heldto-maturity security except as regards credit or foreign currency risk. Foreign currency hedges are not permitted in consolidated accounts unless the group member holding the exposure also holds the hedge; thus a group treasury company that buys the hedge in the market must write a back-to-back instrument with the group member holding the exposure. Accounting The hedge is stated at fair value with changes therein, insofar as they are an effective hedge, initially taken directly to equity. They are later recycled out of equity when the future transaction either: results in an asset or liability, when the cumulative amount is recycled as an adjustment to the cost of that asset or liability; or otherwise affects the income statement in which case the cumulative amount is recycled into the income statement. To the extent that the hedge is ineffective the gains and losses are immediately dealt with in the normal way, for example in the income statement if the hedge is a derivative or in the income statement or in equity according to the companys policy if the hedge is an available-for-sale (non-derivative) asset (see 6.6). There is an additional limit to the cumulative amount that may be reported in equity: it may not exceed the lesser of, on the one hand, the amount necessary to Accounting The hedge is stated at fair value with changes therein, insofar as they are an effective hedge, reported in OCI until such time as the hedged cash flow affects the income statement. At that time it is recycled out of OCI and reported in the income statement. The ineffective element of the hedge is reported in the income statement. There is an additional limit to the cumulative amount that may be reported in OCI: it may not exceed the amount necessary to offset the cumulative change in expected future cash flows. This cumulative limit can be a derived figure of the total change in fair value of the hedge less a computed ineffective element. That element might be computed, for example for a swap hedging floating rate interest payments, by comparing the present value of the change in future interest payments with the present value of the change in future payments on the floating rate leg of the swap.
5. General issues
offset the cumulative change in expected future cash flows and, on the other hand, the fair value of the cumulative change in expected future cash flows. There is no guidance on measuring these amounts. Net investment hedges A net investment hedge is where a derivative or non-derivative is used to hedge the currency risk of a net investment in a foreign entity. However, unlike in the US, for net investment hedges in consolidated accounts the hedge need not be held by the group member holding the investment. Net investment currency hedge The net investment currency model is applied when a derivative or non-derivative is used to hedge the foreign currency exposure in a net investment in a foreign entity. However, such hedging is not permitted in consolidated accounts unless the group member holding the net investment also holds the hedge; thus a group treasury company that buys the hedge in the market must write a back-to-back instrument with the group member holding the net investment. Accounting Such hedges are in fact accounted for very similarly to cash flow hedges. The hedge is stated at fair value and, to the extent that it is an effective hedge, the changes therein are reported in OCI. When the net investment is, for example, sold it is recycled out of OCI and reported in the income statement. To the extent that the hedge is ineffective the fair value adjustment is reported in the income statement. The DIG proposes that the ineffective element is measured by comparing the change in fair value of the hedge with the change in fair value of a hypothetical derivative (in fact, a forward) or nonderivative, as the case may be, that is a perfect hedge of the amount and currency of the hedged portion of the net investment.
Accounting These are dealt with similarly to cash flow hedges, ie the hedge is stated at fair value with the currency element thereof, to the extent that it is an effective hedge, being taken directly to equity until such time as the net investment is sold, when the cumulative amount in equity is recycled into the income statement. If the hedge is a derivative the ineffective element is reported in the income statement; if the hedge is a non-derivative it appears to be required nevertheless to be taken directly to equity for subsequent recycling on a sale of the net investment. There is no guidance on measuring effectiveness.
5. General issues
57
UK I AS US
UK
I AS
US
58
5.10 Interim financial reporting

(The Listing Rules, ASBs Interim reports statement)

(IAS 34, ISA 910)

(APB 28, SFAS 3, FTB 79-9, FIN 18, I73, Regulation S-X)
The ASB has issued Interim reports, a nonmandatory statement under which the recognition and measurement principles are the same as those of IAS 34. The Listing Rules of the Financial Services Authority require that the policies and presentation adopted in interim reports are those adopted in the last audited accounts with one main exception. Where a new policy or presentation is required to be adopted in the next audited accounts (eg, because of new accounting standards) it should be adopted in the interims (with attendant disclosure of that fact). The Listing Rules require interim results to be published for the half year, containing a profit and loss account (minimum contents are specified), balance sheet and a statement of cash flows. However, the ASBs statement suggests the minimum contents of a summarised balance sheet and statement of cash flow and also recommends a summarised STRGL. Auditors are not required to review or to report upon any part of an interim report although it is common practice for listed companies to ask them to do so; if auditors do so then their report must be published. An APB Bulletin governs the form and content of such review reports by auditors. The auditor would report (subject to any qualification) a negative assurance on the amounts reported (ie, based on his limited work he is not aware of any adjustments that should be made).
IASs do not prescribe a requirement for, or frequency of, the publication of interim financial reports. However, there is an IAS on interim financial reports, should a company prepare such a report; the report should state that it complies with this IAS (IAS 34) if this is the case. IAS 34 requires items to be recognised and measured as if the interim period were a discrete stand-alone period, with the sole exception of the tax charge which is based on the expected weighted average effective rate for the full year. The accounting policies to be followed are those that will be applied in the next full financial statements for the year including the interim period. The contents required by IAS 34 are a condensed balance sheet, income statement, statement of changes in equity (or all such changes other than transactions with owners), cash flow statement and certain selected explanatory notes. The extent of any auditors review of interim financial information will depend on local requirements. If a review report is required and the auditors follow ISAs, then negative assurance would be the appropriate form of opinion.
An interim period is viewed primarily as an integral part of an annual period. The results reported should be based on the accounting principles and practices used in a full year; however certain modifications may be required so that the interim results better relate to the results of operations for the full year. APB 28 provides detailed guidance on the preparation of interim statements and, in particular, requires that the interim income tax expense is based on the estimated effective rate for the full year. Some degree of spreading of other items, eg annual major repairs, may also be appropriate, even though this would not be appropriate at a year-end. In addition, declines in inventory values, expected to be recovered by the year-end, would not be booked. The SEC requires that domestic registrants file a Form 10-Q on a quarterly basis. Condensed financial statements including a balance sheet and statements of income, changes in stockholders equity and cash flows are required on this form. The 10-Q must be reviewed by the auditors before it is filed with the SEC. The auditors review report is not published. The SEC also requires that public companies meeting certain criteria disclose certain information, eg sales and net income, in the notes to their annual financial statements or elsewhere within the annual report for each full quarter within the two most recent fiscal years.
5. General issues
5. General issues
59
UK
I AS
US
UK
I AS
US
60
6. Specific balance sheet items
6.1
Intangible assets
6.1
Intangible assets
(IAS 36, IAS 38, SIC 6)
6.1
Intangible assets
Certain development costs may be capitalised and amortised. Purchased intangibles and post-1997 goodwill are capitalised; pre-1998 goodwill may remain set off directly against shareholders funds. Purchased intangibles and post-1997 goodwill are amortised over their useful lives presumed to be limited to 20 years; if the presumption is rebutted, the life may even be indefinite (ie, no amortisation) and annual impairment testing is required.
Certain development costs must be capitalised and amortised. Purchased intangibles and post-1994 goodwill are capitalised; pre-1995 goodwill may remain set off directly against equity. Purchased intangibles and post-1994 goodwill are amortised over their useful lives, presumed to be limited to 20 years; if the presumption is rebutted the life must nevertheless be finite and annual impairment testing is required.
All research and all development costs must be written off when incurred. Acquired intangibles and goodwill are capitalised. Acquired intangibles and goodwill are amortised over their useful lives, never exceeding 40 years.
Research and development

(SSAP 13, FRS 7)
SSAP 13 deals with research and development. However, it is not mandatory for certain private companies meeting certain size criteria. Research (separated into pure and applied research in the UK) and development costs are defined in a manner similar to that under IAS. Pure and applied research costs should be expensed when incurred. Development costs may be capitalised providing all of the following criteria are met:
Research and development Research is original and planned investigation undertaken with the prospect of gaining new knowledge and understanding. Research costs are written off as incurred. Development is the application of research findings or other knowledge to a plan or design for the production of new or substantially improved materials, products etc; it does not include the maintenance or enhancement of the running of
Research and development

(SFAS 2, SFAS 68, R50, R55)
SFAS 2 defines research and development in a similar manner to IAS. Only the costs of materials, equipment, facilities and intangibles purchased from others used in research and development activities which have alternative future uses are capitalised and amortised. With the exception of certain internally developed computer software (see below), all other research and development costs are not capitalised under
There is a clearly defined project. The related costs are separately identifiable. There is reasonable certainty that the project is technically feasible and commercially viable. Future revenues are reasonably expected to exceed future development, production, selling and administration costs. Adequate financial resources exist to complete the project. Where development costs are capitalised they should be included as an intangible asset and amortised by reference to either the sale or use of the related product or process or the period over which the product or process is expected to be sold or used. In addition, such deferred development expenditures should be reviewed at the end of each accounting period. If the circumstances that had justified the deferral of the expenditure no longer apply or are considered doubtful, the expenditure should be written off immediately to the extent it is not considered to be recoverable. There are no specific rules in the UK for arrangements to carry out research and development funded by another party. They should be accounted for according to their substance; to the extent that the company has an obligation to repay the funding party, it should normally record a liability.
ongoing operations. If an internally generated intangible asset arises from the development phase of a project it must be capitalised if the general conditions for intangible asset recognition are met, viz: that it is probable that the future economic benefits attributable to the asset will flow to the enterprise; and the cost can be measured reliably. However, the standard goes on to set out more specific criteria that must be met in order that this general requirement be met. The company must be able to demonstrate: the technical feasibility of completing the intangible asset so that it will be available for use or sale; its intention to complete the intangible asset and use or sell it; its ability to use or sell the intangible asset; how the intangible asset will generate probable future economic benefits. Among other things, the enterprise should demonstrate the existence of a market for the output of the intangible asset or the intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset; the availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset; and its ability to measure reliably the expenditure attributable to the intangible asset during its development. Before the development costs become an asset available for use they should be annually impairment tested (see 6.4). Once the asset is available for use it should be amortised over its life (whether time or unit-of-production based). The normal 20 year rebuttable presumption applies (see below under other intangible assets and
US GAAP but should be charged to expense as incurred. There are special rules for dealing with arrangements under which the research and development activities of a company are funded by other parties. To the extent that the company has an obligation to repay the funding party, it should record a liability and expense the research and development costs as incurred. A presumption exists that the company doing the research will pay back the funding party where 10% or more of the funding party is owned by persons deemed to be related parties of the company, or where the funding party has any direct interest in the company doing the research. The apparent absence of financial ability to repay the funding party does not overcome this presumption.
61
UK I AS US
UK
I AS
US
62
goodwill), although it is unlikely to have an effect in practice. There are no specific IAS rules for the carrying out of research and development funded by another party. To the extent that it has an obligation to replay the funding party, a liability would normally be booked. Computer software (FRS 10, SSAP 13) Purchased or internally developed software for own use is included as part of hardware, ie as a fixed tangible asset, where it is necessary to bring that hardware into working condition for its intended use; this will almost always be the case. With regard to internally developed software products for sale, there is no specific accounting pronouncement; instead the general principles for research and development expenditures, described above, would apply (unless the development was pursuant to a contract therefor, in which case it would be longterm contract work-in-progress - see 7.1). In short, only development expenditures with a reasonable expectation of specific commercial success meeting certain specified criteria may be capitalised; all other research and development costs should be charged to expense as incurred. Capitalised costs are amortised using any appropriate systematic basis and if necessary are written down in the usual way (see 6.4) to the higher of value-in-use and net realisable value. Technological feasibility is one criterion which must be satisfied before capitalisation can commence. As it is not defined in SSAP 13, it is possible that a software project could be regarded as technologically feasible sooner in the UK than in the US, where the definition is quite restrictive. Computer software Software is considered to be integral to a piece of property, plant and equipment where that item cannot operate without that software (eg, software for a computer controlled machine tool). In other cases, for example the development of a software product for sale, it is an intangible asset. Internally developed software of this latter kind is therefore treated as a development cost (see above) and therefore, if the relevant conditions are met, is capitalised, amortised and, if necessary, writtendown to the higher of value-in-use and net realisable value. As noted later (see 6.3), interest may be capitalised into such intangibles. Similar purchased software is capitalised and amortised in the usual way. Computer software (SFAS 86, Co2) Costs incurred internally in creating a computer software product (to be sold, leased, or otherwise marketed as a separate product or as part of a product or process) are research and development costs and as such are charged to expense when incurred until technological feasibility has been established for the product. Technological feasibility is established upon completion of detailed product and program design, or in the absence of the former, completion of a working model (whose consistency with the product design has been confirmed through testing). Thereafter, all software production costs up to the point of general release of the product to customers, are capitalised and subsequently reported at the lower of amortised cost and net realisable value. While SFAS 86 provides additional guidance regarding the determination of technological feasibility, it is a fairly subjective determination. In practice, a significant portion of research and development costs are usually treated as having been incurred prior to the establishment of technological feasibility and are expensed accordingly. Interest should be capitalised pursuant to SFAS 34 (see 6.3), on software costs that are capitalised. Interest would be capitalised from the point in time
Interest cost may qualify for capitalisation as part of such an asset (see 6.3). Software purchased as part of a larger software development (for sale) would be treated as cost of the development in the normal way.
that technological feasibility is established until the product is ready for general release. The cost of purchased software for the same purpose, and which meets the same technological tests as for internally developed software or that has an alternative future use should be dealt with in the same way. Capitalised software costs are amortised on a product-by-product basis. Annual amortisation commences when the product is available for general release to customers and is the greater of the amount computed using: the ratio that current gross revenues for the product bear to the total of current and anticipated future gross revenues for the product; or the straight-line method over the remaining estimated economic life of the product including the period being reported on. The amount by which the unamortised capitalised costs of a computer software product exceed the net realisable value of that asset should be written off. The amount of the write-down cannot be restored subsequently. The reduced amount of capitalised computer software costs becomes the cost for subsequent accounting purposes.
Other intangible assets and goodwill

(FRS 2, FRS 10)
Other intangible assets and goodwill
Other intangibles including goodwill

(APB 16, APB 17, SFAS 72, SFAS 121, B50, I08, I60)
Initial recognition Positive goodwill on a business acquisition (see 5.7) is capitalised; however, this applies only to periods ending on or after 23 December 1998 and any goodwill hitherto set off directly against
Initial recognition Positive goodwill on a business acquisition (see 5.7) is capitalised; however, this applies only to periods beginning on or after 1 January 1995 and any goodwill hitherto set off directly against reserves
Initial recognition Companies are required to capitalise the cost of intangible assets acquired from other entities or individuals, including purchased goodwill. However, the costs of developing, maintaining or
63
UK I AS US
UK
I AS
US
64
shareholders funds (the previous treatment) need not be re-instated but must, on disposal of the related business, be recaptured and included in the profit or loss on disposal. The rules for negative goodwill are complex and are dealt with in 5.7. Internally generated goodwill is never recognised. For an intangible asset to be considered separate from goodwill (purchased or internally generated) it must be identifiable and controlled. It is identifiable only if it can be disposed of or settled separately without disposing of the whole business. Control requires legal rights or custody over the item. For such an intangible asset there are three recognition rules depending on the circumstances. First, a separately purchased intangible is capitalised at its cost. Second, an internally generated intangible, other than development costs (see above), is capitalised only if it has a readily ascertainable market value. A brand does not have such a value and therefore an internally generated brand cannot be capitalised. Third, an intangible purchased as part of a business combination is capitalised at its market value where this is readily ascertainable; if its market value cannot so be determined, eg for a brand, then it is capitalised at its valuation arrived at by other reliable techniques, subject to its not creating or increasing negative goodwill. (the previous treatment) need not have been reinstated. The rules for negative goodwill are complex and are dealt with in 5.7. Internally generated goodwill is never recognised. An intangible asset, if it is to be dealt with separately from goodwill, must be clearly identifiable and controlled. Under IAS 38, to be identifiable requires the asset to be capable of being dealt with or disposed of separately from the rest of the business or to be identifiable in some other way such as by a legal right or by the flow of benefits that it will produce. The asset must be controlled by a legal right or be in some other way protected. The general recognition rule for such an intangible asset is that it is capitalised at its cost once it is probable that the assets benefits will flow to the company and that its cost can be measured reliably. This general rule has particular effects in three areas. First of all, the test is easily met in the case of a separately purchased intangible. Second, internally developed intangibles are capitalised if they meet the development cost rules (see above); otherwise, eg an internally generated brand, they cannot be capitalised as their costs cannot be distinguished from those of developing the business as a whole. The main area, however, is an intangible purchased as part of a business combination, where the reliability-of-cost test becomes paramount. If there is an active market for the intangible concerned then its quoted market price is reliable and is allocated as its cost. If there is no such active market, eg for a brand, other fair valuation techniques may be reliable and the fair value so computed is allocated as its cost to the extent that this does not create or increase negative goodwill. restoring intangible assets that are not specifically identifiable, have indeterminate lives or are inherent in a continuing business and related to an entity as a whole (such as internally developed goodwill) are deducted from income when incurred. In addition, internally developed intangibles such as patents and trademarks, may result in a recorded asset to the extent that direct costs, such as legal fees and filing fees, are incurred. In addition, APB 16 requires the purchased goodwill to be allocated to the acquired business operations on a timely basis as goodwill is inseparable from the acquired business units to which it relates. The value of goodwill is affected by developments at those acquired business units and unless the goodwill is allocated on a timely basis its value cannot be monitored effectively. Negative goodwill is discussed in 5.7. In short, it is credited against the fair values of acquired noncurrent assets and any excess becomes a deferred credit amortised over up to 40 years.
Subsequent amortisation, revaluation and impairment Intangible assets and goodwill should be amortised over their useful lives. In the case of purchased goodwill this is defined as the period over which the value of the business is expected to exceed the value of its identifiable net assets. The lives of goodwill and intangibles are presumed by the standard to be limited to 20 years but this presumption may be rebutted where the useful life is longer, and such longer life may, where appropriate, be indefinite such that the asset is not depreciated at all. Where the life is over 20 years the reasons for rebuttal are disclosed and in addition to any impairment testing that might otherwise be required (see 6.4) the intangible asset or goodwill is impairment tested annually. Where the life is 20 years or less, impairment testing is done as and when required under the normal rules (see 6.4) and in addition at the end of the first full year since the acquisition of that goodwill or intangible. The amortisation method should reflect the pattern of depletion of the asset; if the pattern cannot be determined then the straight line method is used. The method and life should be annually reviewed. Goodwill cannot be revalued. Intangible assets for which there is a readily ascertainable market value may be revalued to that value. Thus brands and similar assets may not be revalued as there is no active market for them. It also follows that intangibles that have not previously been recognised may not be recognised by, as it were, revaluing up from zero cost. If an intangible is revalued then all intangibles of its class must be revalued and the revaluations must be
Subsequent amortisation, revaluation and impairment Intangible assets and goodwill should be amortised over their useful lives. Such lives are presumed by the standard to be limited to 20 years but this presumption may be rebutted where the useful life is longer, although such longer life must always be finite. In such a case the reasons for rebuttal are disclosed and in addition to any impairment testing that might otherwise be required (see 6.4) the intangible asset or goodwill is impairment tested annually. The amortisation method should reflect the pattern of consumption of the economic benefits; if the pattern cannot be determined then the straight line method is used. The method and life should be annually reviewed. Intangible assets for which there is an active market may be revalued to fair value. Thus brands and similar assets may not be revalued as there is no active market for them. Intangibles that have not previously been recognised may not be recognised by, as it were, revaluing up from zero cost. If an intangible is revalued then all intangibles of its class must be revalued and the revaluations must be kept up to date. Amortisation is based on the revalued amount and the revaluation itself is accounted for in the same way as for that on property, plant and equipment (see 6.2).
Subsequent amortisation and impairment Intangible assets must be amortised through the income statement over the period of their estimated useful lives, not exceeding 40 years. The straightline method of amortisation is used unless the company can demonstrate that another systematic method is more appropriate. Amortisation periods should be continually evaluated to determine whether recent events and circumstances warrant revised estimates of useful lives or indicate an impairment. Any write-down of the unamortised costs of intangible assets (including goodwill) is charged through the income statement. Goodwill impairment must be considered on an entity-basis as well as part of any impairment of long-lived assets generally (see 6.4). Impairment on an entity-basis may be determined by either a recoverability test (eg, out of undiscounted or discounted cash flows) or a fair value test (eg, market capitalisation less fair value of other net assets). Future developments The FASB has issued proposals for a new business combinations standard that would reduce the maximum life of goodwill to 20 years. For other intangible assets there would be a presumed maximum life of 20 years but, if certain conditions are met, longer periods may apply (without annual impairment testing); moreover, in particular amortisation will not be required if the life is indefinite and there is an observable market price for the intangible.
65
UK I AS US
UK
I AS
US
66
kept up to date. Amortisation is based on the revalued amount and the revaluation itself is accounted for in the same way as for that on a fixed tangible asset (see 6.2).
6.2
Fixed tangible assets (CA 85, FRS 3,

FRS 15, SSAP 4, SSAP 19, UITF 5)
6.2
Property, plant and equipment

(IAS 16, IAS 20, IAS 36, IAS 40)
6.2
Property, plant and equipment

(ARB 43)
Fixed tangible assets may be revalued. Depreciation would then be based on the revalued amount. Investment properties must not be depreciated and must be carried at open market value with changes therein taken directly to shareholders funds.
Property, plant and equipment may be revalued. Depreciation would then be based on the revalued amount. From 2001 investment properties need not be depreciated and, if undepreciated, must be carried at market value with changes therein flowing through the income statement.
Fixed tangible assets must be carried at depreciated cost. Real estate investment properties must be carried at depreciated cost.
Fixed assets generally It is permissible in the UK to revalue fixed tangible assets to existing-use value (ie, market value without reference to alternative uses) for nonspecialised land and buildings and to depreciated replacement cost in other cases. Any such revaluation must be on a class-by-class basis, ie companies cannot pick and choose individual assets to revalue, and the valuations must be kept up to date; this is a new requirement and on first application (no later than years ending on or after 23 March 2000) a company that had hitherto inconsistently revalued can choose to retain those carrying amounts but not revalue in the future. Any surplus arising from a revaluation must be taken to a revaluation reserve within shareholders funds and be reported in the STRGL, save to the extent that it
Property, plant and equipment generally Property, plant and equipment may be revalued to fair value, which is market value (which may not be the same as the UKs existing-use value) or, for plant and equipment without such a value, depreciated replacement cost. Any surplus arising on the revaluation is taken directly to a revaluation reserve within equity save to the extent that the surplus reverses a previous revaluation deficit on the same asset charged in the income statement, in which case the credit to that extent is to the income statement also. Any deficit on revaluation is charged in the income statement save to the extent that it reverses a previous revaluation surplus on the same asset, in which case it is taken direct to the revaluation reserve.
Property, plant and equipment generally Revaluation above historical cost is not permitted except in connection with business combinations accounted for using the purchase method (see 5.7). The balances of depreciable assets and land, and amounts of accumulated depreciation must be disclosed. Generally, disclosure of additions to and disposals of property, plant and equipment is not required (although the statement of cash flows may provide this information). Accumulated depreciation and the depreciation charge need only be disclosed in total. Unlike the UK and under IASs, there is no requirement to account for separate components of an asset. Such component accounting in largely
amounts to a reversal of an impairment (see 6.4). In the case of a deficit, broadly, the combined effect of the revaluation and impairment rules is that any decrease above depreciated historical cost goes directly to the revaluation reserve; any decrease below that, but above recoverable amount, is charged in the profit and loss account; and any other decrease is taken directly to the revaluation reserve. Where fixed tangible assets have been revalued, depreciation is based on the revalued amounts. Impairments are dealt with as set out in 6.4. When a revalued asset is sold, the gain or loss recognised in the profit and loss account must be calculated by reference to the book (ie, depreciated revalued) amount, any previous revaluation being transferred directly to retained profits (ie, reclassified within shareholders funds). An asset should be split into its major components that have substantially different lives, for the purpose of depreciation and replacement. This is known as component accounting and is an important counter-part to the prohibition of maintenance provisions (see 6.12) as it enables the profit and loss account to remain largely unaffected by that prohibition, thus: A separate physical component, such as a furnace lining, must be treated as a separate piece of plant and equipment and therefore capitalised and depreciated over its own (short) life. For a physical repair, without a separate physical components being involved, the company can choose component accounting or to charge the costs as incurred. For an inspection, without any physical renewal, the company can similarly choose component accounting or write-off as incurred.
If an asset is revalued then all property, plant and equipment of the same class must be revalued and these revaluations must be kept up to date. Depreciation on a revalued asset is based upon its revalued amount, as are gains and losses on disposal. Where of an item of property, plant and equipment has a separate physical component, such as a furnace lining, it must be treated as a separate piece of plant and equipment and therefore capitalised and depreciated over its own (short) life. A component approach is adopted with respect to the cost of inspection or overhaul also. A change in depreciation method is a change in accounting estimate and is therefore applied prospectively. The disclosure requirements are slightly less extensive than the UKs, insofar as the reconciliation of movements is in respect only of the net carrying amount.
unnecessary as there is no prohibition on repairs and maintenance provisions (see 6.12). However, component accounting is sometimes adopted, eg in airline industry. A change in depreciation method (but not of useful life or residual value) is dealt with as a change of accounting principle, for which the cumulative effect to date is put through the current year income statement after extraordinary items.
67
UK I AS US
UK
I AS
US
68
A change in depreciation method is a change in estimate and is therefore applied prospectively. Where an asset, typically a property, is transferred from current to fixed assets it should be transferred at the lower of cost and net realisable value with any adjustment necessary to achieve that being taken through the profit and loss account. The Companies Act requires extensive disclosures about fixed tangible assets. The basic requirement is for reconciliations from the opening to the closing figures for cost/ valuation and for provisions for depreciation/ diminution for each asset type. There are also supplementary disclosures concerning the historical cost equivalents of assets carried on the basis of valuations. Government grants Government grants related to fixed assets are held separately on the balance sheet as deferred income and are amortised into the profit and loss account over the useful life of the related asset. Government grants Government grants related to fixed assets may be either deducted from the cost of the asset concerned, and therefore reduce the future depreciation charge directly, or be carried separately as deferred income that is amortised over the useful life of the asset. Investment properties The following rules apply to accounting periods beginning on or after 1 January 2001. Investment properties are land and buildings held for rental income and/ or capital appreciation rather than for own use or for sale in the ordinary course of business. They exclude property held on operating leases. They may be either treated as a normal property or be undepreciated and stated at fair value, which is market value, with changes therein flowing through the income statement. Government grants US GAAP has no specific requirements for government grant accounting (other than in the notfor-profit sector).
Investment and other non-depreciated properties Investment properties are completed properties held for investment potential with any rental income being negotiated at arms-length and not being occupied by the company or its group for their own purposes. Such investment properties are carried at open market value. Changes in value, other than permanent diminutions, should be charged or credited directly through the STRGL to an investment revaluation reserve within shareholders funds. Permanent diminutions (undefined) are
Real estate investment properties Real estate investment properties are carried at depreciated historical cost. Depreciation must be provided on all buildings, including investment properties. (However, property held for resale is generally not depreciated - see 6.4.)
charged through the profit and loss account. Depreciation is not provided on investment properties except for short leasehold property, usually with an unexpired lease term of 20 years or less. Any other asset need not be depreciated if the depreciation would be immaterial either because of the length of the useful life or because the residual value, based on prices prevailing at acquisition or subsequent revaluation, is close to the carrying amount. This has hitherto been common for certain pubs and hotels and some retail premises. In such cases, and for any tangible asset with a life of over 50 years, FRS 15 has now introduced an annual impairment testing requirement.
6.3
Capitalisation of interest
(CA 85, FRS 4)
6.3
(IAS 23, SIC 2)
6.3
(SFAS 34, I67)
Interest may be capitalised in certain circumstances.
Interest may be capitalised in certain circumstances.
Interest must be capitalised in certain circumstances.
Qualifying assets and interest costs FRS 15 provides that interest directly attributable to the construction of a tangible fixed asset may be capitalised into its cost. A consistent policy on this must be followed. The Companies Act 1985 also permits interest capitalisation for any asset in the course of production, for example development costs. The Act has less detailed guidance than FRS 15; that standards approach, which is set out below,
Qualifying assets and interest costs Interest costs (and similar finance costs) may be capitalised into the cost of certain qualifying assets, although the Benchmark Treatment is to write them off. A consistent policy on this must be followed. A qualifying asset is one which necessarily takes a substantial period of time to be made ready for its intended use or sale.
Qualifying assets and interest costs Interest cost must be capitalised as part of the historical cost of acquiring, and making ready for their intended use, certain qualifying assets. Qualifying assets include: assets that are constructed or otherwise produced for a companys own use; assets intended for sale or lease that are constructed or otherwise produced as discrete
69
UK I AS US
UK
I AS
US
70
would usually be applied by analogy to all interest capitalisation. The interest is that which would have been avoided had there been no expenditure on the asset. Thus if a specific borrowing has been taken out to finance the construction it is the interest on that borrowing. If the finance is from the general borrowings interest is capitalised on the expenditures at the weighted average rate on the general borrowings (ie, excluding borrowings taken out for other specific purposes). The amount capitalised must be pre-tax and cannot exceed the amount of interest incurred in the period. Although not specified by the standard, exchange differences are generally not capitalised. The interest costs that may be capitalised are those that would otherwise have been avoided. These are usually the actual interest on borrowings specifically for the purpose of obtaining the qualifying asset; the amount capitalised is net of the investment income on any temporary investment of the funds pending expenditure on the asset. To the extent that the finance therefor is part of the companys general borrowings, the weighted average interest cost (excluding any borrowings specific to other qualifying assets) is applied to the expenditures on the asset. The amount capitalised cannot exceed the actual interest incurred by the company. The standard does not specify whether the amount is pre- or post-tax. However, exchange differences on foreign currency loans may be capitalised if the exchange is regarded as an adjustment to the interest cost. projects; and investments (equity, loans and advances) accounted for by the equity method under certain conditions, whilst the investee has activities in progress necessary to commence its planned principal operations. The amount of interest to be capitalised is that part of the pre-tax interest cost incurred by the company during the acquisition period of the asset that theoretically could have been avoided if expenditure on the asset had not been made. Exchange differences may not be included as part of capitalised interest. The amount capitalised is determined by multiplying the capitalisation rate by the average amount of accumulated expenditure on the asset during the period. The capitalisation rate is based on the rates applicable to borrowings outstanding during the period. However if, in a companys financing plans, a specific new borrowing is associated with a qualifying asset, the company may use the rate on that borrowing as the capitalisation rate to be applied to that portion of the average accumulated expenditures for the asset that does not exceed the amount of the borrowing. If average accumulated expenditures exceed the amount of new borrowing associated with the qualifying asset (or there are no new borrowings associated with the asset), the capitalisation rate to be applied to such excess (or the entire amount) is a weighted average of the rates applicable to other borrowings of the company. Duration of capitalisation and disclosure The capitalisation period begins when: expenditures for the asset have been made; activities that are necessary to get the asset ready for its intended use are in progress; and interest cost is being incurred.
Duration of capitalisation and disclosure The period during which interest is capitalised is very similar to that of the US and IAS.
Duration of capitalisation and disclosure The conditions for the commencement of capitalisation are the same as in the US. Capitalisation should be suspended during extended delays in which active development is interrupted. It should cease when all the activities
necessary to prepare the asset for its intended use or sale are substantially complete.
Interest capitalisation continues so long as these three conditions are present. The term activities is to be construed broadly (encompassing more than physical construction) including all the steps required to prepare the asset for its intended use. Capitalisation ends when the asset is substantially complete and ready for use.
6.4
Impairment of fixed assets other than investments

(CA 85, FRS 3, FRS 11, SSAP 13)
6.4
Impairment of assets other than investments

(IAS 16, IAS 36, IAS 38, SIC 14)
6.4
Impairment of long-lived assets

(SFAS 121, I08)
An impairment exists if an assets book value exceeds the higher of value-in-use (the net present value of future cash flows) and net selling price. Assets are then written down to the higher of value-in-use and net selling price. Reversals of goodwill impairments are restricted.
An impairment exists if an assets book value exceeds the undiscounted cash flows expected from its use. Assets are then written down to fair value, which may be the discounted cash flows from use. Reversals of impairments are prohibited (other than for assets to be disposed of).
An impairment exists if an assets book value exceeds the higher of value-in-use (the net present value of future cash flows) and net realisable value. Assets are then written down to the higher of value-in-use and net realisable value. Reversals of goodwill and intangibles impairments are restricted.
FRS 11 covers the impairment of virtually all nonfinancial assets (save for, eg, stock, deferred tax) and goodwill, plus that of investments (in the parent company accounts) in subsidiaries, associates and joint ventures. It does not, however, cover investment properties (see 6.2) or trade investments (see 6.6). The standard is effective for periods beginning on or after 23 December 1998 and is prospective, ie any write-downs on first application cannot be priorperiod adjusted.
IAS 36 covers the impairment of virtually all nonfinancial assets (save for, eg, inventories, deferred taxes) and goodwill, plus that of investments (in the parent company accounts) in subsidiaries, associates and joint ventures. It does not cover other investments (see 6.6). The standard is effective for periods beginning on or after 1 July 1999 and is prospective, ie any writedowns on first application cannot be prior period adjusted.
SFAS 121 provides guidelines for recognition of impairment losses on long-lived assets and certain intangibles and related goodwill. Its scope excludes financial instruments (see 6.6), long-term customer relationships of financial institutions, mortgage and other servicing rights, deferred policy acquisition costs and deferred tax assets.
71
UK I AS US
UK
I AS
US
72
Assets to be held and used Assets to be reviewed The UK approach is very similar to that under IAS. As a matter of terminology, income generating unit (IGU) is used instead of cash generating unit. More importantly, annual impairment testing is not required for intangibles not yet ready for use, but is required for all tangible fixed assets that have lives of over 50 years. In the UK a review of asset lives and depreciation methods is required, but only if an impairment is booked.
Assets to be held and used Assets to be reviewed For the purpose of impairment testing assets are grouped together into the smallest group that generate cash inflows from continuing use that are largely independent of the cash inflows of other assets or groups thereof. Such a group is known as a cash generating unit (CGU). Goodwill is allocated to each CGU where it can reasonably be done; where it cannot, then two impairment tests are carried out, one at individual CGU level without goodwill and the second with the minimum collection of CGUs to which the goodwill can be allocated. Impairment testing is required where there is an indication of a possible impairment, eg adverse changes in the business or regulatory environment or in performance. In addition it is required annually for goodwill or intangible assets that have lives of over 20 years and, unlike in the UK, for any intangibles not yet available for use. There is no annual impairment testing requirement for property, plant and equipment. If review is required, then the relevant assets useful lives and depreciation method may need to be reviewed and revised.
Assets to be held and used Assets to be reviewed Although the Statement uses the term asset, that term usually means a group of assets. Assets are to be grouped at the lowest level for which identifiable cash flows are independent from the cash flows of other groups of assets. Goodwill from a business purchase that is associated with a group of assets being evaluated for impairment should be included in the carrying amount of the related assets. If the goodwill is associated with only part of the assets under evaluation, the goodwill should be allocated among the related assets based on the relative fair values of the assets acquired at the acquisition date unless there is evidence to support a different allocation method. Companies are required to review assets for possible impairment when events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Examples of such events or changes in circumstances include: declines in market values of assets; changes in the extent or manner in which assets are used; adverse changes in legal factors, business climate or actions by a regulator; accumulation of costs in excess of amounts originally expected in acquiring or constructing an asset; and current period operating or cash flow losses combined with a history of operating losses and/ or projections for continuing losses. The standard also acknowledges that the recognition of impairment is influenced by depreciation rates and methods used by a company. A company that is required to evaluate an asset for impairment is also
encouraged to re-evaluate depreciation policies. Any changes therein should be considered separately from the measurement of impairment, if any, required by SFAS 121. Recognition and measurement The recognition and measurement principles are the same as those under IAS (but the terminology is net realised value rather than net selling price), save that any impairment is allocated first to goodwill, then to intangibles and the rest amongst the IGUs other assets in some suitable manner (eg, prorating). In addition when an impairment review based on value-in-use (ie, net realisable value was lower) has been carried out, whether or not a write-down ensued, the actual cash flows of the IGU are monitored for the next five years. The original value-in-use is then recomputed each year on the basis of these actual cash flows and any additional impairment thrown up is booked (unless subsequently reversed). Recognition and measurement The measurement is not separate from the recognition test: an impairment is booked to the extent that the book value of a CGU exceeds the recoverable amount, that is, the higher of its valuein-use and net selling price. The value-in-use is the discounted future net cash flows (pre-tax) from the continuing use of the CGU. The discount rate must reflect an appropriate market premium for the risks inherent in the cash flows. Any impairment is allocated first to goodwill then, unlike in the UK, pro rata amongst the CGUs other assets (including intangibles). Recognition and measurement The standard provides a threshold to determine whether recognition of an impairment is required or allowed and a separate calculation to measure impairment, as follows: Recognition trigger - The estimated future cash flows to be derived from the use and disposition of an asset, undiscounted and without interest, is compared with the carrying amount of the asset. If the carrying amount is in excess of the expected cash flows, recognition of an impairment loss is required. If the expected cash flows are in excess of the carrying amount, recognition of an impairment loss is not allowed. Measurement - Measurement of an impairment loss is determined by reducing the carrying amount of an asset to its fair value. The reduced carrying amount becomes the new cost basis for the asset. Thus, the recognition trigger and the measurement of impairment are based on different concepts. This results in what has been described as an accounting cliff: a small cash flow shortfall can precipitate a larger write-down to fair value. Cash flows consist of the future cash inflows expected to be generated by an asset less the future cash outflows expected to be necessary to obtain those inflows. The future cash flows are the companys best estimate based on reasonable and supportable assumptions and projections.
73
UK I AS US
UK
I AS
US
74
Fair value should be based on quoted market prices, if available. If quoted market prices are not available, the best information available is used. Such information may include present value of estimated pre-tax cash flows using a discount rate commensurate with the risks involved, option pricing models, matrix pricing, option-adjusted spread models and fundamental analysis. The objective is to determine the amount at which the asset could be bought or sold in a current transaction between willing parties (that is, other than in a forced or liquidation sale). Any impairment recognised under SFAS 121 is allocated first to goodwill. (Notwithstanding that, the recoverability of the written down goodwill must still be assessed on an entity basis - see 6.1.) Reversal of impairment The principles governing reversals are largely similar to those of IASs, but with some notable differences. First, the general rule is that reversals may not be booked if caused by, in addition to the unwinding of the discount, the occurrence of the cash flows built into the value-in-use. Moreover, the IAS restriction on reversals in respect of goodwill applies also to intangibles in the UK (to which more of the original impairment was likely to be allocated - see above); but for those intangibles it is softened slightly - a reversal can be booked in the case of an intangible with a readily ascertainable market value, if the net realisable value has increased to eliminate the impairment. Presentation Impairment losses caused by a clear consumption of economic benefits (eg, by physical deterioration) are always charged in the profit and loss account. All other impairments are also charged in the profit and Reversal of impairment If the recoverable amount subsequently increases then in some cases the impairment is reversed. The general rule is that this is done where the increase is caused other than by the unwinding of the discount in the value-in-use. Where goodwill is concerned there is an additional test that the original impairment was caused by a specific, exceptional external event that was not expected to recur but that a subsequent external event has reversed its effect. In all cases the maximum amount of the reversal is such as to restore the assets of the CGU to their original pre-impairment carrying value less subsequent depreciation. Reversal of impairment Recognition of any subsequent recoveries in fair value is prohibited.
Presentation Impairment losses are charged in the income statement, although no particular location therein is specified, except where the impaired asset is a revalued one. In that case, it is charged directly to
Presentation Impairment losses are included in income from continuing operations before income taxes.
loss account unless the asset concerned has previously been revalued in which case the impairment down to depreciated historical cost is taken directly to the revaluation reserve and the rest flows through the profit and loss account. Compared with IAS 36 this is a lower amount charged to revaluation - effectively the depreciated revaluation rather than the undepreciated revaluation. Assets to be disposed of The general impairment rules (above) apply equally to assets or IGUs to be disposed of or even to operations to be discontinued. The latter is dealt with in 7.10; the others are dealt with below.
the revaluation reserve to the extent that it reverses a previous revaluation surplus.
Assets to be disposed of The general impairment rules (above) apply equally to assets, CGUs or even discontinuing operations to be disposed of. The latter is dealt with in 7.10; the others are dealt with below.
Assets to be disposed of This part of SFAS 121 applies to assets to be disposed of, other than those relating to a disposal of a business segment (which are dealt with in 7.10), where management of appropriate authority commits itself to a plan to dispose of those assets. In other words, managements intention to dispose of the asset will prompt any write-down. This may be earlier than in the UK or under IASs. Measurement Assets meeting the assessment requirement are to be reported at the lower of carrying amount and fair value less cost to sell. Cost to sell includes incremental direct costs such as broker commissions, legal and title transfer fees and closing costs. Cost to sell generally excludes insurance, security services, utility expenses and other costs to protect or maintain assets during the holding period. Costs required by a contractual agreement for the sale of an asset are included as adjustments to the cost to sell. If fair value is based on market prices, no discounting of sales price or cost to sell is required. If fair value is determined based on discounted cash flows, the cost to sell is also discounted if the sale is expected to occur beyond one year. The impairment loss for assets to be disposed of is
Measurement It is not clear whether a decision to sell an asset or IGU requires it to be impairment tested; in as much as the sale would constitute a reorganisation, it would do so; in other cases the reasons for sale, eg decline in performance, probably dictate the need for review anyway. The normal principles set out above apply. As with IASs it should be noted that the value-in-use is that from continued use.
Measurement A decision to sell an asset or CGU requires it to be impairment tested. The normal principles set out above apply. It should be noted that the value-inuse is that from continued use. Thus if an asset is intended to be taken out of use and disposed of but is still in use, then its recoverable amount will not necessarily be net selling price and so any impairment provision may be less than the ultimate disposal loss. Once the asset is out of use then, having no continuing use, its value-in-use is likely to be the same as net selling price and the remaining disposal loss will flow through at that time.
75
UK I AS US
UK
I AS
US
76
treated as a valuation allowance. Revisions in estimates of fair value are recorded in income by increasing or decreasing the valuation allowance. (Recoveries cannot exceed the amount of the valuation allowance.) Presentation If the impairment is computed by reference to value-in-use then that impairment in fact has no connection with the assets disposal and should in our view be dealt with in the normal way, ie any profit and loss account charge is within operating profit. If the impairment was caused by the sale, that is, the assets value was recoverable from continued use but the company chose to dispose of it (causing a further write-down to net realisable value when taken out of use), then it is more akin to a provision for a sale of an asset and would be charged between operating profit and interest (see 5.1). Presentation Although IASs are not specific on the point, any impairments of such assets are normal impairments, with one exception, and would therefore be expected to be dealt with in the income statement in the companys usual location for impairment, which IASs do not specify. Where the impairment is caused by a disposal, that is the assets value was recoverable from continued use but the company chose to dispose of it (causing a write-down to net selling price when taken out of use), then it is more akin to a provision for a sale of an asset and might be charged in the same place as other such losses (which IASs do not specify). Presentation Recognition of this valuation allowance, and subsequent changes in the valuation allowance, are included in income from continuing operations before income taxes.
6.5
Investments in associates and joint ventures

(CA 85, FRS 9)
6.5
Investments in associates and joint ventures

(IAS 1, IAS 28, IAS 31, SIC 3, SIC 20)
6.5
Investments: equity method

(APB 18, FIN 35, I82)
Significant influence of an associate is more prescriptively defined. In equity accounting losses usually continue to be recognised even if the investment is reduced below zero. Joint ventures, which are distinguished on the basis of substance, may not be proportionately consolidated.
Significant influence of an associate is presumed (rebuttably) for holdings of 20% or more. In equity accounting losses usually cease to be recognised once the investment is reduced to zero. Certain joint ventures, distinguished on the basis of legal form, may be proportionately consolidated.
Significant influence of an associate is presumed (rebuttably) for holdings of 20% or more. In equity accounting losses usually cease to be recognised once the investment is reduced to zero. There is no accounting distinction between associates and joint ventures.
Definitions The UK has three categories of joint activity in between controlled subsidiaries and passive investments.
Definitions IASs have four categories of investment in between controlled subsidiaries and passive investments, although for ease of comparison with the UK approach the last two are presented together in this section. Associates An associate is an investee (other than a subsidiary) in which the company has significant influence; that is, the power to participate in its financial and operating policy decisions. This is presumed to be so when the company has 20% or more of the voting power, unless it can be shown not to be the case; it is presumed not to be so with less than 20%, unless it can clearly be demonstrated otherwise.
Definition US GAAP does not distinguish between associates, jointly controlled entities, assets or operations. Associate is the nearest equivalent under IASs or in the UK.
Associates An associate is an entity in which the investor has a long-term interest and over whose financial and operating policies it exercises a significant influence (other than a subsidiary). First of all, an entity as used in this circumstance refers to any activity that is in substance separate from those of its investors, ie an independent business. In practice this entity requirement is likely to be passed by most potential associates. The key test therefore is that of the exercise of significant influence. This is defined as active, influential involvement in the investee through participation in financial and operating policy decisions, including strategic issues, such that over time the investee generally implements policies that are consistent with the investors strategy. This is perhaps a more difficult test to meet than that of IASs or the US. Joint ventures A joint venture is an entity in which the investor has a long-term interest and which, contractually, is jointly controlled by the investor and other investors. The term entity has the same meaning as above. Thus the distinction between a joint venture and other joint arrangements (as below) is a question of separate substance rather than separate form.
Equity method investments The equity method of accounting is used to account for any investments where the investor has the ability to exercise significant influence over operating and financial policies of the investee. An investor owning 20% or more of the voting stock of an investee is presumed (unless this presumption is overcome by predominant evidence to the contrary) to have the ability to exercise significant influence over the investee. An investment of less than 20% is generally accounted for using the cost method (an exception in where more than five investors jointly control the investee); more than 50% is generally consolidated.
Jointly controlled entities A joint venture is a contractual arrangement by two or more parties jointly to control an economic activity. Where the activity is carried on through a separate entity (eg, company or partnership), it is known as a jointly controlled entity. This is probably the most usual form of joint venture, but there are two others also.
77
UK I AS US
UK
I AS
US
78
Joint arrangements that are not entities This category is for contractual arrangements that do not amount to the carrying on of a trade or business separate from those of the investors. Arrangements that under IAS are jointly controlled assets or operations would not be separate entities and would therefore fall into this UK category. However, because this category is based on substance, jointly controlled assets would still fall into this category even if a corporate shell was put around them. Jointly controlled assets and jointly controlled operations Jointly controlled assets is an arrangement that is a joint venture that is not carried on through a separate entity but that is carried on with assets that are jointly controlled (whether or not jointly owned). An example, quoted in IAS 31, is an oil pipeline that is jointly controlled by two oil producers. Jointly controlled operations is a joint venture carried on neither through a separate entity nor through jointly controlled assets but instead by each venturer using its own assets in pursuit of the joint operation. An example is where the parties each carry out an element of the operation of manufacturing an aircraft, using their own assets, with the sales revenue therefrom shared. Accounting Associates Associates are equity accounted in the consolidated accounts: in the balance sheet the investment is stated at cost, ie including normal acquisitionaccounted goodwill, plus the post-acquisition share of profits and other changes in net assets; the share of profits is included in the income statement in a single line located after finance costs and before tax. For the purposes of consolidation coterminous financial statements of the associate, under policies consistent with those of the investor, should be used unless impractical. There is no prescription as to how much earlier or later the associates financial statements may be. The usual inter-company eliminations are made, to the extent of the investors interest. The investors share of losses of the associate are recognised until Accounting Equity method investments An investor using the equity method initially records an investment at cost. Subsequently, the carrying amount of the investment is increased to reflect the investors share of income of the investee and is reduced to reflect the investors share of losses of the investee or dividends received from the investee. The investors share of the income or losses of the investee is included in the investors net income (after the usual inter-company eliminations). Under the equity method, an investment in common stock is generally shown in the balance sheet of an investor as a single amount. Likewise, an investors share of after tax earnings or losses from the investee is ordinarily shown in its income statement as a single amount. The acquisition of an equity method investment is dealt with by the normal purchase accounting methods.
Accounting Associates Associates are equity accounted in the consolidated accounts, although the term does not have quite the same meaning as under IAS or in the US. In the balance sheet the investment is stated at cost, ie including normal acquisition-accounted goodwill, plus the post-acquisition share of profits as in the US and under IASs. In the profit and loss account, however, the investors share of the associates operating profit, interest and tax are each included adjacent to, or in some cases as a component of, that of the investor. For the purposes of consolidation, coterminous financial statements of the associate should be used unless impractical, but even so the associates accounts may be no earlier than three months before those of the investor (or six where to do otherwise would release price sensitive information) and
adjustment must be made for material subsequent events. Consistent accounting policies should be used. The usual inter-company eliminations are made, to the extent of the investors interest. The investors share of losses of the associate is recognised, notwithstanding that this may result in a negative balance (shown then as a liability), unless the investor is irreversibly withdrawing from the investee. Joint ventures Joint ventures are dealt with on consolidation by a version of equity accounting termed gross equity accounting. In addition to the normal presentation (see above) this requires an analysis of the carrying value, into gross assets and gross liabilities, to be shown on the face of the balance sheet; on the face of the profit and loss account the groups turnover figure is analysed into turnover including the share of that of joint ventures, less the share of joint ventures, giving the normal net total (ie, attributable to the parent and subsidiaries only). In other respects the procedures for associates apply (eg, acquisition accounting).
the equity investment is reduced to zero and thereafter to the extent of any investors obligation to meet the associates obligations.
Jointly controlled entities The Benchmark Treatment on consolidation is proportionate consolidation; the Allowed Alternative Treatment is equity accounting. The proportionate consolidation may be done either by including the investors share of each investee line item within each relevant investors line item or by the investor presenting separate line items for its share of each investee line item. In performing the proportionate consolidation the usual consolidation procedures apply (eg, inter-company elimination, but to the extent only of the investors share). However, there are no specific rules governing the acquisition of a proportionately consolidated jointly controlled entity. In addition, whereas with equity accounting the net investment is not normally reduced below zero (see above), with proportionate consolidation in our view the share of losses continues to be recognised even to the extent of a net deficit. Jointly controlled assets and jointly controlled operations The activities of jointly controlled assets are, in effect, proportionately included in the investors individual company financial statements (and therefore in its consolidation also): its share of the assets, liabilities, income and expenses are
The carrying amount in an investors balance sheet of an investment that qualifies for the equity method of accounting may differ from the underlying equity in net assets as reported by the investee. If the difference is attributable to specific assets of the investee, it is amortised over the estimated remaining useful lives of such assets (where it is attributable to land, no amortisation ordinarily should be provided). Otherwise, the difference is considered to be goodwill and amortised over a period not exceeding 40 years (see 5.7). The financial statements of the investee need not be coterminous; no time limit is set. However, the financial statements should be adjusted for the purposes of consolidation to achieve reasonable consistency of accounting policies with those of the investor. Inter-company profit eliminations are usually made to the extent of the investors interest. The investors share of losses in the associate is recognised until the investment is reduced to zero and thereafter to the extent of any investors obligation to meet the associates obligations.
Joint arrangements that are not entities In this case the investor includes directly in its own individual company financial statements (and thus on consolidation also) its share of the assets, liabilities, income and expense according to the terms of the arrangement.
79
UK I AS US
UK
I AS
US
80
included with its own assets, liabilities, income and expenses. For jointly controlled operations the investor includes, in its individual company financial statements (and therefore in its consolidation also), the assets that it controls and the liabilities and expenses that it incurs in the course of pursuing the joint operation plus its share of the income earned from the joint operation. Disclosure If all associates or individual associates or if all joint ventures or individual joint ventures meet certain size criteria then summarised balance sheet and profit and loss account information for them must be disclosed. Disclosure For all jointly controlled entities together the investor should disclose certain summarised asset, liability, income and expense information. Disclosure Where investments accounted for by the equity method meet certain size criteria summarised information as to assets, liabilities and result of operations should be presented in the notes or in accompanying separate financial statements of the investee.
6.6
Other investments and financial instruments

(CA 85, UITF 5)
6.6

(IAS 39)
6.6

(SFAS 115, SFAS 125, SFAS 133, SFAS 137, SFAS 138, ARB 43, D50, F38, I80)
The availability of the amortised cost basis is not restricted in the same way as in the US or IAS. Market makers would mark-to-market through the profit and loss account. There is no equivalent of the available-for-sale category, although investments may be revalued through the STRGL with no later recycling. Transfers of financial assets are dealt with on a risk-and-rewards substance basis.
Only defined categories of financial instruments may be held at amortised cost. Items held for trading and all derivatives (other than hedges) are stated at fair value through the income statement. Other assets, available-for-sale, are stated at fair value with changes therein flowing through either the income statement or, other than normal foreign exchange, direct to equity with later recycling. Transfers of financial assets are dealt with on a financial components basis.
Only defined categories of financial instruments may be held at amortised cost. Assets held for trading and all derivatives (other than certain hedges) are stated at fair value through the income statement. Other assets, available-for-sale, are stated at fair value with all changes therein, including foreign exchange, flowing through OCI with later recycling. Transfers of financial assets are dealt with on a financial components basis.
General There is no accounting standard that deals specifically with investments (other than investments in subsidiaries, associates and joint ventures) or other financial instruments. Investments are generally treated as fixed assets (ones held for continuing use in the business) if they are held for the long-term and, provided they do not have a limited useful life, are then stated at cost (or revalued amount) less provisions for permanent diminutions in value. Otherwise they are treated as current assets and stated at the lower of cost (or revalued amount) and net realisable value. (In both cases the income from the investment is dealt with on an accruals basis.) A derivative would usually be a current asset. The following paragraphs set out the application of these principles in the format of the IAS classification.
General IAS 39 provides rules covering all financial instruments other than investments in subsidiaries, associates and joint ventures, assets and liabilities arising from leases, assets and liabilities arising from employee benefit plans, interests in insurance contracts (as defined), own equity instruments, certain guarantees and deferred consideration on business combinations. IAS 39 is mandatory for years beginning on or after 1 January 2001; hitherto there was no standard on the subject. All financial instruments are classified as one of the following: held-to-maturity assets; originated-loan-or-receivable assets; trading assets; available-for-sale assets; trading liabilities; and other liabilities. All derivatives, other than hedges (see 5.4), are deemed to be trading assets or liabilities as the case may be. The classification and measurement rules for each of the first five categories are set out below. (There are, in effect, no special rules for other liabilities.) The same rules apply whether the item is classified as current or non-current and note that the rules cover more than just securities.
General US GAAP provides extensive rules for the following classes of financial instrument: held-to-maturity debt securities; trading debt securities and marketable equity securities; available-for-sale debt securities and marketable equity securities; and derivatives (but see 5.9 for derivatives held as hedges). These rules, together with the brief principles for other areas covered by IAS rules, are set out below. They do not apply to investments in equity securities accounted for under the equity method nor to investments in consolidated subsidiaries.
Classification and measurement Held-to-maturity assets If an investment has a limited useful life and a residual (eg, redemption) value differing from cost, then it would be amortised.
Classification and measurement Held-to-maturity assets Held-to-maturity assets are stated at amortised cost. A held-to-maturity asset is one which, naturally, has a fixed maturity. It therefore excludes equity shares. The entity must have the positive intent and ability to hold it to maturity. The conditions for this are similar to those of the US. However, if the company sells
Classification and measurement Held-to-maturity securities Investments in debt securities that the investor has the positive intention and ability to hold to maturity should be classified as held-to-maturity and measured at amortised cost. Positive intention and ability does not mean the mere lack of intention to sell. If the intention of management is not certain
81
UK I AS US
UK
I AS
US
82
any held-to-maturity asset in the current or previous two years, other than in circumstances similar to those in US GAAP, then IAS 39 is more strict in that it prohibits any asset from being classified as heldto-maturity - in effect the consequence of such a sale is that all held-to-maturity assets must be declassified as such for three years. then it is not appropriate to carry that security at amortised cost. Furthermore, if it is managements intention to hold the securities only for an indefinite period (eg, because they would sell it if market conditions changed) then it is not a held-to-maturity security. Managements intention to hold any security to maturity is called into question if it has sold any held-to-maturity securities other than where this is close to maturity date, or after collecting substantially all of the principal or due to an isolated non-recurring event that the company could not reasonably have anticipated. Other amortised cost assets All debts receivable that are not securities, and all equity securities that are not marketable, are usually carried at cost, amortised if appropriate. This gives a similar result to the IAS originated-loans-andreceivables category (of which US GAAP has no direct equivalent), save that it is not necessarily restricted to originated loans and receivables but can extend also to purchased ones. Trading securities and derivatives Debt securities and marketable equity securities that are bought for the purpose of being sold in the very near future should be classified as trading securities. SFAS 115 indicates that trading generally reflects active and frequent buying and selling with the objective of generating profits on short-term differences in price. A derivative is defined as a financial instrument that meets the all of the following conditions: It has some underlying variable (eg, an interest rate) and either a notional amount or a payment provision (eg, a specification as to how much is payable or receivable in response to changes in the underlying) or both. Originated-loans-and-receivable assets Items that would fall into this category under IAS would be dealt with on an amortised cost basis in the UK also. Originated-loan-or-receivable assets An originated-loan-or-receivable is also stated at amortised cost. This category is for financial assets which are not to be sold in the short-term and which arise from the provision of money, goods or services by the company. Thus trade debtors or a banks advances to customers should default to amortised cost without the need to apply the narrow held-to-maturity conditions. Trading assets and liabilities including derivatives The trading category is for any financial asset or liability held to generate short-term pricing profits or that is part of a portfolio actually used for that purpose. Thus past practice can determine whether something is a trading item or not. All derivatives other than hedges (see 5.9) are deemed to be held for trading. A derivative is defined as a financial instrument the value of which changes in response to some underlying variable (eg, as an interest rate swap does) and which requires little or no initial net investment compared with other instruments that have a similar response to the variable (eg, compared with a fixed rate loan). A commitment to
Trading assets and liabilities and derivatives Some companies, such as market makers, mark their current asset investments to market, ie continually revalue them, and take even the unrealised gains through the profit and loss account. Where a market maker has liabilities held for trading the same applies. This is an example of overriding a specific provision of the law in order to meet the overall objective of a true and fair view, in this case in the special context of a market maker. This would apply equally to derivatives traded by a market maker. Practice varies for derivatives held for trading purposes by other companies.
buy or sell a non-financial item, eg a commodity contract, is treated as a derivative unless: the contract was designated at inception as being for the companys purchase, sale or usage requirements; the company intends to settle by delivery of the non-financial item; and the company has no past practice of settling in cash or by off-setting contract. In addition, as in the US, derivatives that are embedded in a host contract should be separately accounted for as derivatives where there are not closely related to the host contract. Trading items are stated at fair value with changes therein flowing through the income statement. If the fair value of any such assets cannot be reliably measured then the asset is stated at amortised cost, although the standard suggests that only unquoted equity instruments are likely to be incapable of reliable fair valuation. In order to provide some measure of relief from these requirements for simple unsettled contracts for the sale or purchase of a financial asset, IAS 39 deems regular way contracts not to be derivatives. These are contracts that require delivery of the assets within the timeframe generally established by regulation or convention in the market concerned. Instead, regular way purchases may be dealt with by trade- or settlement-date accounting; regular way sales must be settlement-date accounted although the IASC proposes to amend IAS 39 to permit trade date accounting also.
It requires little or no initial net investment compared with other instruments that have a similar response to market factors. Its terms require or permit net settlement, or it can be settled net by another means (eg, by some market mechanism) or the item to be transferred in settlement is readily convertible into cash or is itself a derivative. However, a derivative does not include a contract for the delivery of a non-financial item for use or sale over a reasonable period in the normal course of business. However, if the contract has net settlement provisions or can be settled by a market mechanism, it must, in order not to be caught, be the case that it is probable that it will not be so settled. In addition, as under IAS, derivatives that are embedded in a host contract should be separately accounted for as derivatives where there are not clearly and closely related to the host contract. Both trading securities and all derivatives, whether assets or liabilities, (other than certain hedges - see 5.9), are stated at fair value with changes therein flowing through the income statement. If an equity security does not have a readily determinable fair value then it is not treated as a marketable equity security at all. There is no similar exemption for debt securities or for derivatives. Notwithstanding that US GAAP does not have a trading liabilities category, any financial instrument held for trading that is a liability is in practice likely to be a derivative anyway, such that there would be little practical difference arising here. US GAAP provides that regular way securities
83
UK I AS US
UK
I AS
US
84
trades are exempt from these requirements. Such trades are those that provide for the delivery of the security within the time generally established by regulation or custom in the market or exchange in which the trade is executed and that neither contain net settlement provisions nor can be settled by a market mechanism. Available-for-sale By using the statutory facility to revalue from time to time, investments may be stated at a valuation: for fixed asset investments this means market value or any other basis which appears to the directors to be appropriate to the companys circumstances; for current asset investments this means current cost (which in practice is also market value). Unrealised gains, recorded by virtue of revaluation, are required by the Companies Act to be credited directly to a revaluation reserve (part of shareholders funds). Amounts in the revaluation reserve are not recycled through the profit and loss account on realisation. Available-for-sale assets Any asset that does not fall into the previous three categories is classed as available-for-sale. The balance sheet treatment is the same as that for trading items. However, the company has a policy choice, for all available-for-sale items taken together, of either taking the fair value gains and losses through the income statement, like for trading items, or subject to one proviso taking them directly to equity from which they are later recycled into the income statement on the occasion of a sale, realisation or impairment of the asset concerned. The proviso is that the part of the change in fair value that is due to exchange rate changes is always reflected in the income statement. Transfers between categories If an asset is transferred from a fair value category to an amortised cost category the fair value immediately prior to transfer becomes the cost in the new category. Any cumulative gains or losses held in equity on the asset are recycled into the income statement over the period to maturity as a yield adjustment or, if there is no stated maturity, on sale. The fair value adjustment on reclassification from an amortised cost to a fair value category is taken to the income statement or directly to equity as is appropriate to the new classification. Available-for-sale securities All debt and marketable equity securities that are not classed as held-to-maturity or trading securities are classed as available-for-sale. These are also stated at fair value, but the changes in fair value, including that element due to exchange rate changes, are excluded from earnings and are reported (net of any tax effects and minority interests) as a net amount in OCI.
Transfers between categories of investments Where an investment (or indeed any asset) is transferred from current to fixed assets it should be transferred at the lower of cost and net realisable value with any adjustment necessary to achieve that being taken through the profit and loss account. The effect of this is that as at the date of transfer the asset needs to be properly stated under the rules for current assets: it is then transferred at that amount. Accounting standards do not deal with other transfers.
Transfers between categories of securities Transfers between securities categories are accounted for at fair value; unrealised holding gains and losses are recognised in the income statement only if the security is transferred into the trading category. Any unrealised gains or losses associated with transfers into the held-to-maturity category should be amortised over the remaining life of the security as an adjustment to its yield.
Impairment A permanent diminution in the value of a fixed asset investment must be charged in the profit and loss account. (It is a moot point as to how to treat the release of any revaluation previously recorded on that investment.) There is no guidance on the distinction between permanent and temporary diminutions. Current assets are always written down, through the profit and loss account, to net realisable value. However, realisable value takes into account the expected timing of realisation and so a current, but temporary, drop in market value need not necessarily cause a write-down.
Impairment A held-to-maturity asset or an originated-loan-orreceivable is impaired if the present value, at the original effective interest rate, of the expected future cash flows - the recoverable amount - is less than book value. The difference is charged in the income statement. If the recoverable amount later increases due to an event subsequent to the original write-down, then the impairment is reversed to that extent provided that this does not state the asset at more than amortised original cost. For trading assets and available-for-sale assets if stated at fair value through the income statement, impairment is not in point. An available-for-sale asset, for which changes in fair value are reported in equity, is impaired if the fair value (eg, the present value of its cash flows at the current discount rate) is less than amortised cost would have been. The difference is recycled out of the cumulative losses held in equity and is charged in the income statement.
Other-than-temporary impairment of securities If a decline in fair value of a held-to-maturity or an available-for-sale security is considered to be other-than-temporary, then the individual security should be written down to fair value which then becomes the new cost basis. The amount of the write-down should be recognised in the income statement. There is no adjustment to this new cost basis for any subsequent recovery in fair value. Examples of factors to be considered in evaluating whether a decline in the value of a security is other-than-temporary are: both the length of time and the extent to which market value has been less than cost; the financial conditions and near-term prospects of the issuer; and the intention and ability of the investor to retain its investment for sufficient time to allow for a recovery of the market value of a security. The impairment requirements for loans are similar to those of IAS. Transfers of financial assets The so-called financial components approach is used in the US. Under this approach a transferred financial asset is derecognised and new assets and liabilities may need to be recognised for remaining or new rights and obligations (eg, put or call options, guarantee or recourse obligations or servicing liabilities) if all of the following conditions are met: It is isolated from the transferor - ie, put legally beyond the reach of the transferor and its creditors, even in the event of the transferors insolvency.
Transfers of financial assets A purported transfer of a financial asset is accounted for in accordance with its substance determined on a risks-and-rewards basis. Complete derecognition is only appropriate if the transferor retains no significant benefits and risks (eg, credit risk, slow payment risk) relating to the asset. Thus if a loan is sold but any credit risk is retained, then the loan continues to be recognised. In addition, if the transferor is assured of a lenders return only, even if this is just via a transferors call option to re-acquire the asset, the transaction is in
Transfers of financial assets A transferred financial asset, or a part thereof, is derecognised when the transferor loses control of the contractual rights comprising that asset or that part of the asset; when an asset, or part thereof, is derecognised new assets and liabilities may need to be recorded (eg, remunerated servicing rights on transferred loans, interest strips or credit guarantees). The IAS does not give any explicit general principles for the determination of whether contractual rights have been surrendered. However, it gives a number of examples, as follows: the transferee is free to sell or pledge the asset (derecognised)
85
UK I AS US
UK
I AS
US
86
substance a financing and the asset remains recognised. If, however, there is a significant change in the transferors exposure to the benefit and risks, but some are retained, then the amount and/ or description of the asset may need to be changed and any new liabilities recognised. So far as financial asset transfers are concerned the most likely scenario is the sale of part of the item, for example the principal in a loan. The loan would be divided into its two benefit streams, the (discounted) principal and the interest strip, with the former derecognised. More complicated cases, such as a sale of loans with a retained remunerated servicing right and a part of the interest income retained would need to be judged on their individual facts (including the retention of moral risk - eg, for the sake of its ongoing relationship with the borrower, would the transferor provide non-contractual support to the transferee for the loan?) There will come a point at which sufficient small components are retained for it to be wrong to book any derecognition. There is also the special case of a transfer that is an in-substance financing but where the recourse is strictly limited to a fixed monetary amount. The linked presentation on the face of the balance sheet (see 5.5) may be available subject to certain strict conditions, for example that the finance will only be repaid out of the cash generated by the asset or by the transfer of the asset itself. Securitisations sometimes achieve the linked presentation. the transferor is entitled and obliged to reacquire it at a price giving a lenders return to the transferee, or has achieved the same through a total return swap (continued recognition); and the transferor has a right to re-acquire it at other than fair value and the asset concerned is not one that is readily obtainable in the market (continued recognition). Thus IAS 39 takes the US financial components approach, ie each component of the transaction is separately dealt with rather than, as in the UK, accounting for the risk-and-rewards of the whole transaction. However, it should be noted that IAS 39s examples do not necessarily coincide exactly with the US rules. For example, whilst the US prevents derecognition where the transferor is both entitled and obliged to repurchase, IAS 39s example includes that the pricing gives a lenders return to the transferee. By way of contrast with the UK, this is a two way lenders return test whereas a one way test (mere entitlement to repurchase at a lenders return) is used in the UKs risks-andrewards approach; although the IAS here accounts for the whole transaction rather than its components it could be said to do so more because of its overall contractual certainty than because of its risk-and-rewards. In any event, it should not be overlooked that if the transferee in any of these cases is an SPE then the transferred asset may come back into the group on consolidation if certain risks-and-rewards based tests are met (see 5.6). There is no equivalent of the UKs linked presentation. In a securitisation the assets are more likely to leave the companys balance sheet than in the UK, but on the other hand, subject to the facts of any particular case, will very likely come back into the groups balance sheet as a consolidated SPE. The transferee has the unrestrained right to pledge or exchange the assets or, where the transferee is an SPE, the holders of beneficial interests in that entity have the unrestrained right to pledge or exchange those interests. The transferor is neither both entitled and obliged to repurchase the asset before maturity (and has received cash or collateral sufficient to enable it to do so should the transferee default), nor is it just entitled to do so when the asset is one that is not readily obtainable. It should be noted that if the transferee is an SPE meeting certain criteria (see 5.6) then even if the asset is derecognised by the company it may come back into the group on consolidation, although this is perhaps less likely than under IASs as US GAAP does not employ a risks-and-rewards approach to consolidation of SPEs holding financial assets. If the conditions noted above are not met, the transfer is accounted for as a financing arrangement and a liability is recognised. There is no equivalent of the UKs linked presentation. Securitised assets are perhaps more likely to be removed from both the company and consolidated balance sheets than in the UK and under IASs.
6.7
Stock
(CA 85, SSAP 9)
6.7
Inventory
(IAS 2, SIC 1)
6.7
Inventory
(ARB 43, I78)
LIFO would rarely be an appropriate basis for cost. Stock provisions are written back if no longer required.
LIFO is an allowed alternative basis for cost. Inventory provisions no longer required are written back.
LIFO is an acceptable basis for cost. Inventory provisions may not be written back.
Stock is stated at the lower of cost and net realisable value. This comparison should be made for each item of stock separately. Where this is impractical, groups or categories of stock items which are similar will need to be taken together. While SSAP 9 does not permit stocks to be valued above cost in the historical cost financial statements, in certain circumstances (such as commodity dealers) the valuation of stocks at market value is an accepted industry practice necessary to give a true and fair view. Any provision for diminution in value of stocks which is no longer required must be written back.
Inventory is stated at the lower of cost and net realisable value, determined on an individual item basis. Where the individual basis is impractical, items may be grouped by product lines of similar purpose/ use. However, in certain cases where it is accepted industry practice to carry inventory always at net realisable value (eg, mineral ores), this is permitted by the standard. Any write-down of inventory which is no longer required must be written back.
Inventory (stock) is stated at the lower of cost or market value. Depending on the character and composition of the inventory, the rule of the lower of cost or market value may be applied either directly to each item or to the total of the inventory; whichever most clearly reflects periodic income. Only in exceptional cases may inventory be stated above cost (eg, agricultural, mineral and other products, units of which are interchangeable and have an immediate marketability and for which appropriate costs may be difficult to obtain). Certain specialised industries, for example commodity dealers, carry their inventories at fair market values. Once a provision has been made to write down inventory to market value it cannot be subsequently restored.
Cost Cost may be determined on a variety of methods with a view to providing the fairest approximation of the expenditure actually incurred in bringing the product to its present location and condition (including attributable overheads). Methods such as the base stock and last-in-first-out (LIFO) method
Cost Cost is the cost of purchase, conversion and other costs incurred in bringing the inventory to its present location and condition (including attributable overheads). Where it is necessary to use a cost formula (because of there being a large number of interchangeable items) the Benchmark
Cost Cost is defined as the sum of the applicable expenditures and charges directly or indirectly incurred in bringing inventories to their existing condition and location. Exclusion of all overhead cost from inventory cost is not an acceptable accounting method. Cost may be determined on a
87
UK I AS US
UK
I AS
US
88
are usually not appropriate methods because they often result in stocks being stated in the balance sheet at amounts that bear little relationship to recent cost levels. Treatment is first-in-first-out but the last-in-firstout (LIFO) is the Allowed Alternative Treatment. SIC 1 specifically provides that the same type of cost formula need not be used for all inventory; different bases may be appropriate for inventories of different natures and uses. Net realisable value Net realisable value is the estimated selling price less the estimated costs of completion and sale. Market value Market value is equal to current replacement cost to the extent that it does not exceed net realisable value, ie, estimated selling price in the ordinary course of business less reasonably predictable costs of completion and disposal. In addition, market value should also not be less than net realisable value reduced by an allowance for an approximately normal profit margin. variety of methods. This includes last-in-first-out (LIFO) as long as it is also adopted for tax purposes. Net realisable value Net realisable value is equal to the estimated sale proceeds less all further costs to completion and all directly related marketing, selling and distribution costs.
6.8
Debt instruments
(FRS 4, UITF 11)
6.8
Debt instruments
(IAS 1, IAS 32, IAS 39, SIC 5)
6.8
Debt instruments
(APB 14, SFAS 76, SFAS 84, SFAS 114, SFAS 118, SAB 94, D10, D22)
Shares are classified as shareholders funds. There is no split accounting for inseparable equity elements. Debt due within one year is virtually always classified as such. The gain or loss on repurchase or early settlement of debt is presented within or adjacent to interest.
Shares are classified as debt if they contain an obligation (eg, some preference shares). Instruments with debt and equity features are split accounted. Debt due within one year may be classified as non-current on the basis of a post-balance sheet refinancing. The gain or loss on extinguishment of debt is very unlikely to be an extraordinary item.
Preferred stock redeemable at the holders option is presented separately from stockholders funds and from debt. There is no split accounting for inseparable equity elements. Short-term debt may be reclassified as longterm on the basis of a post balance sheet refinancing. The gain or loss on extinguishment of debt is generally presented as an extraordinary item.
Classification as debt FRS 4 deals with all instruments issued as a means of raising finance, including options or warrants giving the holders rights to subscribe for or obtain such instruments. Where such a capital instrument is not a share of the reporting company and it contains an obligation, or a contingent obligation, to transfer economic benefits then it is classified as debt. Other instruments, such as shares or warrantsfor-shares, would be classified as shareholders funds or as minority interests if issued by a subsidiary. However, if a share issued by a subsidiary to a minority has been, for example, unconditionally guaranteed by another group company then the instrument is classed as debt.
Classification as a liability An instrument is classified as a liability, ie as debt, when it contains an obligation to transfer resources, eg cash or other financial assets. Instruments that do not do so are classified as equity (shareholders or stockholders funds). Where an obligation to transfer resources is contingent on uncertain future events outside the control of the holder or the issuer, then this is sufficient to classify the instrument as a liability unless the possibility of the transfer of cash or other financial assets is remote. This is applied even where the instrument is a share. Thus many preference shares would be classified as debt. Instruments that are not shares but are to be settled in equity shares (mandatorily or at the issuers option) are classed as debt when the number of such equity shares to be issued varies with the share price at the time of settlement. More fundamentally, a compound debt-and-equity instrument is split for accounting into separate debt and equity components (split accounting). There is no mandated method of apportioning the value.
Classification as debt The distinction between debt and stockholders equity is similar to that of FRS 4. However, the SEC requires that preferred stock, whose redemption is not controlled by the company, is reported separately from stockholders equity and separately from debt. This presentation is know as the mezzanine level.
Debt with share purchase warrants If debt and warrants-for-shares are issued simultaneously and either can be transferred, cancelled or redeemed independently of the other then the two components should be accounted for separately. Clearly it will be necessary in such a case to apportion the issue proceeds to each component in some appropriate fashion. However, there is no specified method of apportionment. The debt would then be accounted for as a liability and the separate warrant as part of shareholders funds. Where the two components are not separable, then since the hybrid instrument contains an obligation
Debt with share purchase warrants As a result of split accounting it is irrelevant whether share purchase warrants are detachable from a debt for commercial purposes or not. For accounting purposes they are detached and accounted for as equity.
Debt with stock purchase warrants The issue proceeds of debt securities with detachable warrants to purchase stock should be allocated between the warrants and the debt securities based on their relative fair values at time of issue; the part allocated to the warrants should be accounted for as additional paid-in capital (part of stockholders equity), and the remainder should be accounted for as a liability. However, debt securities with non-detachable warrants are classed entirely as liabilities.
89
UK I AS US
UK
I AS
US
90
(in respect of the debt element), it is classed a single debt instrument. Convertible debt Convertible debt should be reported as a separate item within liabilities until such time as it is converted. On conversion no gain or loss is recognised. The amount recognised within shareholders funds is the carrying amount of the debt immediately before conversion. The finance cost of convertible debt must always be calculated on the assumption that the debt will never be converted. Allocation of finance costs and the carrying amount of debt The finance cost is the difference between the net proceeds of issue and the total amount of payments (or other transfers of economic benefits) that the issuer may be required to make in respect of the instrument. It therefore includes issue costs (as defined) and redemption premiums (including those payable in the event of non-conversion - see above) less redemption discounts. Finance costs are generally allocated, on the constant effective rate method, over the period to the earliest date on which either party may require the instrument to expire, be redeemed or be cancelled. Finance costs do not include premiums payable on early redemption where that early redemption is solely at the option of the issuer. Such an option must, of course, be a genuine one. For example, if the interest rate becomes punitive in the event of failure to exercise the option, then the option is effectively an obligation. Issue costs are restricted to those costs that are incurred directly in connection with the issue, that Convertible debt This is split into a debt element and an equity element for the share option effectively embedded in it. There is no guidance on the accounting for the conversion (ie, whether or not it is a no-gain-or-loss transaction). Convertible debt Convertible debt should be accounted for entirely as a liability and the finance cost is determined in a manner similar to that in the UK. Allocation of finance costs and the carrying amount of debt A debt is initially stated at issue proceeds net of transaction costs, ie those incremental costs directly attributable to the debts issue. Thereafter it is stated at the initial amount less principal repayments plus or minus the cumulative amortisation of any difference between that initial amount and the maturity amount (unless the debt is held for financial trading purposes, in which case see 6.6). Thus issue and redemption premiums and discounts and the transaction costs are amortised. However, IAS 39 does not specify the method of amortisation. Furthermore, it is silent on the charging of interest payments. In our view it flows from the accruals principle in the Framework that interest payments should be charged so as to give a constant effective rate (eg, one should not simply charge as incurred where the interest is stepped up gradually over time) and that the initial amount-vsmaturity amount should be brought into this calculation. Allocation of finance costs and the carrying amount of debt The discount or premium associated with debt instruments together with expenses incurred in issuing the debt should be amortised over the term of the debt so as to give a constant rate of interest (interest method). Unamortised issue costs are presented as a deferred charge separate from the debt instrument.
is, those that would not have been incurred had the specific instrument in question not been issued. The carrying amount of debt is the net proceeds of issue, ie the fair value of consideration received less issue costs, plus finance costs charged to date less payments made to date. However, accrued finance costs that are payable in the next accounting period can, optionally, be separately reported within accruals. Maturity of debt (for presentation and disclosure purposes) The maturity of debt is the earliest date on which the lender could require repayment. Where there are committed back-up facilities through which the debt could be refinanced, the maturity is still assessed by reference to its own maturity date unless, exceptionally, certain rigorous conditions are met in which case the maturity of the facilities should be used. The conditions are meant to identify facilities which are effectively part of the original debt instrument itself. Depending upon the facts, most multi-option facilities probably would meet the conditions; commercial paper programmes probably would not. Repurchase and restructuring of debt The difference between the amount to repurchase or settle the debt and the previous carrying amount of the debt is generally charged or credited in the profit and loss account immediately. It is shown either within or adjacent to interest. The repurchase or early settlement of debt is not defined. However, in most cases it will probably be clear that it has been settled. The case where the company has apparently been released from its Maturity of debt (for presentation and disclosure purposes) A debt should be classified as current or noncurrent (if the companys balance sheet distinguishes between current and non-current items at all (see 5.1)) based on whether it is due within one year or not. The due date is the earliest date on which either the lender could require repayment or the issuer could make repayment and intends to do so. In addition, a debt due within one year, provided that the original maturity of the debt was over one year, may be reclassified as noncurrent on the basis of intention and agreement (including post-balance sheet agreement) to refinance it. Extinguishments and restructurings of debt IASs do not specify whereabouts in the income statement the gain or loss on the extinguishment of a debt is to be included. However, given the definition of extraordinary items (see 7.13) it is very unlikely that it would fall into that category. Debt is extinguished when: payment is made to the lender; or Maturity of debt (for presentation and disclosure purposes) The maturity of debt is the earliest date on which the lender could require repayment or on which the borrower intends to repay. However, the maturity of debt that would otherwise be classified as shortterm, may be taken to be long-term on the basis of intention and ability to refinance it. That ability must be demonstrated prior to issuing the financial statements, for example, by a financing agreement obtained post year-end.
Extinguishments and restructurings of debt The difference between the amount paid to extinguish the debt and the net carrying amount of the debt must generally be dealt with as an extraordinary item. Debt is considered extinguished for financial reporting purposes when: the issuer pays the holder and is relieved of all its obligations with respect to that debt; or
91
UK I AS US
UK
I AS
US
92
obligation but has given a guarantee of the novated indebtedness, or of the performance of other assets from which the loan is to be repaid, would be assessed on a risk-and-rewards basis. Derecognition of the debt is unlikely. The difficulty arises where the debt is replaced with a new or restructured debt. Where this debt is effectively a continuation of the old debt under a new guise then it would usually not be taken to be a repurchase or early settlement. In such a case any apparent gain or loss is spread forward as part of the finance costs. FRS 4 does not specifically address the treatment of inducements promptly to convert debt to equity. However, while each case would need to be examined on its facts, it seems likely that a prompt-conversion payment is in substance compensation to the holder for foregoing further interest payments (before eventual conversion). Accordingly it would be charged immediately as a finance charge. the borrower is legally released, either judicially or by the creditor, from primary responsibility for the liability irrespective of any guarantee given by the borrower. Any assets transferred as part of this extinguishment are derecognised only if the relevant conditions are met (see 6.6). If not, then a new liability to the transferee will need to be recognised at fair value. Any guarantees given should also be recognised at fair value. Where a debt is restructured or refinanced on substantially modified terms it is accounted for as an extinguishment of the old debt, with a consequent gain or loss, and the inception of the new, at fair value. The terms are taken to be substantially modified where the net present value under the new terms differs by more than 10% from that of the remaining payments under the old terms. In other cases changes in the terms are dealt with prospectively. IASs do not specifically address the treatment of inducements promptly to convert convertible debt (and there is no guidance on conversion generally). Troubled debt restructuring The normal rules (above) apply even where the borrower is in financial difficulties. Thus a borrower might recognise a gain. It is very unlikely that such a gain would be classed as extraordinary notwithstanding its curious nature (effectively a gain caused by the borrowers decline in ability to repay its own debts). Troubled debt restructuring The accounting for a troubled debt restructuring, such as when the lender, for reasons relating to the issuers financial difficulties, grants a concession to the issuer that it would not otherwise consider, is dependent upon whether it is effected: by a transfer of assets, including repossessions and foreclosures, or of an equity interest from an issuer to a lender in full settlement of a debt; or by a modification of terms. In the former case, to the extent that the fair market value of the assets transferred, or equity interest the issuer is legally released, either judicially or by the holder, from being the primary party under obligation under the debt. Where a company offers additional securities or other consideration to the holders of its convertible debt as an incentive to exercise promptly their rights to convert the debt to equity (sometimes known as a convertible debt sweetener), the company is required to recognise as an expense (but not an extraordinary expense) an amount equal to the fair value of the additional securities or other consideration issued as an inducement.
Troubled debt restructuring There are no special rules for this type of restructuring. The general principles set out above apply. Where, under those principles, a new debt comes into existence (rather than a continuation of the old), a measurement question arises: what is the amount of the settlement and what is the amount of the inception of the new debt? There is no consensus on this matter.
granted, is less than the issuers book value of the debt (or the lenders recorded investment in the debt) the difference is generally treated as an extraordinary gain to the issuer and an ordinary loss to the lender. The issuer must also recognise a gain or loss for any difference between the book value of the assets transferred and their fair value. In the latter case any issuers apparent gain is generally spread forward.
6.9
Leases
(SSAP 21, FRS 5, UITF 12)
6.9
Leases
(IAS 17, IAS 39, SIC 15)
6.9
Leases
(SFAS 13, SFAS 28, SFAS 98, L10)
The distinction between a finance lease and an operating lease is based on conceptual principles rather than detailed requirements. Accordingly, the classification of leases is a more subjective process but one that should always result in accounting that follows the real commercial effect. It is possible that a lease designed to be an operating lease under US GAAP would be recognised as a finance lease in the UK. Lessee A finance lease is one which transfers substantially all the risks and rewards of ownership to the lessee. In determining whether or not this is the case all aspects and implications of the leasing arrangements should be identified and greater weight given to those more likely to have a commercial effect in practice. However, there are two more specific pieces of guidance to assist in this process. Firstly, it should be presumed that such a transfer of risks and rewards occurs if, at the start of the lease, the present value of the minimum lease payments, including any initial payment, amounts to
The distinction between a finance and an operating lease is based on conceptual principles rather than detailed requirements. As in the UK, the classification issue is more subjective but should result in accounting that follows the real commercial effect, although there is perhaps less guidance in IAS 17 than in the UK to assist in the process.
While US GAAP is similar in concept to SSAP 21 and IAS 17, its detailed requirements are much more extensive and differences exist.
Lessee A finance lease is one which transfers substantially all the risks and rewards incident to ownership of the asset. IAS 17 cites situations which would normally indicate a finance lease. Ownership is transferred to the lessee. A bargain purchase option exists. The lease term is for the majority of its economic life. The present value of minimum lease payments amounts to substantially all of the fair value of the leased asset.
Lessee From the standpoint of the lessee, SFAS 13 classifies leases as either operating or capital leases. A lease meeting any one of the following four criteria must be treated as a capital lease: The lease transfers ownership. The lease contains a bargain purchase option. The lease term is equal to or greater than 75% of the estimated economic life of the property. The present value of the minimum lease payments equals or exceeds 90% of the fair value of the property, less any investment tax credit retained by the lessor.
93
UK I AS US
UK
I AS
US
94
substantially all (normally 90% or more) of the fair value of the leased asset to the lessor at the start of the lease. This 90% test is only a presumptive guideline; it does not provide a strict mathematical definition of a finance lease. Secondly, where the transaction includes a lessees option to purchase the asset (or to extend the lease for the remaining asset life) and the optional payments are priced so that the lessor receives a lenders return and no more, then this indicates that the substance is a financing. A finance lease should be recorded in the balance sheet of a lessee as an asset and an obligation to pay future rentals, initially in the amount of the present value of the minimum lease payments discounted at the interest rate implicit in the lease. Rentals paid should then be apportioned between the finance charge and a reduction of the outstanding obligation for future amounts payable so as to produce a constant periodic rate of interest on the balance of the lease obligation outstanding. Leases other than finance leases are operating leases. Their rentals are charged on a straight-line basis over the period of the lease. Incentives to enter into an operating lease (typically a property lease) are to be treated as part of the rentals. This applies regardless of the form of the incentive, eg an up-front cash payment, a rent-free period or a contribution to certain lessee costs (such as fitting out or relocation). Accordingly such incentives should be spread on a straight-line basis over the period of the lease (or, if shorter, over the period to the review date on which the rent is first expected to be adjusted to the prevailing market rate). However, in the exceptional circumstances where it can be proved that the incentive is not part of the lessors market return, then the incentive may be spread on whatever systematic and rational basis is appropriate. The leased asset is specialised so that major modifications would be required for its use other than by the lessee. At inception the leased asset and the lease liability are recorded at the lower of the fair value of the leased asset and the present value of the minimum lease payments discounted at the interest rate implicit in the lease. The rental payments should be allocated between reducing the lease liability and the finance charge (interest paid) so that a constant rate of interest is achieved on the balance of the lease liability. A lease other than a finance lease is an operating lease. The rental payments, including any incentive to enter into the lease, are expensed on a straightline basis or any other systematic basis more representative of the true pattern of benefits to the lessee. The lessee records a capital lease as an asset and an obligation at an amount equal to the lesser of the present value of the minimum lease payments at the beginning of the lease term or the fair value of the leased property (ie, the lease is treated as a purchase on deferred terms). Lease payments should be allocated between interest expense and reduction of the lease obligation so as to give a constant periodic rate of interest. If none of the criteria is met, the lease is classified as an operating lease by the lessee. Neither an asset nor an obligation is recorded. Rental payments including, for example, rent free periods or cash incentives - are expensed in the income statement generally on a straight-line basis, unless some other systematic basis is more representative of the time pattern of benefits.
Lessor The criteria for classifying a lease as either a finance or an operating lease are the same for lessors as for lessees. The lessor records a finance lease at the amount of its net investment (ie, the present value of the remaining minimum lease payments plus the unguaranteed residual, usually equal to the assets fair value at inception). A manufacturer/ dealer lessor records an initial selling profit limited to the excess of the fair value of the asset over its cost. If a lessor were to finance its net investment on a nonrecourse basis then the US treatment of netting, effectively derecognising (part of) the net investment, would only be appropriate where the provider of the finance is in substance a subparticipator in the lease (for which there are strict conditions to be fulfilled). Under SSAP 21, the lessor allocates lease receipts under finance leases so as to achieve a constant rate of return on the net cash investment in the lease. This is not the same as the net investment. It is calculated after taking into account all the cash flows related to the lease including tax.
Lessor The definitions of finance and operating leases are the same for lessors as for lessees. The lessor initially records a finance lease at the amount of its net investment, as in the UK. The rental receipts are then split between reducing the net investment and finance income so as to produce a constant rate of return on the net investment. If a lessor were to finance its net investment on nonrecourse basis then the US treatment of netting, effectively derecognising (part of) the net investment, would only be appropriate if the arrangements transferred control of the (part of) the lease receivable to the provider of finance; this is unlikely with simple non-recourse finance. A manufacturer/ dealer lessor records an initial selling profit that is usually computed as the excess of the fair value of the leased asset over its cost.
Lessor From the standpoint of the lessor, a lease is a capital lease if it meets one of the conditions specified for the lessee and: the recoverability of the minimum lease payments is reasonably predictable; and no important uncertainties surround the amount of non-reimbursable costs yet to be incurred by the lessor under the lease. Lessors capital leases are then further subdivided into three categories as follows: A sales-type lease is one where a manufacturer / dealer lessors cost (or carrying amount if different from cost) differs from the fair value of the leased property (but see below for real estate leases in these circumstances). Normally, such leases arise when manufacturers or dealers use leasing as a means of marketing their products. The lessor records a profit on sale and then calculates the net investment in a similar fashion to that under SSAP 21. Lease receipts are allocated between interest income and reduction of the investment so as to achieve a constant periodic rate of return on the net investment. A leveraged lease is one where, broadly, the lessor finances its net investment in the lease, on a non-recourse basis, with a third party longterm lender. There are special accounting rules for these but the key feature is that the net investment in the lease is presented net of the non-recourse finance. Other capital leases are direct financing leases. The net investment in the lease is measured in a similar way to that under SSAP 21. Lease receipts are allocated between interest income and reduction of the investment so as to achieve
95
UK I AS US
UK
I AS
US
96
a constant periodic rate of return on the net investment. Additionally, where a real estate lease gives rise to a manufacturer/ dealers profit the lease is either a sales-type capital lease, if the lease eventually transfers ownership to the lessee, or an operating lease in all other cases. Sale and leaseback transactions Where a sale and leaseback transaction results in a finance lease, SSAP 21 requires that any apparent gain or loss be deferred and amortised over the lease term (or the useful life of the asset if shorter) in the financial statements of the seller-lessee. Where the transaction results in an operating lease, the profit or loss should be recognised immediately unless the transaction was not at fair value, in which case special rules apply. SSAP 21 does not provide any separate guidance regarding sale and leaseback transactions involving property. Sale and leaseback transactions Where a sale and leaseback results in a finance lease, any apparent profit should be deferred and amortised over the lease term. If the transaction results in an operating lease that is clearly established at fair value any profit or loss should be recognised immediately, otherwise special rules apply. There are no separate guidelines regarding the sale and leaseback of property. Sale and leaseback transactions Generally, any gain or loss on the sale is deferred and amortised in proportion to the amortisation of the leased asset (if a capital lease) or in proportion to rental payments (if an operating lease). A sale and leaseback transaction involving real estate is accounted for as a sale only if the transaction meets certain criteria (regarding the extent of the buyers investment in the property being sold, whether the sellers receivable is subject to future subordination and the degree of the sellers continuing involvement with the property after the sale) and the seller-lessee will actively use the property during the lease term. If the transaction does not qualify as a sale, it should be accounted for as a deposit or as a financing.
6.10 Product financing arrangements

(FRS 5)

(Framework, IAS 1, IAS 18)

(SFAS 49, D18)
There are no specific rules about product financing arrangements. The subject depends upon the concepts of FRS 5 (see 5.5). In general if the seller retains all significant rights or other access to the benefits inherent in the sold asset, and all significant exposure to the risks inherent in those benefits, then in substance a sale has not taken
No IAS deals with the specific transactions described in SFAS 49. The treatment could be determined by the Frameworks general requirement to account for substance rather than legal form and by IAS 18s requirement that, inter alia, a sale of goods should not be recognised unless the significant risks and rewards to
The product financing arrangements dealt with by SFAS 49 are ones whereby a company (known as the sponsor) sells a product to a third party on terms which require the sponsor to repurchase the product, a substantially identical product or processed goods, of which the product is a component, at specified prices. The sponsor is required to record the sale
place. Further, where the purchaser is assured of a lenders return and no more then the transaction is in substance a financing. For example, the transactions described in SFAS 49 would not be sales under FRS 5. If a purported sale of a product is in substance a financing, then the sale proceeds are accounted for as a borrowing.
ownership of the goods have been transferred to the buyer. Accordingly, the transactions described in SFAS 49 would very probably be dealt with as financings rather than sales.
proceeds as a liability where the specified price is fixed subject only to changes for finance and holding costs. This applies even if the repurchase provision is a sponsors call option, where there is a significant penalty for not exercising that option, or if the repurchase provision is the third partys put option. The same accounting also applies where the third party sells the product to others but the sponsor gives a resale price guarantee to the third party.
6.11 Tax provisions

(FRS 16, SSAP 15)
6.11 Tax provisions

(IAS 12)
6.11 Tax provisions

(SFAS 109, I27)
Deferred tax is provided for timing differences. Timing differences originate in the profit and loss account. The provision is partial, that is, it recognises only that part of the full potential liability which will probably crystallise.
Deferred tax is provided in respect of temporary differences. Temporary differences are differences between the accounting and tax measurement of assets and liabilities. Liabilities are provided in full; assets are recognised to the extent that it is probable that future taxable profit will be available against which the deferred tax asset may be utilised.
Deferred tax is provided in respect of temporary differences. Temporary differences are differences between the accounting and tax measurements of asset and liabilities. Liabilities are provided in full; assets are recognised to the extent that they are more likely than not to be recovered.
Overall approach to tax accounting Tax accounting in the UK differs fundamentally from that of the US and IASs in two respects. The UK approach to deferred tax is one of partial provision (on the liability method) for timing differences. The objective is to provide for the tax relating to all profits and losses earned or incurred to date where that tax will probably crystallise now or in the
Overall approach to tax accounting IAS 12 largely follows the US approach to deferred tax, ie temporary differences. The overall approach is as follows: A current tax liability or asset is recognised for the all remaining tax payable or recoverable in respect of all periods to date. Deferred tax liabilities or assets are recognised for the estimated future tax effects attributable
Overall approach to tax accounting The objectives of accounting for income taxes under SFAS 109 are to recognise: firstly, the amount of taxes payable or refundable for the current year; and, secondly, the deferred tax liabilities and assets for the expected future tax consequences of events that have been recognised in a companys financial statements or tax returns.
97
UK I AS US
UK
I AS
US
98
future. This also applies to recoverable tax although, in accordance with the fundamental concept of prudence, a more stringent approach is taken in the assessment of the probability of crystallisation in that case. The overall approach could be summarised as follows: A current tax liability or asset is recognised for the best estimate of the amount remaining to be paid or recovered in respect of tax returns for all periods to date. A deferred tax liability or asset arises in respect of timing differences (between accounts and tax returns). Such deferred tax liabilities or assets are measured at the amount that will probably be paid or received in the future, after taking account of future transactions that may further defer payment or receipt. This includes the use of the tax rate that will probably be in force at that future time. If there is a net deferred tax asset its carrying amount is prudently assessed. Tax relating to items charged or credited in the STRGL is also reported in that statement. Where the pre-tax item was reported in the STRGL in a prior year and the amount of related tax subsequently changes, whether that tax effect is reported in the STRGL or not will depend on the particular circumstances (eg, the irrecoverability of a previously recognised deferred tax asset may be connected with general profitability rather than the original STRGL item itself). In addition, in the profit and loss account there is no grossing up for underlying tax (as opposed to withholding tax) on investment income or to to temporary differences (as defined) and tax loss carry-forwards. However, the carrying value of deferred tax assets is restricted to the amount that can be utilised against future taxable profits that will probably be available. The measurement of current and deferred tax liabilities and assets is based on provisions of the substantively enacted tax law, which may include announcements of future changes; otherwise the effects of future changes in tax laws or rates are not anticipated. Tax relating to items charged or credited directly to equity is itself credited or charged directly to equity. Where the pre-tax item was reported to equity in a prior year and the amount of related tax subsequently changes (eg, a deferred tax asset becomes irrecoverable) then a pro-rata allocation of the tax effect is made between the income statement and equity. IASs do not deal specifically with the presentation either of underlying and withholding taxes on investment income, or of items taxed at nonstandard rates. Accordingly the following basic principles are applied: A current tax liability or asset and current tax expense or benefit are recognised for the estimated taxes payable or refundable based on the tax returns for the current and previous years. Deferred tax liabilities or assets are recognised for the estimated future tax effects attributable to temporary differences (as defined) and tax loss carry-forwards. The measurement of current and deferred tax liabilities and assets is based on provisions of the enacted tax law; the effects of future changes in tax laws or rates are not anticipated. The balance sheet carrying value of deferred tax assets is reduced, through a valuation allowance, so as to recognise (net) only the amount of any tax benefits that, based on available evidence, are more-likely-than-not to be realised. Tax relating to current year items reported as OCI is also reported as OCI. US GAAP does not deal specifically with the presentation either of underlying and withholding taxes on investment income, or of items taxed at non-standard rates.
normalise the tax rate on items subject to nonstandard rates. Timing differences Timing differences are differences between profits or losses as computed for tax purposes and results as stated in financial statements, which arise from the inclusion of items of income and expenditure in tax computations in periods different from those in which they are included in financial statements. Timing differences originate in one period and are capable of reversal in one or more subsequent periods. This UK approach of matching tax with accounting profits, on the basis that over time they will be the same (permanent differences aside), is fundamentally different from that of the US and IAS. Under the latter the temporary differences method works on an implied premise that the carrying amount of assets and liabilities are their pre-tax recoverable amounts and seeks to provide the tax, if any, arising on their recovery (ie, through use, realisation, sale or whatever). It will be evident to readers that a timing difference is a narrower concept. Deferred tax is the tax attributable to timing differences. Temporary differences As in the US, a temporary difference is the difference between the tax basis of an asset or liability and its accounts basis, that will result in taxable or deductible amounts in future years when the accounts carrying value is recovered or settled. So, again as in the US, it includes not only timing differences but also other differences, for example the recovery of non-deductible assets (although exemption is made for certain of these, as will be seen below) such as some fair value adjustments in a business combination. Temporary differences A temporary difference is the difference between the tax basis of an asset or liability and its accounts basis, that will result in taxable or deductible amounts in future years when the accounts carrying value is recovered or settled. At first sight this seems close to the UK timing differences method. However, it is fundamentally different and the key lies in the concept of the recovery or settlement of the accounts carrying value. This concept is that the carrying value is recovered either through use generating receipts, revenue or contribution at least equal to the carrying amount - or through sale generating proceeds at least equal to book value. Temporary differences thus include the UK-style timing differences and other differences, for example: a reduction in the tax basis of depreciable assets because of tax credits; an increase in the tax basis of assets because of indexing for the effects of inflation; and business combinations accounted for by the purchase method. Deferred tax is the tax attributable to temporary differences. Extent of provision for timing differences However, tax deferred or accelerated by the effect of timing differences should be accounted for to the extent only that it is probable that a liability or asset will crystallise. This is known as the partial provision method. Under this method, when assessing the likelihood of crystallisation of future liabilities, it is Extent of provision for temporary differences A deferred tax liability is recognised in full for all taxable temporary differences, irrespective of how unlikely crystallisation may appear, subject to a general exception and to some specific exceptions (eg, goodwill and undistributed earnings of Extent of provision for temporary differences SFAS 109 requires the recognition of a deferred tax liability on all taxable temporary differences, in full, regardless of the likelihood of crystallisation with only a few, and very specifically defined exceptions (for example goodwill and undistributed earnings of
99
UK I AS US
UK
I AS
US
100
necessary to consider future revenues and expenditures. Partial provision recognises that, if a company is not expected to reduce the scale of its operations significantly, it will often have what amounts to a hard core of timing differences - since the effect of future reversal of present timing differences will be offset by new timing differences originating in the future - so that the payment of some tax will be permanently deferred. For example, it is often possible to show that the amount of timing differences for the difference between capital allowances (tax basis depreciation) and accounts depreciation would not reverse since similar levels of capital expenditure are anticipated in the future. In accordance with this principle, deferred tax assets are recognised only to the extent that they are expected to be recoverable without replacement by equivalent debit balances. Tax losses carried forward are a particular type of timing difference that may give rise to a deferred tax asset. There is additional guidance on the determination of when this particular asset is recoverable without replacement, that is: the loss results from an identifiable and nonrecurring cause; and the company, or predecessor entity, has been consistently profitable over a considerable period, with any past losses being more than offset by income in subsequent periods; and it is assured beyond reasonable doubt that future taxable profits will be sufficient to offset the current loss during the carry forward period prescribed by tax legislation. Specific deferred tax issues The tax rate used is that which is expected to apply when the timing difference reverses. One would not necessarily wait until a new rate was enacted before overseas subsidiaries - see below). The general exception is that no provision is made in respect of a temporary difference arising on the initial recognition of an asset or liability (save where this is in a business combination) which affects neither accounting nor taxable profit. On the same basis, and subject to the same exceptions, deferred tax assets are recognised for temporary differences that will result in deductible amounts in future years and for tax loss carryforwards. However, the recognition is restricted to the extent to which it is probable that a taxable profit, against which the asset can be recovered, will be available. The standard does not give particularly specific guidance on the assessment of this probability, save that in the case of tax losses carried forward the losses should arise from an identifiable cause that is unlikely to recur. overseas subsidiaries - see below). A deferred tax asset is recognised for temporary differences that will result in deductible amounts in future years and for tax loss carry-forwards. However, a valuation allowance is deducted from this asset if, based on the weight of the available evidence, it is more-likely-than-not that some portion or all of the deferred tax asset will not be realised. All available evidence, both positive and negative, is considered to determine whether such an allowance is needed. Judgment must be used in considering the relative impact of negative and positive evidence. The weight given to the potential effect of negative and positive evidence should be commensurate with the extent to which it can be objectively verified. The more negative evidence that exists the more positive evidence is necessary and the more difficult it is to support a conclusion that a valuation allowance is not needed.
Specific deferred tax issues Deferred tax liabilities and assets are stated at the rate of tax expected to apply when it is paid or recovered based on rates that are enacted or
Specific deferred tax issues SFAS 109 requires that deferred tax liabilities and assets be adjusted in the period of enactment (eg, when royal assent, or its equivalent, is received) for
putting through the change. The effect of changes in tax rates is part of the normal tax charge. (There is no requirement to analyse the tax between continuing and discontinued operations.) The tax rate applied to timing differences on intra-group stock transfers is that of the selling subsidiary. Deferred tax is only provided in respect of fair value adjustments to assets and liabilities brought in under acquisition accounting where that tax is actually expected to crystallise. This is assessed under the normal partial provision principles but from the perspective of the enlarged group (see 5.7). For example, capital expenditure plans elsewhere within the acquirers group may mean that the acquired entitys capital allowance timing differences may never crystallise a tax payment for the postacquisition group. If (as is most often the case) no deferred tax asset is recognised at the time of acquisition for tax losses carried forward by acquired subsidiaries, any subsequent realisation is treated as a reduction of the tax charge in the year of realisation, to the extent that this occurs after the hindsight period for adjusting fair values (see 5.7). The revaluation of an asset will create a timing difference insofar as the profit or loss that would result from realisation at the revalued amount is taxable, unless disposal of the revalued asset and of any subsequent replacement assets would not result in an actual tax liability, after taking account of any expected rollover relief (a relief whereby gains are not taxed but are deducted from the base cost of replacement assets). Unremitted overseas earnings may give rise to timing
substantively enacted (ie, rates announced by the government in some jurisdictions have the substantive effect of actual enactment) at the balance sheet date. In addition, where the rate depends upon the manner of recovery (eg, whether it is as capital or revenue) the rate used is that of the expected manner of recovery (sale is assumed for a non-depreciable asset). Where inventory has been sold intra-group the deferred tax is computed at the rate applicable to the purchasing subsidiary. In respect of business purchases the differences between the tax bases and the fair values of the assets acquired (and liabilities assumed) are temporary differences for which deferred tax is provided in the normal way. However, deferred tax is not provided on goodwill unless it is deductible for tax purposes. If deferred tax assets of a purchased business are subsequently recovered at an amount over and above the amount originally recognised at acquisition, then an adjustment, although not necessarily for the whole amount, is made to goodwill (see 5.7). Taxable temporary differences in respect of investments in subsidiaries and joint ventures are not provided where the investor can control the timing of reversal (eg, the timing of profits remittance) and it is probable that it will not reverse. The same principle applies to associates but the control-of-reversal condition is unlikely to be met. A temporary difference usually arises when current purchasing power adjustments are made to assets under IAS 29 (see 5.4 and 5.8): the accounts value
the effect of an enacted change in tax laws or rates. The effect is included in income from continuing operations. If the tax rate depends upon the manner of recovery, the rate used is that applicable to the intended use. Where inventory is sold intra-group then, in effect, deferred tax is booked at the rate of applicable to the selling subsidiary. In respect of business purchases the differences between the tax bases and the fair values of the assets acquired (and liabilities assumed) are temporary differences for which deferred tax is provided in the normal way. However, deferred tax is not provided on goodwill unless it is deductible for tax purposes. If operating loss carry forwards of a purchased business are subsequently recovered at an amount over and above the deferred tax asset, less valuation allowance, originally recognised at acquisition, then goodwill is adjusted (see 5.7). Where the accounts value of an investment in a foreign subsidiary or joint venture exceeds the tax value, perhaps because of unremitted overseas earnings, then deferred tax is provided in respect of this temporary difference unless it will not reverse in the foreseeable future. There is no similar exception for investments in equity accounted investees. Deferred tax is not provided in respect of the remeasurement of a highly inflationary subsidiarys financial statements from its currency to the group reporting currency. However, where the economy ceases to be highly inflationary, the subsidiarys functional currency reverts to the overseas currency at that point the deferred tax is provided.
101
UK I AS US
UK
I AS
US
102
differences and, to the extent that there is an intention to remit them which would result in a liability crystallising, that liability should be provided. Current purchasing power adjustments, for example in a consolidated subsidiary in a hyper-inflationary economy, do not give rise to timing differences. Non-taxable government grants do not give rise to timing differences. As an exception to the general partial provision approach, companies may choose to make full provision in respect of pension accounting timing differences.
is increased but the tax value usually remains stated in the historical measuring unit. Full provision is made for this. No deferred tax asset is recognised in respect of unamortised government grants, whether deducted from the cost of the fixed asset or presented as deferred income, since the temporary difference arose on initial recognition and affected neither accounting nor taxable profit. There are no special rules for pensions accounting temporary differences.
Subject to the normal recoverability rules, deferred tax is booked on the receipt of a fixed asset related government grant, with the credit reducing the cost of the asset. There are no special rules for pensions accounting temporary differences.
Classification Deferred tax liabilities are shown under the heading provisions for liabilities and charges which does not distinguish between current and long-term elements. A deferred tax asset would be shown within debtors and, given the measurement rules, it is unlikely that a deferred tax asset recoverable after more than one year would be recognised at all. A deferred tax balance arises on an aggregate basis for all categories of timing differences since this is the way in which tax is assessed. Thus assets and liabilities would (apparently) be netted off. However, this netting off would be restricted to the same tax jurisdiction since deferred taxes in different jurisdictions are clearly separate assets and liabilities. Future developments The ASB proposes to retain the timing differences basis, as it has serious reservations about the temporary differences basis, but to move towards a full provision basis for those timing differences,
Classification Deferred tax liabilities and assets should always be classified as non-current. Deferred tax liabilities and assets should be off-set within each tax jurisdiction to the extent that actual tax payments and receipts can be settled net and either the deferred tax liabilities and assets relate to the same taxable entity in the group or to different entities where they can settle net and intend to do so.
Classification Deferred tax liabilities and assets, but not the valuation allowance, are classified in the balance sheet as either current or non-current according to the classification of the related asset or liability. The valuation allowance is allocated against current and non-current assets pro rata to the allocation of all of the deferred tax assets as a whole. The expected timing of the reversal of deferred taxes is not considered in the classification of deferred tax balances except in certain instances where a deferred tax balance cannot be related to an identifiable asset or liability for financial reporting purposes. The net balance of deferred tax asset or liability for each tax paying component of a company in each tax jurisdiction is presented in two classifications: a net current asset or liability and a net non-current asset or liability. However, the offsetting of deferred tax assets and liabilities that relate to different tax jurisdictions is not permitted. For example, a current deferred tax asset resulting from the calculation of deferred UK income taxes may not be offset against
subject certain exceptions, eg: revaluations where there is no commitment to sell; or unremitted overseas earnings where there is no commitment to remit them. The ASB is also considering whether deferred tax should be discounted
a current deferred tax liability resulting from the calculation of deferred US income taxes. Accordingly, companies that operate in multiple tax jurisdictions may have current and non-current deferred tax assets and current and non-current deferred tax liabilities, as well as current taxes refundable and current taxes payable.
6.12 Other provisions

(FRS 12, CA 85)

(IAS 16, IAS 19, IAS 37)

(SFAS 5, EITF 94-3, SFAS 88, C59)
There is a comprehensive framework for provision recognition. All restructuring costs are provided on a commitment basis. An announced voluntary redundancy programme is provided for to the extent of the expected take-up. Decommissioning is provided upfront on an undiscounted basis and is charged to the cost of the asset. Repairs and maintenance of own assets cannot be provided.
There is a comprehensive framework for provision recognition. All restructuring costs are provided on a commitment basis. An announced voluntary redundancy programme is provided for to the extent of the expected take-up. Decommissioning is provided upfront on an undiscounted basis and is charged to the cost of the asset. Repairs and maintenance of own assets cannot be provided.
There is no comprehensive framework for provision recognition. Some restructuring costs, ie those other than employee termination, are provided on a decision basis. Voluntary employee severance is provided only when the employee accepts the terms. There are no rules on decommissioning; it is generally spread on an undiscounted basis. There is no prohibition on repairs and maintenance provisions.
The section deals with all provisions other than pensions and other post-retirement/ employment benefits (see 7.5 - 7.8), tax (see 6.11 above), restructurings in acquisition accounting (see 5.7) and restructurings that involve the sale or termination of operations (see 7.10). The UK standard on this subject, FRS 12, was used
The section deals with all provisions other than post-employment benefits and those payable on termination in accordance with certain pre-existing arrangements (see 7.5 - 7.6), tax (see 6.11 above), restructurings in purchase accounting (see 5.7) and restructurings that involve the sale or termination of operations (see 7.10).
The section deals with all provisions other than pensions and other post-retirement/ employment benefits (see 7.5 - 7.8), tax (see 6.11 above), restructurings in purchase accounting (see 5.7) and restructurings that involve the sale or termination of operations (see 7.10).
103
UK I AS US
UK
I AS
US
104
by the IASC as the basis for its standard, IAS 37, described in the next column. The two are very similar and the following describes only the differences in the UK standard. General Recognition The recognition principles of FRS 12 and IAS 37 are the same. General Recognition IAS 37 uses what might be termed the commitment basis of provision, ie it requires that a provision is recognised when: there is a legal or constructive obligation arising from past events, or in cases of doubt as to the existence of an obligation (eg, a court case), it is morelikely-than-not that a legal or constructive obligation has arisen from a past event; and it is more-likely-than-not that there will be an outflow of benefits; and the amount can be reliably estimated. Thus, for example, a management decision alone does not trigger recognition. A constructive obligation is defined as one where other parties have a valid expectation that the company will carry out an action, because of past practice or sufficiently detailed public statements. An example is a retailers non-contractual practice of accepting returns. An integral part of an obligation is that it must arise from a past event. This means that, inter alia, a cost of operating in the future cannot be provided. Provisions and related assets cannot be off-set. Thus reimbursements (such as insurance recoveries) must be recognised separately, as must profits on asset sales related to any provision (eg, General Recognition US GAAP does not provide a general framework to provision recognition, other than the contingent loss rules of SFAS 5 (see 6.13). Under those rules provision is made if it is probable (ie, likely) that a future event will confirm that a liability had been incurred by the balance sheet date and if the amount can be reasonably estimated.
related to a restructuring), which may not be anticipated. Measurement The measurement principles of FRS 12 and IAS 37 are the same. Measurement The amount provided is the best estimate of the expenditure, discounted. If there is a large population (say, product warranties) the expenditure is estimated as the expected value; if there is a single item it is usually the most-likely outcome; where there is a range of possibilities then it is the point in the range at which the probability becomes more-likely-than-not. Future events should be taken into account in computing the amount. An example is a reasonable technological development that would make decommissioning cheaper. In the discounting risk is reflected either by adjusting the cash flows (upwards) or the discount rate (downwards). The unwinding of the discount is presented as a component of interest. Disclosure As well as a table of movements on each class of provision, various details are disclosed, for example: the nature of the obligation, expected timing, uncertainties about amount or timing and the expected amount of any re-imbursement. However, in the extremely rare cases where any of this disclosure could seriously prejudice the companys position in a dispute with another party on the subject matter of the provision, it need not be given although that fact and the general nature of the dispute should instead be given. These requirements are comparatively new and it is difficult to see how the exemption will work in practice - stating that one is taking advantage of it may signal something to the other party in a prejudicial way. Measurement SFAS 5 does not provide general rules on the measurement of provisions, save that where only a range can be estimated then the best estimate within the range is provided or, failing that, the minimum.
Disclosure The disclosures required by FRS 12 and IAS 37 are the same. However, the Companies Act 1985 requires similar disclosures to FRS 12, but without any seriously-prejudicial exemption.
Disclosure There are no general disclosure requirements in respect of amounts provided.
105
UK I AS US
UK
I AS
US
106
Transition FRS 12 is mandatory in years ending on or after 23 March 1999. In general it is effected by the normal prior year adjustment (see 5.2), though normal changes in estimate must be made through the profit and loss account. Applications Restructurings FRS 12s application to restructurings is the same as that of IAS 37, save that redundancies are expressly within the scope of the normal FRS 12 provision rules. Transition IAS 37 is mandatory for years beginning on or after 1 July 1999. Companies may implement it by making the necessary adjustment directly against opening equity and restating comparatives, rather than by following the usual rules (see 5.2). Applications Restructurings A constructive obligation for a restructuring arises only when: there is a formal plan for the restructuring in specified detail, including that the timetable for implementation is not so long as to give the opportunity for plans to be changed; and the entity has raised a valid expectation in those affected that it will carry it out by either: starting to implement the plan; or announcing its main features to those affected by it. These rules apply to all restructuring costs other than redundancies; however, such restructuring costs cannot include costs associated with ongoing activities (costs of operating in the future), such as investment in new systems, retraining or relocation. Thus loyalty bonuses would not be provided. Operating losses may not be provided either. Redundancy payments are outside IAS 37 as IAS 19 applies instead. It has two tests that must be met for provision to be made: the first is the same as the first bullet above; the second is that the company is demonstrably committed to the plan without realistic possibility of withdrawal. In our view the only logical way to apply this test is to apply the IAS 37 test set out in the second bullet point above. Applications Restructurings - other than sale or termination of an operation The rules governing involuntary employee termination provisions are similar to those of the UK and IAS. A liability, in excess of any required under pre-existing arrangements, is recognised in the period in which management (with appropriate authority) approves, and commits the company to, the termination plan provided that in respect of the plan: management establishes - before the balance sheet date - the benefits that the employees will receive; before the balance sheet date it is communicated to the employees enabling them to establish the nature and type benefits which they would receive; it identifies the number, function and location of employees to be terminated; and the timetable for plan completion would not accommodate significant plan changes. The liability does not include remuneration, either of a normal level or a loyalty bonus, relating to the period after approval of the plan but before the date of termination of employment where that remuneration is the cost of services rendered in that future period. Such costs would instead be charged as operating costs at that future time.
The IASC proposes to amend IAS 19 to make this point clear. IAS 19s rules apply to both compulsory and voluntary redundancies, but in the latter case provision would be made to the extent that it is expected that volunteers will come forward. A restructuring may also entail asset disposals or impairments. These are dealt with in 6.4; but profit on asset disposals must not be anticipated in order to reduce provisions.
Voluntary severance benefits are accrued when the terms are accepted by the individual employee. Other exit costs are recognised in the period in which management (with appropriate authority) approves, and commits the company to, an exit plan that identifies an expected completion date and all significant actions required to carry out the plan (eg, location of activities to be discontinued and manner of disposition); execution of the plan must commence as soon as possible and the timetable for completion would not accommodate significant plan changes. Thus so far as exit costs other than redundancies are concerned there is no equivalent of the UK and IAS announcement or actualcommencement rule - a detailed management decision is sufficient. To be included in any provisions other exit costs, as in the UK and under IAS, must not benefit or be associated with future revenues and activities. Operating losses may not be rolled into the provision either. In addition, a restructuring may also include asset disposals or impairments; these are dealt with in 6.4 and 7.10. Where asset disposals will generate profits these are not permitted to reduce any restructuring provision.
Decommissioning Decommissioning is dealt with in the same way as under IAS.
Decommissioning The obligation to make good environmental or other damage incurred in installing, say, an oil rig, is provided in full immediately as it flows from a past event - the installing of the oil rig. The provision will be discounted (the effect of which is likely to be material). The debit side of this provision, instead of being charged immediately in the income statement
Decommissioning Decommissioning is generally spread (on an undiscounted basis) over the lifetime of the plant or facility, for example in the case of the oil and gas industry. There is currently a proposal to move into line with the UK and IAS approach.
107
UK I AS US
UK
I AS
US
108
is added to the cost of the installation as it is a directly attributable cost thereof. Repairs and maintenance As under IAS, repairs and maintenance cannot be provided. However, UK standards are clear that such costs may instead be dealt with by fixed asset accounting (see 6.2). Repairs and maintenance Repairs and maintenance of own assets cannot be provided since they are a cost of the future use of the asset. This applies even where the need to carry out maintenance is the subject of a legal requirement (eg, aircraft overhaul). Instead the such costs are dealt with by fixed asset component accounting (see 6.2). Repairs and maintenance There is no prohibition on the making of provisions for repairs and maintenance.
6.13 Contingencies
(CA 85, FRS 12)
6.13 Contingencies
(IAS 37)
6.13 Contingencies
(SFAS 5, SOP 94-6, C59)
The UK standard on contingencies, FRS 12, was used by the IASC as the basis for its standard, IAS 37, described in the next column. The two are very similar and the following describes only the difference in the UK standard. Definition The definitions and terminology are the same as in IAS 37. Definition IAS 37 uses the term contingent liability differently from US GAAP, although the effect is similar. In IAS 37 a contingent liability is a liability of sufficient uncertainty that it does not qualify for recognition as a provision (see 6.12), ie: it is a possible obligation, but one that is not more-likely-than-not; or it is an obligation but it is not more-likely-thannot that there will be an outflow; or it is so, but its amount cannot be reliably estimated. However, unlike the US, it does not include a probable or possible impairment of an asset. Definition A contingency is defined as an existing condition, situation, or set of circumstances involving uncertainty as to possible gain (a gain contingency) or loss (a loss contingency) to a company that will ultimately be resolved when one or more future events occur or fail to occur. Resolution of the uncertainty may confirm the acquisition of an asset or the reduction of a liability or the loss or impairment of an asset or the incurring of a liability. The following terms are used to describe the likelihood that a future event will confirm that an asset had been impaired or a liability had been incurred at the date of the financial statements:
A contingent asset is one whose existence will be confirmed by the occurrence of uncertain future events.
Probable: the future event is likely to occur. Reasonably possible: the chance of the future event occurring is more than remote but less than likely. Remote: the chance of the future event occurring is slight. Recognition and disclosure If information available prior to issuing the financial statements indicates that it is probable that, at the balance sheet date, an asset has been impaired or a liability has been incurred, and the amount of loss can be reasonably estimated, then that estimated loss should be accrued. If no accrual is made because these conditions are not met, then disclosure of the loss contingency is made, provided that there is at least a reasonable possibility that a loss, or a further loss over and above that accrued, may have been incurred. The disclosure should indicate the nature of the contingency, give an estimate of the possible loss or range of loss, or state that such an estimate cannot be made, and state that it is reasonably possible that this estimate will change (where this is the case). Disclosure of a loss contingency is not required if the likelihood of potential loss is considered remote. Notwithstanding this, other disclosures are customarily made even though the possibility of loss may be remote (for example, loan guarantees, material long-term commitments, assets pledged, unused letters of credit and warranty obligations). Where a loss contingency has been incurred but the reasonable estimate of the loss is a range, then accrual is still necessary. If some amount within the range appears at the time to be a better estimate than any other, that amount is accrued. When no amount
Recognition and disclosure The recognition principles and disclosures of FRS 12 are the same as those of IAS 37. However, the Companies Act 1985 requires disclosures similar to those of FRS 12, but without any seriouslyprejudicial exemption.
Recognition and disclosure Whereas under US GAAP probable (ie, likely) contingent losses are accrued where they can be estimated reliably, under IAS 37, putting it simply, if the possibility of outflow is more-likely-than-not and if a reliable estimate can be made then it is not a contingent liability as defined but a provision and is provided for (see 6.12 above). Contingent liabilities, as the term is defined in IAS 37, are never provided. The difference here is more of terminology than of effect. Contingent liabilities are disclosed unless an outflow is only remotely likely. Disclosure includes the nature of the contingency and where practical the estimated financial effect, an indication of the uncertainties and the possibility of any reimbursement. Where the latter are impractical, that fact must be stated. Contingent assets are not recognised. Their nature and, where practical, their estimated financial effects are disclosed where an inflow of benefits is more-likely-than-not. The same seriously-prejudicial exemption applies to contingency disclosures as to provisions (see 6.12).
109
UK I AS US
UK
I AS
US
110
within the range is a better estimate than any other, however, the minimum amount in the range is accrued. Gain contingencies are usually not reflected in the accounts since to do so might be to recognise revenue prior to its realisation. While adequate disclosure regarding gain contingencies is appropriate, care should be exercised to avoid misleading implications as to the likelihood of realisation. Certain significant estimates UK standards include no direct equivalent of the US certain significant estimates requirement. Any recognised liability that is subject to sufficient uncertainty as to amount will meet the definition of a provision and thus be subject to the disclosure requirements therefor (see 6.12). There are no equivalent disclosures for recognised assets. Certain significant estimates IASs include no direct equivalent of the US certain significant estimates requirement. However, any recognised liability that is subject to sufficient uncertainty as to amount will meet the definition of a provision and thus be subject to the disclosure requirements therefor (see 6.12). There are no equivalent disclosures for recognised assets. Certain significant estimates Many assets and liabilities are measured on the basis of estimates (eg, loan receivables). Where it is reasonably possible (but not probable) that such estimates may change materially in the near term, then disclosure of the nature of the uncertainty is required.
6.14 Capital & reserves, or shareholders funds

(CA 85, FRS 4)
6.14 Equity
(Framework, IAS 1, IAS 32, IAS 39, SIC 16)
6.14 Stockholders equity
A companys shares are always cancelled on repurchase or redemption. The repurchase or redemption price (less any fresh issue proceeds) must always be charged to distributable profits and only in the last resort, and never for a public company, be charged to capital. Where a company holds its own shares in substance, but not in legal form, they are shown as an asset. Total shareholders funds are analysed into funds attributable to equity and to non-equity shareholder
Whether repurchased shares must be cancelled or may be held for resale (treasury shares) is a matter of the law of the country of incorporation, not one of IASs. Any capital maintenance adjustments within equity are a matter of the law of the country of incorporation, not of IASs. Treasury stock is shown as a deduction from equity. Shares that contain an obligation are classified as debt.
A companys shares need not be retired (cancelled) on repurchase but instead may be held as treasury stock. Any premium over par (nominal) value paid on retirement may be charged either to additional paid in capital (similar to share premium) or to retained earnings. Treasury stock is shown as a deduction from stockholders equity. Where the company does not control the redemption of preferred stock, it is classified between debt and stockholders equity; all other stock is part of stockholders equity.
Capital maintenance generally Capital and reserves consists of share capital (that is, the nominal, or par value thereof), share premium (the proceeds of share issues in excess of the nominal value of the shares issued), revaluation reserve, retained earnings and any other reserve representing the net assets belonging to the shareholders. The Companies Act 1985, and case law, provide numerous rules for the maintenance of capital (principally share capital and share premium) and the related matter of profit distribution. The main rule is that a company cannot return capital to its shareholders except by the reduction of capital sanctioned by the Courts. There is an
Capital maintenance generally IASC standards deal solely with accounting and therefore contain nothing regarding capital maintenance in the legal sense of what assets must be retained in the company and what may be distributed. Such requirements, if any, are instead imposed by the law of the country of incorporation.
Capital maintenance generally (ARB 43, A31) In general there are no capital maintenance requirements. In particular, dividends may be paid out in excess of retained earnings. However, as in the UK, there may be specific restrictions on distributions including those imposed by the laws of the state of incorporation, regulatory authorities, the companys by-laws or debt agreements.
111
UK I AS US
UK
I AS
US
112
occasional exemption for private companies which may purchase or redeem their own shares out of capital in some circumstances (see below). Only realised profits may be distributed to shareholders. Unrealised profits would include, for example, profits arising from the revaluation of non-current assets. The fact that such unrealised profits may have been credited to shareholders funds is of no significance to the question of distributability. There may also be additional restrictions on distributable profits imposed, for example, by law (eg, for public limited companies), regulatory authorities and debt agreements. Distributable profits are determined on a company by company basis, not on a group basis. Purchase of own shares The Companies Act 1985 permits a company to redeem or acquire its own shares (subject to the conditions discussed below) which must then be cancelled and it also specifies the accounting treatment for such transactions. Broadly speaking, the net price of a share repurchase or redemption (repurchase or redemption price less the proceeds of any new issue) must be appropriated from distributable retained earnings and, additionally, a capital redemption reserve must be established as a substitute for the nominal value of the shares repurchased or redeemed less the proceeds of any new issue. This reserve is part of the companys capital. Public companies are prohibited from purchasing or redeeming shares for a net price in excess of the balance of distributable retained earnings and thus cannot reduce their total capital in this way. Private companies are not restricted from doing so, provided certain specified legal Treasury stock The purchase price of a companys own shares, whether they are immediately cancelled or held for re-sale (ie, treasury shares), is debited directly to equity as it is a transaction with owners; the re-sale proceeds of treasury shares are credited directly to equity. Gains or losses do not arise on such transactions or on the holding of own shares. IASs do not mandate any one method of allocating the cost of treasury shares within equity. The law of the country of incorporation may do so. Treasury stock (ARB 43, C23) The laws in some states govern the circumstances in which a corporation may acquire its own shares and prescribe the accounting treatment; others do not. In the absence of such legal restrictions the following principles apply. Shares may be purchased either for retirement (cancellation) or for other purposes. Where shares are not purchased for retirement, ie, when they are purchased to be held as treasury stock, the cost of the acquired shares is generally shown as a deduction from stockholders equity although other treatments may be permissible (for example, treated as if retired). Gains on resale of treasury shares should be credited to additional paid-in capital; losses should be charged to additional paid-in capital only to the extent of previous gains and any excess should be charged directly to retained earnings. Neither gains nor losses on treasury share sales are reflected in income.
requirements have been met, and any such excess net price is charged first to capital and then to undistributable reserves (eg, revaluation reserve). Notwithstanding the above, a company may, in substance, hold its own shares, for example in connection with an employee share option scheme (see 7.8). In such cases the shares are not cancelled (as legally the company does not own them) and are presented in the balance sheet as assets. Share splits, bonus issues and scrip dividends Share splits and bonus issues Where a share is split into two or more shares (with correspondingly reduced nominal values) the total amount of called-up share capital remains unchanged. Where bonus shares - that is, a free issue of new shares - are issued the amount of called-up share capital is increased by their nominal value by means of a transfer from share premium account or, failing that, by capitalising reserves, generally utilising the least distributable reserves first. Scrip dividends Where shares are issued (or proposed to be issued) as an alternative to cash dividends, an arrangement known as a scrip dividend, the value to be reflected in the profit and loss account as an appropriation, in addition to the actual cash dividends, is the cash alternative amount. However, the legal form of the scrip dividend will determine the entries to be made within capital and reserves. If the legal form is a share issue at the full amount of the cash alternative (which is rare) then Share splits, bonus issues and share dividends Share splits and bonus issues Neither a simple split of shares nor a bonus issue requires any accounting entry save for any reallocation of capital within equity that may be required by the law of the country of incorporation.
Where shares are purchased for retirement, the excess of the purchase price over par value may be charged against additional paid-in capital, against retained earnings or against a mixture of the two. Any excess of par value over purchase price should be credited to additional paid-in capital.
Stock splits and stock dividends (ARB 43, C20)
Stock splits Stock splits (where the number and par value of shares is subdivided to create a greater number of shares in issue) are usually intended simply to increase the number of outstanding shares in order to reduce their unit market price and thereby encourage a more liquid market for the shares. The recorded aggregate amount of stock remains unchanged after a stock split.
Share dividends Shares to be issued as an alternative to cash dividends are a liability in the amount of the cash alternative. When the shares are issued the liability is released and credited directly to equity as the proceeds of the issue. Any re-allocation of capital within equity will be in accordance with the law of the country of incorporation. It is a non-adjusting post-balance sheet event.
Stock dividends Stock dividends are shares issued to existing shareholders for no consideration in order to give the recipient a share in the companys earnings without the distribution of cash or other assets. A company issuing a stock dividend should capitalise retained earnings (transfer an amount to share capital and additional paid-in capital) by an amount equal to the fair value of the shares issued. A stock dividend is treated as an adjusting post-balance sheet event.
113
UK I AS US
UK
I AS
US
114
reserves of this full amount are capitalised (into share capital and share premium). However, it is more common for the legal form to be a bonus issue and thus for only the nominal amount of the shares to be recorded. To complete the accounting entries the amount of the dividend appropriation not paid in cash is then written back as a reserves movement. Although the profit and loss account entry may be treated as an adjusting post-balance sheet event (see 7.14), the entries within capital and reserves are not. Enhanced scrip dividends In an enhanced scrip dividend scheme, shareholders are offered a choice between a cash dividend and shares with a substantially greater market value (typically 50% greater). Arrangements are put in place whereby the shares taken can be sold to a financial institution, generally at a very small discount to their market value. FRS 4 does not consider such schemes explicitly. We consider there to be two alternative views of an enhanced scrip dividend: It is akin to a discounted rights issue, in that the cash dividend is effectively taken and reinvested in the shares. Under this interpretation the normal scrip dividend accounting described above would be applicable. In substance as well as in legal form it is a bonus issue rather than a dividend. According to this view, the shares are not issued as an alternative to cash dividends, since the terms of the arrangement are such that the cash and shares are not genuine alternatives. (Any shareholder wishing to receive cash would take the shares and sell them to the financial institution involved.) Under this interpretation the normal bonus issue accounting described above would apply. There would be no dividend appropriation Enhanced scrip dividends/share dividends equivalent to share splits IASs do not consider such schemes. In our view either the discounted rights issue approach (dividend effectively taken and re-invested in shares) or the bonus issue approach (no accounting entities required other than any legal re-allocations within equity) could be adopted. Stock dividends equivalent to stock splits A stock dividend would be considered to be a stock split when the number of additional shares issued is so great that it has the effect of materially reducing the share market value (distributions involving 25% or more of the number previously outstanding are usually accounted for as stock splits). Where shares are issued in a stock split, retained earnings should only be capitalised to the extent required by law, normally par value.
in the profit and loss account (except in the unlikely event of some shareholders taking the cash alternative). Attribution of shareholders funds to equity and non-equity The disclosures for shareholders funds include an analysis between the amount attributable to equity and that to non-equity shareholders. Non-equity shares are those which have any of the following characteristics: Any of their rights to payments (eg, dividends, redemptions) are for a limited amount (not calculated by reference to profits, assets or equity dividends). Their rights to a surplus on wind-up are for a limited amount (not calculated by reference to profits or assets) and this prospect was expected to have an effect at the time of introducing the limitation. They are redeemable according to their terms or at the holders option. The carrying amount of non-equity shares, to be disclosed in the analysis, is determined in the same way as the carrying amount of debt, ie, net issue proceeds plus finance cost (again calculated in the same way as for debt) less payments made. The remainder of shareholders funds is attributed to equity. Future developments The UK government currently proposes to amend the law to permit public companies to hold their own shares without cancelling them, ie hold them as treasury shares. Disclosure of equity As noted in 6.8, only those shares that are not liabilities are included in equity; those (eg, mandatorily redeemable preference shares) that are liabilities are classified as such. There is no UKlike requirement to allocate total equity between classes of equity shares. Stockholders equity All stock issued by the company, other than certain redeemable preferred stock, is included in stockholders equity. Redeemable preferred stock whose redemption is outside the control of the company, including mandatory redemption, is presented in a separate classification between debt and stockholders equity (known as the mezzanine level).
115
UK I AS US
UK
I AS
US
116
7. Specific profit and loss account items
7.1
Revenue
7.1
Revenue
(IAS 11, IAS 18)
7.1
Revenue
General (CA 85) There is no UK standard dealing generally with revenue recognition, although the Companies Act 1985 does provide a rather bare definition of turnover as amounts derived from the provision of goods and services.
General Under IASs revenue recognition can be categorised under the three headings: sale of goods, provision of services and construction contracts, although the basic rules for the last two are virtually identical. In all cases there are three common requirements, viz: the revenue can be reliably measured; it is probable that the economic benefits of the transaction will flow to the company; and the costs (both incurred to date and any to come) can be reliably measured. Goods For goods the following tests must also be met: the significant risks and rewards of ownership of the goods have been transferred to the buyer; there is no continuing managerial involvement over the goods to the degree usually associated with ownership; and there is no effective control over the goods. The standard gives some guidance on the significance of risks and rewards transferred. For example, the retention of normal warranty risks is not significant but the guarantee of performance beyond that would be. Other significant risks and rewards that should not be retained include cases
General (SAB 101) There is no US standard dealing generally with revenue recognition, although there are many standards dealing with individual such issues. The SEC staff have stated that based on the specific standards that do exist, they believe that revenue should generally be recognised when: delivery has occurred or services have been rendered; the price is fixed or determinable; and collection of the price is reasonably assured. Goods (SAB 101) Again there are no general rules but the SEC staff have stated that in assessing the above conditions, delivery is not considered to have occurred unless legal title, and the risks and rewards of ownership of the goods, have been passed to the buyer.
Goods (FRS 5) There are thus no general rules for sales of goods, save that FRS 5 might sometimes be relevant to deciding whether goods should be derecognised by the seller (say, if a manufacturer sells to a distributor on some form of consignment stock arrangements) and thus revenue be recognised. FRS 5 is based on a risk-and-rewards approach (see 5.5).
where the sellers revenue depends upon that of the buyer, goods shipped subject to installation where installation is a significant part of the contract or sales subject to a customers right to rescind the purchase together with uncertainty as to whether this will occur Software revenue Again there are no specific requirements here but, depending upon the facts of any particular case, it may be that, for example, contract accounting is the appropriate treatment. Software revenue Software is not specifically addressed in IAS 18 but would fall under the normal rules. Where the transaction is a simple sale then the principles for goods would apply. If other services are bundled together with the software itself, eg support, then contract accounting would probably be the appropriate treatment. Software revenue (SOP 97-1, SOP 98-9) Where the software being sold does not require significant production or customisation revenue is recognised under the general rules, set out above. Where the sale involves multiple elements (eg, upgrades, enhancements, service) the approach is that revenue on each element of the sale is recognised separately when the above conditions are met for that element. However, for this to apply the revenue must be capable of being so allocated by reference to the price charged for each element if sold separately (including, in some cases, any management pricing decision in advance of that elements being sold separately) and no part of the delivered elements revenue must be dependent on delivery of the remainder. Long-term construction-type contracts (ARB
45, SFAS 56, SOP 81-1, Co4, Co5)
Long-term contracts (SSAP 9) There are specific requirements for long-term contracts. These are contracts for the design/ manufacture/ construction of a single substantial asset or the provision of a service where the time taken to complete the contract will fall into more than one accounting period. Such contracts should be assessed on a contract by contract basis and reflected in the profit and loss account by recording turnover and related costs as contract activity progresses. Turnover is ascertained in a manner appropriate to the stage of completion of the contract, the business and the industry in which it
Services and construction contracts IASs do not deal with long-term contracts per se. However, they deal with construction contracts, ie contracts for the construction of an asset, and all contracts for the provisions of services; thus they deal with all such contracts rather than merely the long-term ones. Revenue on such contracts is recognised in one of two ways, depending on the circumstances. If the general requirements above are met and (other than for a cost-plus type of construction contract) the stage of completion of the contract can be reliably measured, then the outcome of the contract is said to be reliably
The US standard deals with long-term construction-type contracts. Construction is widely defined but does not extend to the provision of services unless related to the construction. In such cases if estimates of costs to complete, and of the extent of progress towards completion, are reasonably reliable then the percentage-ofcompletion method of accounting is preferable. Under this method revenue (ie, a percentage of total expected revenue) is recognised based upon the extent of completion. Ordinarily this is measured
117
UK I AS US
UK
I AS
US
118
operates. Where it is considered that the outcome of a long-term contract can be assessed with reasonable certainty before its conclusion, the prudently calculated attributable profit should be recognised in the profit and loss account as the difference between the reported turnover and related costs for the contract. No method is specified by accounting standards. The percentage-ofcompletion method may often be acceptable, but other methods would be necessary if profit does not accrue evenly over the life of the contract or if profit cannot be assessed with reasonable certainty in the early stages. There are no special requirements for cost plus contracts.
estimated and revenue is recognised by reference to the stage of completion. No method of assessing that stage is mandated. Surveys, percentage-ofwork-done and percentage-of-costs are all possible methods suggested by the standard. On the other hand, where the conditions are not met, unlike in the US, revenue is recognised to the extent of costs incurred that are recoverable. In the balance sheet a single asset is presented for the total of revenue receivable plus any costs, net of progress payments, incurred in respect of which revenue has not yet been taken.
by reference to costs incurred as a percentage of total estimated costs (although others, such as those mentioned in IAS, are possible). The completed-contract method is preferable where there is doubt about the forecasts, either because of a lack of reliable estimates or because of inherent uncertainty. Under this method revenue is recognised only if the contract is completed, or substantially so. Special rules apply for cost plus fixed fee contracts where the contractor is reimbursed for the costs incurred plus a fixed fee. Ordinarily fees may be accrued as they are billable provided that this reasonably reflects proportionate performance; however, other methods such as partial deliveries or percentage-of-completion may also be used.
As in the US, where the outcome of a project cannot be assessed with reasonable certainty, no profit is recognised but provision for foreseeable losses should be made. This is similar to the completedcontract method adopted in the US, except that in the UK, as under IAS, turnover and cost of sales are shown in the profit and loss account (with turnover adjusted so that no profit is recognised). In the balance sheet the revenue receivable is presented separately (in debtors) from any costs, net of progress payments, in respect of which revenue has not yet been taken (which are work-in-progress).
7.2
Advertising costs
7.2
Advertising costs (IAS 38)
7.2
Advertising costs (SOP 93-7)
There is no specific UK standard dealing with advertising costs. Practice varies.
Advertising costs must be expensed as incurred.
SOP 93-7 requires all advertising costs, except for direct response advertising, to be expensed in the periods in which those costs are incurred, or when the advertising first takes place.
The cost of direct response advertising is deferred if both of the following conditions are met: the primary purpose is to elicit sales to customers who could be shown to have responded specifically to the advertising; and there is persuasive evidence, including historical patterns, that the advertising will result in probable future economic benefits. The amortisation of the deferred costs should be pro rata to the related revenue recognition. Some companies reimburse their customers for some or all of the customers advertising costs (eg, co-operative advertising). Usually the related revenues are generated before the payment is made. The liability should be accrued when the revenues are recognised.
7.3
Non-monetary transactions
7.3
Non-monetary transactions (IAS

16, IAS 18)
7.3
Non-monetary transactions (APB 29,

N35)
While there is no specific standard in the UK for non-monetary transactions, practice is generally similar to that in the US and under IAS, with one exception as follows. Since the non-monetary asset received would not be near-cash, any gain would be unrealised and would not be reported in the profit and loss account. Instead it would be reported in the STRGL. Alternatively, in such cases the new asset may simply be brought in at the book value of the old (exchanged) asset.
Exchanges of non-monetary assets of a similar nature and value do not give rise to revenue or gains as the earnings process is incomplete; the acquired asset is recorded at the previous carrying value of the asset given in exchange. Where the assets exchanged are dissimilar, the transaction gives rise to revenue or gains by reference to fair value.
Non-monetary transactions include exchanges and non-reciprocal transfers that involve little or no monetary assets or liabilities. In general, nonmonetary transactions should be accounted for on the basis of the fair values of assets or services involved. Thus, the cost of a non-monetary asset acquired in exchange for another non-monetary asset is generally the fair value of the asset surrendered to obtain it, and a gain or loss should be recognised on the exchange. The fair value of the asset received is used to measure cost if it is more clearly evident than the fair value of the asset surrendered.
119
UK I AS US
UK
I AS
US
120
Historical cost (book values) should normally be used to account for non-monetary transactions between related parties or transactions which do not represent the culmination of an earning process (such as an exchange of similar productive assets).
7.4
Holiday pay
7.4
Compensated absences (IAS 19)
7.4
Compensated absences (SFAS 43,

C44)
There is no specific UK standard dealing with holiday pay. Practice varies.
Where the compensated absence is payable within one year it is dealt with as described in this section; otherwise it is a long-term employee benefit, for which see 7.7. An employer accrues for the obligation for paid absences if it both relates to employees past services and it accumulates (ie, can be carried forward to a future period). The amount provided is that which the company expects to pay in respect of unused entitlement. Thus if it is not probable that an amount will be paid then it is not accrued. Sick pay is another form of compensated absence. If the entitlement accumulates then it is accrued, as above, regardless of whether it vests (a vested benefit is one that is paid over if the employee leaves). Thus a company would always provide carried forward entitlement to the extent that it expects employees to be ill in future.
An employer should accrue a liability for employees remuneration for future paid absences (eg, holiday and sick pay) if all of the following conditions are met: The obligation is attributable to employees past services. The obligation relates to rights that vest (ie, payment is made even if an employee leaves) or accumulate (ie, may be carried forward to later periods notwithstanding that there may be a limit on this.) Payment of the compensation is probable. The amount can be reasonably estimated. If an employer meets the first three conditions but fails the final condition, and accordingly makes no accrual, that fact should be disclosed. However, an employer is generally not required to accrue a liability for non-vesting accumulating rights to receive sick pay benefits.
7.5
Pensions and other postretirement benefits (SSAP 24, UITF 6)
7.5
Pensions and other postretirement benefits (IAS 19)
7.5
Pensions and other post-retirement benefits (SFAS 87, SFAS 88, P16)
Scheme assets are valued on an actuarial basis. Scheme liabilities are discounted at a longterm stable rate. There is much flexibility about actuarial methods and assumptions. Assumptions should be reasonable in the aggregate. Actuarial valuations are usually carried out every three years. Past service costs fall under the general rules for actuarial gains and losses to the extent covered by a surplus; otherwise they are charged immediately. Actuarial gains and losses are spread; there is no corridor. There is no requirement to accrue a current funding level deficit.
Plan assets are valued at market value. Plan liabilities are discounted at high quality corporate bond rates. Actuarial methods and assumptions are prescribed in some detail. Assumptions must be mutually compatible. Valuations should be sufficiently regular that the effect in the financial statements is not materially different from that based on annual valuations. Past service costs are charged immediately to the extent that they are vested; the remainder are spread. Other actuarial gains and losses falling outside a corridor are spread, subject to an option to recognise the whole amount in any faster systematic fashion. There is no requirement to accrue a current funding level deficit.
Plan assets are valued on a market-related basis. Plan liabilities are discounted high quality fixed income rates. Actuarial methods and assumptions are prescribed in detail. Assumptions must be determined individually. Actuarial valuations are required annually. Prior service costs are dealt with in a similar way to actuarial gains and losses generally. Actuarial gains and losses are spread subject to an option not to do so if they remain within certain limits - the corridor. A liability is recognised (and charged to intangibles or OCI) when plan assets are less than employees accumulated benefits.
Scope SSAP 24 deals with both defined contribution pension schemes, for which the costs are expensed as incurred, and defined benefit pension schemes. It is the latter which cause the most problems and towards which SSAP 24 - and this section - directs its attention. In principle, SSAP 24 applies to all foreign pension schemes. In practice, however, it permits a more flexible approach with respect to foreign schemes but only where there are significant practical
Scope IAS 19 deals with all benefits payable after retirement, whether pensions or medical benefits etc, in the same way. Under IASs these are more properly known as post-employment benefits as the same principles apply to all benefits paid after employment, whether that is before or after retirement, although the former are the subject of a separate section - 7.6 - of this publication. Defined benefit plans are the main focus of the standard and are addressed by this section. IAS 19
Scope SFAS 87 applies to all defined benefit pension plans including foreign ones and all multi-employer plans.
121
UK I AS US
UK
I AS
US
122
difficulties in obtaining the necessary information. It applies also to multi-employer schemes but in practice these are treated as defined benefit schemes only where sufficient information can be obtained to attribute a share of the surplus or deficit to the company. Valuation of the schemes assets and liabilities SSAP 24 does not make an explicit distinction between the valuations of scheme assets and scheme liabilities. It simply requires that the actuarial assumptions and methods, taken as a whole, should be compatible and should lead to the actuarys best estimate of the cost of providing the pension benefits promised. However, so far as liability valuation is concerned it is in point that the method chosen must be such that the regular pension cost is a substantially level percentage of current and future pensionable payroll. Accordingly there is a good degree of flexibility in the actuarial methods for determining liabilities with, for example, the projected unit (the most commonly used in practice), entry age, attained age and aggregate methods all likely to be acceptable. The current unit method is unlikely to be acceptable. It will be evident from the foregoing that the valuation, for both assets and liabilities, must be reasonable in the aggregate (ie, the spread between the variables should be acceptable). However, since the assumptions and method are to lead to an actuarys best estimate of the costs, with the regular cost being a substantially level percentage of (present and future) pensionable payroll, the implication is that long-term relatively stable assumptions should be used. Accordingly, scheme assets as well as liabilities are measured on an actuarial basis: thus assets are valued as the applies to all such plans, domestic or otherwise; however, if insufficient information is available for a multi-employer defined benefit plan it is accounted for as a defined contribution plan. Valuation of the plan assets and liabilities The projected unit credit method must be used to determine the present value of the defined benefit obligation. Benefits are attributed to periods of service in accordance with the plans benefit formula, unless that formula is back-end loaded, in which case a straight-line attribution is used instead. The actuarial assumptions must represent the enterprises best estimates of the future variables and should be unbiased - ie, neither imprudent nor excessively conservative - and mutually compatible and the standard devotes a significant amount of its guidance to these generally. The financial assumptions are based on the markets expectations of future events (eg, medical cost inflation). The assumptions must include not only the stated plan benefits but also, firstly, any constructive obligations - those established by informal practice which the company has no realistic alternative but to continue - such as discretionary inflationary increases in pensions. Second, the assumptions must include any future changes in state benefits that affect those under the plan and for which there is reliable evidence that the change will occur. The rate at which the obligation is discounted is that of a high quality corporate bond (or a government bond where there is an insufficiently deep corporate bond market). The plans assets are stated at market value. Valuation of the plan assets and liabilities SFAS 87 requires the use of one specific valuation method - the projected unit credit method - in measuring plan obligations. Benefits are attributed to periods of service in the same way as under IAS. Each individual assumption should be the best estimate of future experience, although these may not anticipate either changes in state benefits that affect the plan or other future changes for which there is no substantive commitment (thus such matters may affect the accounting later than in the UK or under IAS). Moreover, SFAS 87 provides specific guidance regarding the determination of some assumptions. For example, assumptions should be market related. Thus the discount rate should be based on the rate at which pension benefits could be effectively settled (such as the rates of return implicit in current prices of annuity contracts or on high quality fixed income investments). This can lead to more volatility in the determination of pension expense compared to the more stable regular cost under SSAP 24. SFAS 87 requires that the measurement of plan assets and obligations be at or within three months of each fiscal year end (although the information may be prepared as at an earlier date and projected forward to the year end).
projected future income streams discounted at a long-term rate of return on the relevant investments; and liabilities are discounted at a similar rate, ie one that reflects the assets in which the fund is invested. SSAP 24 requires that increases to pensions, where they are likely to be granted on a regular basis, should be allowed for in the actuarial assumptions. Future changes in state benefits that affect the scheme should also be anticipated in the assumptions. SSAP 24 does not specify the frequency or timeliness of actuarial valuations. However, for commercial and regulatory reasons they are usually carried out every three years. Accounting SSAP 24 divides the pension cost into regular cost, which is the consistent ongoing cost recognised under the actuarial method used, and variations from the regular cost. Such variations are, as a general rule, allocated over the expected remaining service lives of the current employees. No method of allocation is specified and the straight-line, annuity and constant percentage-of-pay methods are generally acceptable. Variations may arise from: interest on any surplus or deficit; experience surpluses or deficits; the effects on the actuarial value of accrued benefits and/ or assets of changes in assumptions or method; retrospective changes in benefits or in conditions for membership; or increases to pensions in payment or to deferred pensions for which provision has not previously been made.
IAS 19 does not mandate the frequency of valuations. It requires them to be of sufficient regularity that the amounts recognised in the financial statements do not differ from those which would be based on valuations as at the balance sheet date. Thus, inter alia, a valuation a few months before the year-end is acceptable if it is adjusted for material subsequent events (including market price and discount rate changes up to the year-end).
Accounting The total cost is essentially the entire periodic change in the plan liabilities less assets, aside from certain changes not fully recognised. The total comprises the following (which need not necessarily each be charged or credited in the same income statement line item): current service cost (increase in the present value of the benefit obligation due to the current years service); interest cost (the unwinding of discount in the present value of the benefit obligation); expected return on plan assets; certain actuarial gains and losses (ie, the differences between actual and expected outturn of the valuation of the obligation and the assets, including the effect of assumption changes); and certain past service cost. Actuarial gains and losses are required to be recognised when the cumulative amount thereof
Accounting The annual pension cost is separated into four categories, as follows: Service cost: the actuarial present value of future service benefits earned by all participants during the current year. Interest cost: the increase in the benefit obligation due to the passage of time. Actual return on plan assets: determined based on the fair value of plan assets at the beginning and the end of the period, adjusted for contributions and benefit payments. Net amortisation and deferral of the following components, as discussed in more detail below: the net transition obligation (or asset); the prior service cost; and the difference between the estimated and actual amounts of both the projected benefit obligation (PBO) and the return on plan assets.
123
UK I AS US
UK
I AS
US
124
An exception to this spreading principle is where no allowance is made in the actuarial assumptions for increases to pensions in payment and deferred pensions. If such a variation is incurred - in IAS terminology a past service cost - it should be expensed in the period in which it is granted to the extent that it is not covered by a surplus. In some cases other variations may not be spread forward (see below). SSAP 24 permitted the cumulative adjustment arising from implementation of the standard (in 1988) either to be spread over the expected remaining service period of active employees or to be accounted for as a prior year adjustment. The corridor, and the US 15 year amortisation option for the net transition obligation (or asset), have no equivalents in SSAP 24. exceeds a corridor (10% of the greater of the present value of the obligation and the market value of the assets); the amount recognised is the excess spread on a straight-line basis over the expected remaining working lives of the employees in the plan. However, it is permitted to account for (both) actuarial gains and losses in any systematic method that results in faster recognition, for example ignoring the corridor and spreading the full amount or even immediate recognition of the full amount. Past service cost is the increase in the present value of the obligation, in respect of prior periods service, due to changes in benefit entitlement. If such entitlements are not conditional on future service (ie, are vested) they are taken in full immediately; if they are not vested then they are spread on a straight-line basis over the period until they vest. In practice most are likely to be vested and charged immediately. The effect on the balance sheet of all of the above is that a liability is recorded as the present value of the obligation less the market value of the plan assets less unrecognised past service cost and actuarial losses (gains). If this turns out as an asset then its amount is further limited to the present value of available contribution reductions or refunds plus unrecognised amounts as above. All of the above apply for periods beginning on or after 1 January 1999. On transition the liability or asset previously recorded is either prior period adjusted immediately to the full amount of the obligation less the assets less any relevant unvested past service cost or, where such adjustment would be an increase in the liability, it may be spread over five years. Upon implementation of SFAS 87 in 1987, a calculation was made of the net transition obligation (or asset) as the excess (or deficit) of the PBO over the fair value of plan assets. This transition obligation (or asset) was then amortised on a straight-line basis over the greater of the average future service period of active participants or 15 years. The prior service cost is the liability arising from plan supplements or amendments in respect of prior periods service. It is amortised on a straight-line basis over the average future service lives of the active participants or, if most participants are inactive (eg, retired) over their remaining life expectancy. The variations between estimated and actual PBO and assets are, in effect, the experience surpluses and deficits (even if they are attributable to changes in assumptions). The amortisation period is the average remaining service period of active participants. However, SFAS 87 gives employers an option not to amortise a part of this amount, known as the corridor amount (equal to 10% of the greater of the PBO or the market related value of plan assets).
Current funding level deficit SSAP 24 has no requirement to accrue for a current funding level deficit (ie, where the accumulated benefit obligation exceeds the schemes assets).
Current funding level deficit IAS 19 has no special requirements equivalent to US GAAP in such circumstances; the normal rules, above, apply.
Additional liability for certain deficits When the accumulated benefit obligation exceeds the fair value of the plan assets, the excess is immediately recognised as an additional liability. The cost of this is capitalised as an intangible asset up to the amount of any unrecognised net transition obligation plus the unrecognised prior service costs, and the remainder is charged through OCI. Immediate recognition of settlements and curtailments SFAS 88 prescribes the method for determining the amount to be recognised immediately in earnings when a pension obligation is settled or a plan is curtailed. A settlement is defined as an irrevocable action that relieves the employer (or the plan) of primary responsibility for an obligation and eliminates significant risks related to the obligation and the assets used to effect the settlement. A curtailment is defined as a significant reduction in, or an elimination of, defined benefit accruals for present employees future services.
Immediate recognition of some variations SSAP 24 requires that a significant change in the normal level of contributions due to a significant reduction in the number of employees covered by the companys pension arrangements should be recognised immediately if it is part of a sale or termination of operations (see 7.10). Otherwise it the reduction in contributions - should be taken as it occurs.
Immediate recognition of settlements and curtailments On the occasion of a settlement or curtailment there is immediate recognition of the consequent change in the present value of the obligation and in the market value of the assets together with any (related) previously unrecognised actuarial gains and losses or past service costs. A settlement is, put simply, an early settlement of all or part of the plan obligation. A curtailment is where the company is demonstrably committed to reduce materially the number of employees in the plan or where the benefits for future services are reduced.
On a business acquisition In acquisition accounting the fair value of a pension asset or liability is recognised in full, but in the case of an asset only to the extent that it is actually recoverable.
On a business acquisition An acquired companys pension arrangements are brought in as the full amount of the present value of the obligation less the market value of plan assets. If this results in an asset it is restricted to the extent recoverable as refunds or contribution reductions. Disclosure The disclosure requirements are similar to those of the US.
On a business purchase When a company is acquired, SFAS 87 requires a pension asset or liability (reflecting the difference between the PBO and the fair value of plan assets) to be recognised as part of the fair value allocation required under purchase accounting. Disclosure Amongst other disclosures, SFAS 87 requires the amount of net periodic pension cost to be separated into its various components and requires a schedule reconciling the funded status of the plan with amounts reported in the employers balance sheet.
Disclosure While SSAP 24s disclosures are numerous, they do not include a breakdown of net pension cost into its various components or a schedule reconciling the funded status of the scheme with amounts reported in the employers balance sheet.
125
UK I AS US
UK
I AS
US
126
Post-retirement benefits other than pensions Post-retirement benefits other than pensions are liabilities which should be recognised in the accounts. The measurement and disclosure principles of SSAP 24 in respect of pensions are applicable. Exceptionally, where the group has a US subsidiary which has already measured its liability under SFAS 106, then those amounts may be used in the UK group accounts. Future developments An exposure draft for a new pensions standard proposes to bring the UK closer to IAS and US practice. Scheme assets would be at market value and scheme obligations would be discounted at a high-quality corporate bond rate. The projected unit credit method would be mandated. However, there would be no spreading: the full asset (to the extent recoverable) or liability would be on the balance sheet; the annual movement would be split-reported with a regular-type cost, plus past service costs, in the profit and loss account and the rest in the STRGL. Post-retirement benefits other than pensions The foregoing principles apply equally to other forms of post-retirement benefit other than pensions, eg health-care. Post-retirement benefits other than pensions (SFAS 106, P40) Post-retirement benefits, such as health-care benefits, are a form of deferred compensation for services already rendered. Accordingly an employers obligation for post-retirement health care costs should be measured in a manner similar to that required by SFAS 87 for pension costs, although there are some differences. For example, benefits are attributed to periods on a straight-line basis unless the plans formula is front-end loaded, in which case the formula is used.
7.6
Other post-employment benefits

(SSAP 24, FRS 12)
7.6

(IAS 19)
7.6

(SFAS 112)
In theory SSAP 24 covers any benefit for employees on or after their leaving service, except for redundancy (severance) payments. In practice redundancy is the major post-employment benefit. These fall under the general rules for provisions. The effect of this is that if the benefits are payable regardless of the reason for the employees leaving then some provision would be made. The result would be similar to the application of SSAP 24 save
Under IAS 19 the principles that apply to pension and other post-retirement benefits (see 7.5 above) apply equally to benefits payable after employment but before retirement. All such benefits together are known as post-employment benefits. Post-employment benefits include severance payments where these are payable regardless of the reason for the employees leaving. On the other
Post-employment benefits are those provided to former or inactive employees after employment, but before retirement. For example, workers compensation, disability benefits, medical benefits, job training and counselling, life insurance coverage, supplemental unemployment benefits and severance payments.
that a risk-free based discount rate would be used and there would be no spreading. If the benefits are only payable on a forced redundancy, eg in a restructuring, then a constructive obligation for the redundancy is required before provision should be made (see 6.12).
hand, amounts payable only as a result of an employees involuntary termination or his acceptance of a voluntary termination offer are not. These are termed termination benefits and are dealt with in 6.12 of this book.
SFAS 112 requires post-employment benefits to be accrued over the employees service period if all of the following recognition criteria are met: The employers obligation is attributable to employees services already rendered. The obligation relates to rights that vest or accumulate. Payment of benefits is probable. The amount of the benefits can be reasonably estimated. Benefits accumulate when the level of benefits increases with years of service. Conversely, if the levels of benefits are the same for all employees, regardless of the amount of service provided by the employees, then the benefits do not accumulate. Vested rights are those which have been earned and which are not contingent upon future service. If post-employment benefits are not accrued only because the amount cannot be reasonably estimated, the financial statements are required to disclose that fact. While SFAS 112 does not indicate specific measurement methodologies, its refers to SFASs 87 and 106 (pensions and other post-retirement benefits) where similar issues arise, thereby establishing the SFAS 87/ 106 methods as a general framework for measurement that may be followed. Nevertheless, SFAS 112 does not require companies to follow such methodologies. Other measurement methodologies that reasonably estimate the liability may be used. If the four criteria are not met, then the benefits are accounted for under the normal rules for contingencies (see 6.13).
127
UK I AS US
UK
I AS
US
128
7.7
Other long-term employee benefits
7.7
Other long-term employee benefits (IAS 19)
7.7
Other long-term employee benefits
There are no specific rules for other long-term employee benefits other than share-based remuneration (for which see 7.8). The most likely such benefit is a long-term profit sharing or bonus scheme. Where material this would fall under the general provision rules (see 7.12), the profit and loss account effect of which would be similar to that under IAS 19.
An employee benefit payable during employment, other than equity compensation (see 7.8), but payable more than one year after the employees services were rendered is accounted for in a manner similar to post-employment benefits, save that all actuarial gains and losses and past service costs are recognised immediately. Thus the balance sheet includes a liability for the present value of the obligation less the market value of any plan assets. Such other long-term employee benefits would include paid long-service leave, other long-service benefits and profit sharing and other bonus schemes payable more than one year after the employees services were received by the company. Thus if a bonus scheme runs for three years after which those still in employment receive a threeyears profit related amount, the treatment is as follows: at the end of year one, one third of the amount expected ultimately to be paid (based on staff turnover expectations and profit expectations) is accrued, discounted; and after two years two thirds is accrued, discounted.
There are no specific rules for other long-term employee benefits other than share-based remuneration (for which see 7.8). The most likely such benefit is a long-term profit sharing or bonus scheme, which would be spread over the period concerned.
7.8
Employee share purchase and option schemes (CA 85, UITF 13, UITF 17)
7.8
Equity compensation benefits

(IAS 19, SIC 16)
7.8
Employee share purchase and option plans (APB 25, SFAS 123, FIN 28)
Cost is determined as the intrinsic value at the date of grant, though some schemes are exempt from this. Where shares are (in substance) held by the company in connection with an option scheme they are shown as an asset and their cost may affect the cost of the scheme.
There are no recognition or measurement rules for any form of equity compensation benefits. Where treasury stock is held by the company in connection with an equity compensation scheme, it is shown as a deduction from equity and does not affect the cost of the scheme.
There is a choice of methods for determining cost: fair value of the option itself; or intrinsic value at a measurement date that may be later than the grant date, though some schemes are exempt from intrinsic value accounting. Treasury stock held in connection with an employee share plan is shown as a deduction from equity and does not affect the cost of the plan.
General In the UK there are fewer rules than in the US. Moreover, since the UK rules deal with this issue in a different format from that of the US, the structure of this UK section of this book is not comparable with the layouts of the US section or the IAS section. Holdings of own shares in connection with employee share schemes It is usual in the UK for a company to hedge its employee share scheme by setting up a trust (often known as an ESOP trust) to purchase sufficient of the companys shares to cover the scheme. The trust is usually funded by cash contributions or loans from the company or by bank loans guaranteed by the company. Its assets and liabilities are reported as those of the company - that is own shares are shown as an asset rather than as a deduction from shareholders funds - where the company has de facto control of the trusts shareholding and bears their benefits and risks (until they vest
General Equity compensation benefits are those entitling the employee to the companys equity instruments or where the benefit otherwise depends upon the price of such instruments (eg, share appreciation rights). There are no rules dealing with such benefits. Whatever policy a company adopts it must be applied consistently. It should be noted that since treasury shares are accounted for as a deduction from equity (see 6.14), ie treated as in-substance cancelled, then the purchase of shares to cover a plan is of no relevance to the accounting. Extensive disclosures are required.
General There is a choice of two methods for accounting for stock-based remuneration of employees: SFAS 123 (a fair value method) or APB 25 (an intrinsic value method). For fixed plans (see below) the former will generally give a higher cost. If SFAS 123 is chosen then a company may not choose to revert to APB 25 at a later date. If a company chooses APB 25 then it must also disclose pro forma net income and EPS as if SFAS 123 had been adopted. The standards accord the same rules to plans for subscription for new shares as to plans for purchase of existing shares. Furthermore, companies may buy their own shares as treasury stock to cover their positions with respect to employee stock-based remuneration without affecting the accounting for the remuneration itself, but note that such shares would be shown as a deduction from equity (see 6.14).
129
UK I AS US
UK
I AS
US
130
unconditionally in employees). This is almost universally the case with such trusts for the following reasons: Increases in the value of unallocated shares (those in excess of options written) enable the company to reduce the cost of future option grants. The company bears the risk of falls in value of the shares (whether allocated or unallocated). The company ultimately bears the holding cost of the shares and any income from the shares benefits the company in defraying that cost. The shares are usually treated as a fixed asset investment of the company and accordingly any permanent diminution in their value should be charged to the profit and loss account as soon as it is identified. The cost of the scheme For any share scheme the charge is based on intrinsic value. If shares are held in a trust to cover the scheme, then the value is the difference between the book value of these shares, after any write down for permanent diminutions in value before the granting of options, and the exercise price of the employee options. This intrinsic value is charged over the period of performance to which the award of shares relates, eg the period to which any performance criteria relate. The amount is also based on the latest expectation as to the extent to which any performance criteria will be met. Where the trust acquired its shares by subscription to the company, rather than by purchase of preexisting shares, then the holding is ignored from the purposes of determining the profit and loss account charge. Where there is, or is treated as being, no purchased shares covering the scheme then, with Since the US rules deal with this issue in a different format from those of the UK and IAS, the structure of this US section of this book is not comparable with the layouts of the UK and IAS sections. APB 25 method APB 25 addresses the accounting for shares, or options to purchase shares, issued to employees in terms of non-compensatory and compensatory plans. The latter are further subdivided into fixed and variable plans. It is an intrinsic value method in that the cost is based on the difference between the share issue or purchase price and the value of the underlying share. Non-compensatory plans Under a non-compensatory plan no expense is recognised. Such a plan is one possessing all the following characteristics: Substantially all full-time employees, meeting limited employment qualifications, may participate. (However, employees owning a specified percentage of the outstanding shares and executives may be excluded.) Shares are offered to eligible employees equally or based upon a uniform percentage of salary or wages. The time permitted for exercise of an option or purchase right is limited to a reasonable period. The discount from the market price of the stock is no greater than would be reasonable in an offer of shares to stockholders or others. Compensatory plans - general Compensatory plans are those which fail any of the four criteria set out above. They usually arise out of an offer or agreement by an employer to issue shares to one or more officers or other employees (grantees) at a stated price. The grantees are
one exception, the intrinsic value on which the charge is based is the difference between the grant date market value of the share and the price to be paid by the employee. An exception is made for schemes that obtain a particular UK tax status (SAYE schemes), for which no charge at all is required. A feature of such schemes is that the grant date intrinsic value is strictly limited. Share appreciation rights (phantom share options) Where a company grants an employee a right, or an option, to the difference between the market value of the companys shares and a pre-determined price then there is a simple cash cost to the company to be accrued over the relevant period, eg the period to which performance criteria relate. If the scheme is covered by an ESOPs shareholdings then the cost is modified to be based on the shares (external) purchase cost. Disclosure Details of the number of shares that may be issued under options to subscribe, together with dates and prices, must be given.
accorded the right to require the issue of the shares either at a specified time or during some determinable period. Compensation cost under share purchase and option plans is measured as the excess of the quoted market price of the share at the measurement date over the amount, if any, that the employee is required to pay. The measurement date is the first date on which are known both the number of shares that an individual employee is entitled to receive and the option or purchase price. It is important to note that whilst this is the date upon which the amount of compensation becomes fixed, an estimate of the compensation should be recognised before that date (ie, for variable plans - see below). Compensatory plans - fixed Compensatory plans are classified as either fixed or variable. In a traditional fixed plan, the measurement date is the date of grant. Total compensation cost is fixed at the grant date as the excess (if any) of the shares prevailing market price over the amount that the employee is required to pay. In such fixed plans, the resulting compensation cost is then recorded as expense and a corresponding increase in stockholders equity evenly over the vesting period. Subsequent changes in the market price of shares have no effect on the recognition of compensation expense in fixed plans. Compensatory plans - variable Certain plans are designed to motivate employees to reach specified targets or goals. In those plans, the number of shares to be issued may not be known until some point in the future when the target or goal is achieved or is not achieved. Such plans are considered to be variable plans because the measurement date
131
UK I AS US
UK
I AS
US
132
(ie, the date on which both the number of shares an employee is entitled to receive and the exercise price are known) is after the grant date. In variable plans, compensation expense is measured in each period by reference to the prevailing market price of the companys shares (less amounts to be paid by the employees). Subsequent changes in the market price of the shares changes compensation expense under variable plans in the period that the changes occur until the date the number of shares and the purchase price are both known. In other words, an estimate of the compensation is recognised between the grant date and the measurement date at which time the actual amount becomes known.
If the employee can compel the company to settle the share award in cash or other assets, then the plan must be treated as a variable plan. Compensatory plans - shares issued before services are rendered If shares are issued before some or all of the employees services are performed, part of the consideration recorded for the stock issued is unearned compensation and is shown as a separate reduction of stockholders equity. The unearned compensation is accounted for as an expense of the period(s) in which the employees perform the services. Compensatory plans - options over a parent companys shares Under US GAAP, shares or options to purchase shares of a parent company that are granted to employees of a subsidiary company may result in compensation expense recorded at the subsidiary level. For example, assume that subsidiary company B is 75% owned by parent company A. Executives of B participate in As share option scheme and receive
shares in A upon the exercise of those options. Even though the employees of B receive shares of A compensation cost must be measured and recognised in the separate financial statements of B. Disclosure Disclosure is made of the status of the option or plan at the end of the period, including the number of shares under option, the option price, and the number of shares over which options are currently exercisable. As to options exercised during the period, disclosure should be made of the number of shares involved and the option price. As discussed above, where APB 25 has been used, the pro forma net income and EPS, as if SFAS 123 had been used, must be disclosed. SFAS 123 method SFAS 123 is a fair value method in that the cost is based on the fair value of the option itself. Fair value of the option The fair value is determined using an option pricing model. This takes into account numerous factors: exercise and current stock prices; risk-free interest rates; and expected option life, volatility and dividends. An option is valued at the date of grant and is not subsequently revisited. Accounting for the fair value The total cost to be accounted for is determined as the number of options that eventually vest, stated at fair value as at the grant date. If a vested option fails to be exercised and thus lapses, its cost is still taken into account. On the other hand, options forfeited before vesting (because the relevant conditions are not fulfilled) are left out of account.
133
UK I AS US
UK
I AS
US
134
The total amount is charged over the related period of service of the employee. So if the option is for past services, it is expensed in full at the grant date. If the right to it vests over a future period of service then the fair value is spread over that period, usually on a straightline basis, but other methods may be appropriate, eg where vesting occurs gradually over the period. The credit entry is taken to stockholders equity. The eventual number of vested options will be uncertain at the outset. Companies must, subject to one exception, estimate the eventual number of vested options ab initio and then revise their estimates each year - with the difference, if any, treated as a normal change in accounting estimate. The exception is that, optionally, companies may presume at the outset that all of the relevant employees will remain in service during the vesting period, and deal with any forfeiture caused by leavers as and when they occur. The standard contains further detailed guidance for other aspects, eg option modifications, repurchase, cash settlement arrangements. Disclosure There are extensive disclosure requirements.
7.9
Exceptional items (FRS 3)
7.9
Exceptional items (IAS 1, IAS 8)
7.9
Unusual items (APB 30, SAB 67, I22)
Exceptional items are material items which derive from events or transactions that fall within the ordinary activities of the reporting company (see 7.13) and which individually or, if of a similar type, in aggregate, need to be disclosed by virtue of their size or incidence if the financial statements are to give a true and fair view. In assessing the materiality of a potential exceptional item, it should be looked
Although IASs use neither the term exceptional nor unusual items, they require disclosure of items arising from ordinary activities (ie, not extraordinary - see 7.13) which are of such size, nature or incidence that their disclosure is required to explain the companys performance.
Unusual charges, expenses or credits (comparable to exceptional items in the UK) which relate to assets or activities for which the associated revenues or expenses have historically been included in operating income from continuing operations should be included as part of operating income, notwithstanding any unusual nature of that expense or credit.
at in aggregate, even if it will in fact be allocated over a number of format items for presentational purposes. All exceptional items should be credited or charged in arriving at the profit or loss on ordinary activities by inclusion under the statutory or supplementary (see 5.1) format headings to which they relate. An adequate description of each exceptional item should be given to enable its nature to be understood. Exceptional items may occur in either continuing or discontinued operations and need to be identified individually as belonging to one or other category. In showing the amount of each exceptional item, individual items or groups of a similar type of item should not be combined if separately they relate to continuing and to discontinued operations. The amount of each exceptional item, either individually or as an aggregate of items of a similar type, should be disclosed separately by way of note, or on the face of the profit and loss account if that degree of prominence is necessary in order to give a true and fair view. However, where an item is shown separately on the face of the profit and loss account it must be shown as part of its appropriate statutory or supplementary format item. Thus, the total of that format item must be shown inclusive of the amount of the exceptional item. There is no separate line item for exceptional items. Disclosure in accordance with these requirements is usually effected by a sub-analysis of the format item either horizontally or vertically (ie, a columnar profit and loss account).
The disclosure is usually made in the notes to the financial statements but it is also possible for it to be effected by additional line items on the face of the income statement where that is necessary for a fair presentation.
These items may however be shown as a separate component on the face of the income statement (if significant).
135
UK I AS US
UK
I AS
US
136
7.10 Sale or termination of an operation & discontinued operations (FRS 3, FRS 11, FRS 12) Significant differences
The provisions rules deal with both continuing and discontinued operations. Provision for a sale or termination is made when there is a binding sale agreement, or an announced plan or a start has been made on implementing the plan. Any such provision includes certain operating losses. The discontinued operation definition is more widely drawn. Operating results of a discontinued operation are identified by analysis on the face of the profit and loss account. The gain or loss on sale or termination is presented between operating profit and interest. Assets and liabilities of a discontinued operation are not presented net.
7.10 Sale or abandonment of an operation & discontinuing operations (IAS 1, IAS 35, IAS 36, IAS 37) Significant differences
The provisions rules deal with both continuing and discontinuing operations. Provision for a sale or abandonment is made when there is a binding sale agreement, or an announced plan or a start has been made on implementing the plan. Any such provision excludes operating losses. The discontinuing operation definition is narrower than the UKs but wider than the USs. No method of presenting the post-tax results of discontinuing operations is mandated; it is not clear whether a single line item can be used. The location in the income statement of the gain or loss on the sale or abandonment is not mandated. It is unclear whether the assets and liabilities of a discontinuing operation may be presented net.
7.10 Sale or abandonment of an operation & discontinued operations (APB 30, SAB 93, I13) Significant differences
The provisions rules deal only with discontinued operations. Provision is made for a planned sale or abandonment of a discontinued operation when management commits the company to the plan no announcement is required. Any such provision includes certain operating losses. The discontinued operation definition is more narrowly drawn. Post-tax results of a discontinued operation are presented as a single figure before extraordinary items. The gain or loss on sale or abandonment of a discontinued operation is presented adjacent to the results of discontinued operations. Assets and liabilities of a discontinued operation may be presented net.
General FRS 3 provides rules for gains and losses resulting from the sale or termination of an operation whether or not that operation is also a discontinued one or is simply a (former) part of the companys continuing operations. It also provides rules for the classification of operations as discontinued and their presentation.
General The same rules apply to the recognition of gains and losses from the sale or abandonment of any operation, whether that operation is a discontinuing or continuing one. A discontinuing operation is defined purely for classification and disclosure purposes.
General US GAAP provides a definition and accounting rules for discontinued operations. Accounting for a business segment which is sold or abandoned, but which does not qualify as a discontinued operation, is not specifically addressed in US GAAP. However, the general rules for impairment of assets (see 6.4) and restructuring provisions (see 6.12) may be relevant.
Sale or termination of an operation The same recognition and measurement rules apply to sales or terminations of both continuing and discontinued operations. Provisions for losses on the sale or termination of an operation cannot be recognised unless the company is demonstrably committed, at the balance sheet date, to the sale or termination; management decisions are irrelevant. This should be evidenced by a binding sale agreement or by a detailed formal plan of termination the implementation of which has started or the main features of which have been announced. A provision for such losses should include only: the direct costs of the sale or termination; and any operating losses of the operation up to the date of sale or termination. In both cases the provision should be determined after taking into account any aggregate future profit to be generated by the operation. A net profit should not be recognised until the completion date. The profit, or provision for loss, is presented as a separate item after operating profit but before interest (it is one of the supplementary items - see 5.1.) If the necessary level of commitment has not been achieved it may still be necessary to consider whether the operation or its assets are impaired in the normal way (see 6.4): assets should not, of course, be written down to net realisable value where value-in-use, from continuing use, is greater. Any impairment charge at this point is just the recognition of a pre-existing impairment irrespective of the sale of termination and therefore is charged against operating profit.
Sale or abandonment of an operation Provision is made for any loss on the sale of an operation only once there is a binding sale agreement, ie on a commitment- rather than a decision-basis. Before that point, any necessary impairment write-downs of the operation should be made in the normal way (see 6.4); this will not entail a write-down to expected net selling price where value-in-use, on a continuing basis, is higher. Provision is made for any loss on the abandonment of an operation, other than by sale, when in accordance with the normal restructuring rules (see 6.12) the company has a formal plan for the abandonment and has either started to implement it or has announced its main features to those affected by it. Again, this is a commitment- rather than decision-basis. (There is a slight relaxation of this for acquisition accounting - see 5.7). Before this point impairment write-downs of assets should of course be made in the normal way: assets should not be written down to net selling price where value-in-use, from continuing use, is greater. Once provisions can be made they must not be reduced by anticipated gains on related sales of assets or operations. Moreover, such provisions may not include any operating losses, although onerous contracts should be provided for. IASs do not specify any location in the income statement for gains and losses arising on sale or abandonment (other than that it is not extraordinary). However, where the operation concerned is also a discontinuing one (below) the gain or loss is required to be presented on the face of the income statement rather than in the notes.
Sale or abandonment of a discontinued operation Expected losses which are clearly a direct result of the decision to dispose of the discontinued operation - as defined below - should be accrued for at the measurement date. Such losses are abated or augmented by net income or losses from the segments operations between the measurement date and the expected disposal date. If, overall, a gain is expected it should be recognised when realised (ie, at the disposal date). The measurement date is the date on which management of appropriate authority commits itself to a formal plan to dispose of a business segment, whether by sale or abandonment. Unlike the UK or IASs, and unlike the US treatment of restructurings other than discontinued operations, for discontinued operations the plan does not need to be communicated, ie provision is on a decision-basis. If the measurement date falls after the year end it may still be necessary to consider whether provisions are required for impairment to individual assets within the operation. The gain or loss on sale or abandonment is presented adjacent to the net result of that operation (see below), that is, before extraordinary items.
137
UK I AS US
UK
I AS
US
138
Discontinued operation Definition A discontinued operation is defined as one which meets all of the following conditions: The sale or termination of the operation is completed either in the period or before the earlier of (i) three months after the start of the subsequent period and (ii) the date on which the financial statements are approved. If a termination, the former activities have ceased permanently. The sale or termination has a material effect on the nature and focus of the companys operations, and represents a material reduction in its operating facilities resulting from either: its withdrawal from a particular market (class of business or geographical); or a material reduction in turnover in its continuing markets. The assets, liabilities, results of operations and activities are clearly distinguishable, physically, operationally and for financial reporting purposes. The nature and focus of a companys operations refers to the positioning of its products or services in their markets including the aspects of both quality and location. Since this condition is market related the materiality of the effect of the sale or termination would normally be judged by reference to turnover. However, a sale or termination having such an effect does not necessarily give rise to a discontinued operation - what is required is that such a reduction arises from a strategic decision fully to withdraw from, or materially to reduce activity in, a particular market. Discontinuing operations Definition A discontinuing operation is a component of an enterprise that, pursuant to a single plan, is being disposed of or abandoned and that represents a separate major line of business or geographical area of operation and can be distinguished operationally and for financial reporting purposes. This is narrower than the UK definition with regard to the major line of business, but wider than that of US where the geographical basis is not permitted. In addition, an operation is not a discontinuing one until either there is a binding sale agreement (for substantially the whole of the operation) or there is an announced plan for the discontinuance, whichever is the earlier. Once this point - the initial disclosure event - is reached, the operation is classified as discontinuing in all financial statements issued thereafter, eg where the event occurs between the balance sheet date and the approval of the financial statements for issue. Discontinued operation Definition A discontinued operation is the operation of a business segment that has been sold or abandoned. A business segment is defined as a component of an enterprise the activities of which represent a separate major line of business or class of customers provided that its assets, results of operations, and activities can be clearly distinguished, physically and operationally and for financial reporting purposes from the other assets, results of operation and activities of the entity. Moreover, the fact that the results of operations of the segment being sold or abandoned cannot be separately identified strongly suggests that the transaction should not be classified as the disposal of a segment of the business. For example, the sale of a subsidiary that manufactures furniture would not qualify as a disposal of a segment if the company retains other subsidiaries which manufacture furniture in other parts of the world; a segment cannot normally be defined by the geographical area of the operations. This definition, focussing on a major line of business or class of customers and not including geographical distinctions, is more narrowly drawn than those of the UK and IASs. Furthermore, to qualify for classification as a discontinued operation, the plan of disposal must contemplate the likely consummation of the sale, abandonment, or other disposal of the whole of the business segment within twelve months of adoption of the plan.
This definition is perhaps wider than those of IAS and the US, since it focuses on a material effect (of a strategic decision) rather than on a major line of business. The terms are not defined; nevertheless, not all material matters are necessarily major. Presentation The results of the discontinued operation are not presented as a separate line item. They are disclosed by analysis of each line of the profit and loss account, into continuing and discontinued operations, from turnover down to at least the level of operating profit, plus the supplementary items (see 5.1) which include the result on sale or termination of the operation itself. This analysis of turnover, operating profit and of the supplementary items must be given on the face of the profit and loss account but other items may be analysed within the notes. The assets and liabilities of the discontinued operation are not permitted to be presented on a net basis. Presentation The income statement disclosures are of revenues and expenses, including interest and tax where they are attributable (ie, where they relate to items that will be reduced or eliminated by the discontinuance). The amounts of the total assets and total liabilities of the operation must also be disclosed, together with each of the attributable net cash flows from operating, investing and financing activities. All of this information should be given for each discontinuing operation separately. It may be given in the notes, although the standard expresses a preference for the income statement and cash flow information to be on the face of those statements. It is not clear whether it is possible to follow the US treatment of presenting the net result and net assets as single line items in the income statement and balance sheet. Presentation The post-tax results of all discontinued segments operations for the current and prior periods are presented as a separate component of income before extraordinary items. Assets and liabilities (which will be assumed by others) related to all discontinued operations may be netted in the balance sheet after the decision to discontinue has been made; however, a description of the remaining assets and liabilities must be disclosed. Where there is more than one discontinued operation the aggregate figures from the face of the income statement and balance sheet must be attributed in the notes to each discontinued operation.
7.11 Sales of property (FRS 3, FRS 5)
7.11 Sales of property (IAS 18)
7.11 Sales of real estate (SFAS 66, R10, Re1,

Re2, Re3)
Recognition and measurement There is no specific standard dealing with sales of property. The general concepts of prudence and accruals would apply as would FRS 5s requirements for transactions in previously recognised assets (see 5.5). Where property has previously been revalued, the profit or loss is measured by reference to the (depreciated) revalued amount (see 6.2).
Recognition and measurement The normal revenue recognition principles (see 7.1) apply to sales of property whether retail or otherwise. The key principles are therefore that the risks and rewards have been transferred and there is no effective control or continuing managerial involvement (of a kind associated with ownership) by the seller.
Recognition and measurement SFAS 66 establishes accounting standards for recognising profits or losses on sales of real estate. It distinguishes between retail land sales and other sales of real estate. For retail land sales profit is recognised in full when any refund period has expired, the buyer has made
139
UK I AS US
UK
I AS
US
140
sufficient cumulative payments, any balance owing is collectible, the receivable is not subordinated and the seller has no significant remaining construction or development obligation. If these conditions are not met, the sales must be recorded under either the percentage-of-completion or the instalment method depending upon the circumstances. For other sales of real estate, profit should be recognised in full or on one of several other bases depending on whether a sale has been consummated, the extent of the buyers commitment to the purchase of the property, the degree of the sellers continuing involvement with the property and whether the buyers debt to the seller is subject to future subordination. The extent of the buyers commitment to purchase the property is determined in part by the adequacy of the buyers initial and continuing investment (eg, cash paid as a downpayment). Depending on the type of property, the minimum required down-payment varies from 10% to 25% of the sales value of the property. Separate guidance is provided for companies in the real estate industry, which are frequently involved in highly complex transactions. Depending upon the circumstances, use of the cost recovery, deposit or reduced profit method of accounting may be deemed more appropriate than the methods discussed above. Presentation A property developer or a house builder would record property sales as turnover since the properties would be held as current assets. For most companies, however, such transactions are merely incidental sales of fixed assets. Profits and losses on the sales of fixed assets, unless they represent marginal adjustments to depreciation, are shown as Presentation A property developer is likely to include the income as part of its revenue. For other companies inclusion in revenue is inappropriate but the location of the gains and losses elsewhere in the income statement is not specified by standards. Presentation A property company would present real estate sales as revenue. In most other cases such sales are dealt with as normal disposals of property, plant and equipment and are disclosed on the face of the income statement (or in the notes).
a separate item after operating profit and before interest. Profits or losses on property sales are highly likely to fall within this category.
7.12 Imputation of an interest cost

(FRS 4, FRS 7)

(IAS 22, IAS 39)

(APB 21, I69)
The finance cost on a debt instrument is the difference between the fair value of the consideration received for the issue and the payments which the issuer may be required to make in respect of the debt. The finance cost is allocated to periods on the interest method (see 6.8). The allocation of finance costs, ie the imputed interest rate, is not normally revisited. Some other assets and liabilities are inherently discounted, such as pensions or finance leases. Monetary assets and liabilities of an acquired company may need to be discounted in order to bring them in at fair value at the date of acquisition. In addition there is some debate as to whether - in a future standard - deferred tax should be discounted (see 6.11).
When a note or debt instrument is issued it is recorded at the fair value of the net issue proceeds, which will be the same as the fair value of the note (less transaction costs). To this extent an interest cost is imputed where the face value of the note is higher as the difference is amortised over the notes term. No amortisation method is specified, although we should expect the effective interest method to be used. Some other items are discounted, for example longterm receivables and payables of an acquired company in acquisition accounting.
Where a note, with an interest rate which is other than a market rate, is exchanged for property, goods or services, the exchange is valued at the fair value of the property, goods or services or at an amount that reasonably approximates the market value of the note, whichever is more clearly determinable. In the absence of established exchange prices for the property, goods or services or evidence of the market price of the note, the present value of the note is determined by discounting all future payments using an imputed rate of interest. The imputed interest rate used is one that approximates the rate that an independent borrower and lender would have negotiated in a similar transaction. Any difference between the face amount of the note and its present value is accounted for as a discount or premium and amortised over the life of the note by the interest method or any other method that produces approximately the same results. The discount rate is not normally revised; the purpose of imputing interest is to reflect market rates at the time of the transaction, not permanently to tie it to fluctuating market conditions. These rules do not apply in certain specified circumstances including security deposits and retained amounts, trade receivables and payables
141
UK I AS US
UK
I AS
US
142
maturing in less that one year and the customary lending activities of financial institutions.
7.13 Extraordinary items (FRS 3, CA 85)

The statutory profit and loss account formats provide a line for extraordinary items (after minority interests) and require related note disclosures (nature of item, gross amount, tax and minority interest therein). However, FRS 3s definitions are so very restrictive as to, in effect, abolish extraordinary items: Extraordinary items: material items possessing a high degree of abnormality which arise from events or transactions that fall outside the ordinary activities of the reporting entity and which are not expected to recur. They do not include exceptional items nor do they include prior period items merely because they relate to a prior period. Ordinary activities: any activities which are undertaken by a reporting entity as part of its business and such related activities in which the reporting entity engages in furtherance of, incidental to, or arising from, these activities. Ordinary activities include the effects on the reporting entity of any event in the various environments in which it operates, including the political, regulatory, economic and geographical environments, irrespective of the frequency or unusual nature of the events. The reference to the various environments in effect rules out inter alia expropriation of assets and natural disasters. There are no exemptions - for debt rescheduling or anything - from these restrictive definitions.
7.13 Extraordinary items

(IAS 1, IAS 8, IAS 12)
7.13 Extraordinary items

(APB 30, SAB 67, I13)
Extraordinary items are presented, net of tax, as a line item separate from profit on ordinary activities after tax. They are defined as follows: Extraordinary items: income or expenses that arise from events that are clearly distinct from the ordinary activities of the enterprise and therefore are not expected to recur frequently or regularly. Ordinary activities: any activities which are undertaken by an enterprise as part of its business and such related activities in which the enterprise engages is furthermore of, or incidental to, or arising from these activities. Although extraordinary items are rare, these definitions are slightly wider than the UK ones and IAS 8 gives as examples of extraordinary items natural disasters and the expropriation of assets. These examples should be used with caution, however, as individual circumstances should be considered.
Extraordinary items are reported separately after the caption income after tax from continuing operations (or after income from discontinued operations, if applicable). The amount of the extraordinary item is shown net of tax with the related tax disclosed in parentheses on the face of the income statement. Extraordinary items, which are rare in practice, are defined as events or transactions that are both unusual in nature and infrequent in occurrence. APB 30 states that an event or transaction shall be presumed to be an ordinary and usual activity of the reporting company unless the evidence clearly supports its classification as an extraordinary item. This is clarified as follows: Unusual in nature: the underlying event or transaction possesses a high degree of abnormality and is of a type clearly unrelated to, or only incidentally related to, the ordinary and typical activities of the entity, taking into account the environment in which the entity operates. Infrequent in occurrence: the underlying event or transaction is of a type that would not reasonably be expected to recur in the foreseeable future, taking into account the environment in which the entity operates. Certain transactions involving the early redemption of debt and debt rescheduling (see 6.8) must be treated as extraordinary items.
7.14 Dividends (CA 85, SSAP 17, FRS 4) Significant differences

Dividends are presented as a deduction at the foot of the profit and loss account. Dividends are accounted for in the period to which they pertain, which may be earlier than the date of their declaration. Dividends should be analysed between equity and non-equity.
7.14 Dividends (IAS 1, IAS 10, IAS 32, IAS 39) Significant differences
Dividends are presented as a deduction in the statement (or note) of changes in equity. Dividends are accounted for in the period in which they are declared. Dividends on shares classified as debt (see 6.8) are classified as interest.
7.14 Dividends Significant differences

Dividends are presented as a deduction in the statement of changes in stockholders equity. Dividends are accounted for in the period in which they are declared. There is no requirement to distinguish any equity and non-equity categories of dividends.
General Dividends are normally expressed as relating to a particular years profits and are appropriated from (that is, shown after and deducted from) that years profits at the foot of the profit and loss account. (It is of course permissible for dividends in any year to exceed the profits for that year, provided that there are sufficient distributable reserves brought forward to cover any shortfall.) Although the final dividend for the year will normally be proposed by the directors after the year end, for subsequent approval by the shareholders at the annual general meeting, by concession dividends are reflected in the financial statements in the year to which they pertain. Scrip dividends Scrip dividends are usually shown in the profit and loss account at the amount of the cash dividend alternative. (See 6.14 for more details.) Equity and non-equity dividends Dividends should be analysed between those on equity and those on non-equity shares. (See 6.14 for
General Dividends on equity instruments are shown in the statement (or note) of changes in equity. They are not accounted for until they are declared, ie later than is the case in the UK.
General Dividends are not associated with a particular periods earnings and are shown as a deduction from retained earnings in the statement of changes in stockholders equity. In contrast to the UK, dividends declared after the end of a financial year would not be reflected in that years financial statements. Instead, they are recorded and reflected in the financial statements of the period in which they are declared by the directors.
Share dividends Share dividends are shown at the cash alternative amount, as that will usually be fair value (see 6.14 for more details). Equity and non-equity dividends There is no requirement to distinguish dividends between any UK-style equity and non-equity
Stock dividends Stock dividends are normally measured at the fair value of the shares issued. (See 6.14 for more details.) Equity and non-equity dividends There is no requirement to distinguish dividends by any equity and non-equity classifications.
143
UK I AS US
UK
I AS
US
144
the equity vs non-equity distinction.) Furthermore, it may be necessary to record an additional appropriation in order to state the total finance cost on non-equity shares in accordance with FRS 4, that is on measurement principles applicable to debt (see 6.8). For example, arrears of cumulative preference dividends may need to be appropriated notwithstanding a low likelihood of payment. Such additional appropriations do not necessarily result in the recognition of additional liabilities; rather, they may represent movements between equity and non-equity shareholders funds. categories. Some shares are classified as debt (see 6.8) and the dividends on these are charged as interest. Arrears of dividends on such instruments would be accrued. Generally arrears of cumulative preference dividends are not recorded until declared. However, where the shares concerned are shown at the mezzanine level in the balance sheet (see 6.8), and if the arrears are payable on redemption, then they are deducted at the foot of the income statement in the period to which they relate (and are added to the amount recorded at the mezzanine level).
7.15 Earnings per share (EPS)

(FRS 3, FRS 14)
7.15 Earnings per share (EPS) (IAS 33)
7.15 Earnings per share (EPS)

(SFAS 128, E11)
There is more detailed guidance than under IASs but less than in the US. Diluted EPS is not computed on a year-to-date basis.
There is less detailed guidance than in the UK and US. Diluted EPS is not computed on a year-to-date basis.
There is more detailed guidance than in the UK and under IASs. Diluted EPS is computed on a year-to-date basis.
The UK standard, FRS 14, is very similar to IAS 33. However, it gives additional guidance on a number of points and there are a few other differences, as set out below. If a company gives an EPS figure based on an alternative level of earnings then this must be done consistently over time, the reasons therefor explained and the alternative EPS must be no more prominently presented than the measures required by the standard.
The EPS standard, IAS 33, was developed in a joint project with the FASB, although the resulting standards have some differences, including that IAS 33 has less detailed guidance. IAS 33 also formed the basis of the UKs FRS 14, although the FRS includes some additional matters and guidance. A general rule under IAS 1 (see 3.1) is that, where an IAS is silent on an issue, other GAAPs may in some cases be looked to for guidance; thus it may be difficult to interpret IAS 33, in areas where its guidance is shorter, in a way that does not accord with the more detailed
The US standard, SFAS 128 was developed in a joint project with the IASC. It is therefore very similar to IAS 33, and to the UKs FRS 14 that was based on IAS 33, However, it contains additional guidance and there are a few other differences from the UK and IAS standards as set out below. In addition to net income, EPS data are given for income from continuing operations, discontinued operations, extraordinary items and the cumulative effect of accounting changes (eg, policy changes).
guidance in the UK and US standards, provided that such guidance is consistent in principle. EPS must be given by companies with publicly traded ordinary shares (as defined) or potential ordinary shares (as defined), or those in the process of issuing such instruments. The EPS data to be given is basic EPS and diluted EPS for each class of ordinary share. EPS based on alternative measures of earnings may also be given if desired. Basic EPS An ordinary share is defined as an equity share as per FRS 4 (see 6.8). If there is more than one class of ordinary share then the earnings are apportioned amongst them in accordance with their relative rights to dividends or participations and EPS is given for each class. Although in the UK own shares are shown as an asset, FRS 14 provides that such shares are nevertheless excluded from the denominator of EPS. Basic EPS Basic EPS is the net profit (or loss) attributable to ordinary shareholders, after extraordinary items, minority interests and dividends on preference shares (including any arrears not otherwise accounted for), divided by the weighted average number of shares outstanding (ie, in issue or for which the consideration is receivable). An ordinary share is defined as an equity instrument that is subordinate to all other equity shares. Consistently with their classification, treasury shares are treated as not in issue. Diluted EPS Diluted EPS takes into account all contracts that may entitle the holder to ordinary shares, known as potential ordinary shares; the SIC currently proposes that where a contract can be settled in either cash or shares it is treated as a potential ordinary share. Potential ordinary shares are considered dilutive when their inclusion in the calculation would decrease EPS, or increase the loss per share, from continuing operations, ie from net profit other than from discontinuing operations and extraordinary items. It should be noted that the definition of discontinuing operations and the method of allocating interest Basic EPS Basic EPS requirements and guidance are substantially the same as in the UK.
Diluted EPS Where a contract can be settled in cash or in ordinary shares at either partys option it is not treated as a potential ordinary share to the extent that experience or policy provides a reasonable basis for concluding that it will be settled in cash. Employee share schemes are treated as simple share options in cases where there are no performance criteria other than the passage of time; otherwise they are contingently issuable shares. For optiontype schemes the issue price of the shares is increased by the amount of any cost of the scheme (see 7.8) to be charged in future years accounts.
Diluted EPS SFAS 128 provides detailed guidance on employee stock compensation and contingently issuable shares generally. In addition, where a contract can be settled in cash or stock at either partys option US GAAP contains further guidance on the computations. For example, where the option is that of the holder, policies and past experience are irrelevant and instead the most dilutive method must be assumed. It also specifies that where a contract has been classified as part of stockholders equity but is assumed for EPS purposes to be settled in cash, then diluted earnings must be adjusted.
145
UK I AS US
UK
I AS
US
146
Earnings are not adjusted for any cost charged to date. As with IAS, the number of contingently issuable shares taken into account is based on the assumption that the balance sheet date is the end of the contingency period. FRS 14 explains that, for example, a condition stated as average annual profits over three years to exceed 1 million, should be interpreted as a condition for total profits over the contingency period to exceed 3 million; thus at any intervening year end, no contingently issuable shares are considered until cumulative profits have reached 3 million, irrespective of whether annual profits exceed 1 million. Whether a potential ordinary share is dilutive is based on the same test as under IAS 33. For the purposes of excluding discontinuing operations profits FRS 14 requires this to include attributable interest and tax (which would not otherwise be attributed - see 7.10). Interest and tax are specifically allocated as far as possible and thereafter are pro-rated. and tax thereto (see 7.10) may not necessarily be the same as in the UK. Where the issue of ordinary shares is not subject to conditions then they are taken fully into account. In other cases - known as contingently issuable shares - the number taken into account is based on the assumption that the balance sheet date is the end of the contingency period. There is no further guidance on the application of this principle either generally or in respect of employee share schemes. However, in our view the additional guidance in the UK standard, being consistent in principle with that of IAS 33, should be followed. For options and similar instruments dilution is computed on the treasury stock method (ie, only the bonus element of the issue is taken into account). In so doing the market price of shares is taken to be the average market price during the year. For other potential ordinary shares, eg convertible debt, net profit is adjusted to exclude any expenses related to that instrument and the number of shares is adjusted for the simple number that would be issued on conversion. Note that this is so notwithstanding that convertible debt is otherwise split accounted as a plain debt and a separate option (which might otherwise suggest that it be dealt with solely as an option under the treasury stock method). Restatement In respect of basic EPS the current and prior year figures should be adjusted for all events including post balance sheet events, other than conversion of potential ordinary shares, that adjust the number of shares without a corresponding change in resources, eg a share consolidation or the bonus element of a rights issue. The same applies to Restatement EPS data are restated for stock splits, reverse stock splits, stock dividends and rights issues, even if these occur after the balance sheet date. It is not clear how to deal with a reverse stock split coupled with a special dividend, equivalent to a stock buyback at market value. Further, in applying the treasury stock method SFAS 128 gives more guidance as to how the average market price of the stock is to be computed. It also requires the treasury stock method to be applied in a year-to-date fashion: the year is broken down into interim periods (usually quarters) and any dilutive issue is added-in in respect of each interim period by reference to that interim periods average stock price. This will not necessarily produce the same result as applying the treasury stock method to the year as a whole. In addition, SFAS 128 also specifies that the reverse treasury stock method should be applied where relevant (eg, for written put options).
Restatement Both basic and diluted EPS are restated in all cases, save one, where events other than conversion of potential ordinary shares adjust the number of shares without a corresponding change in resources, even if this occurs after the balance sheet date. The exception is where there is a share consolidation linked to a special dividend that
together have the effect of a share buy-back at market value.
diluted EPS in the case of bonus issues, share splits and share consolidations and, in our view, any other event, other than conversion of potential ordinary shares, that adjust the number of shares without a corresponding change in resources. In addition, in our view there should be no restatement for a share consolidation coupled with a special dividend equivalent to a share buy-back at market value.
147
UK I AS US
UK
I AS
US
148
8. Specific major disclosure items
8.1
Segmental reporting (SSAP 25, CA 85)
8.1
Segmental reporting (IAS 14, IAS 36)
8.1
Segmental reporting (SFAS 131, FTB

79-4, FTB 79-5, S30)
Segments are distinguished by their differing risks and returns. The disclosures are based on amounts as shown in the financial statements. Disclosures include net assets but not capital expenditure, depreciation or cash flow. There is no disclosure of a significant customer or concentrations of business risk.
The segmentation is largely based on the internal reporting structure. The disclosures are based on amounts as shown in the financial statements. The disclosures include total assets, total liabilities, capital expenditure and cash flow. There is no disclosure of a significant customer or concentrations of business risk.
The segmentation is wholly based on the internal reporting structure. The amounts disclosed are based on amounts reported internally. The disclosures include total assets and, depending on their internal reporting, interest, unusual and extraordinary items, tax, capital expenditure, depreciation and significant noncash expenditure. Disclosure is required of a significant customer and concentrations of business risk.
Scope and definitions The Companies Act contains segmental disclosure requirements applicable to all companies. SSAP 25 contains requirements applicable only to public companies (or companies with public subsidiaries), banking or insurance companies, or to any company larger than a specified size. In the latter case a company is exempt if it is a subsidiary of a company that itself complies with SSAP 25. More importantly, any company may omit to give a SSAP 25 disclosure if, in the opinion of the directors, the making of that disclosure would be seriously
Scope and definitions Segmental disclosures are required of only those companies with publicly traded equity or debt securities, or those which are in the process of issuing such securities. IAS 14 follows the US management approach to segmentation. It is based on the internal organisational components into which the company is divided up for the purposes of internal financial reporting to its board, however arbitrary that might be. However, if this is based neither on product/
Scope and definitions Segmental disclosures apply only the SEC registrants. An operating segment is a component of a business about which separate financial information is available that is evaluated regularly by the chief operating decision-maker in the allocation of resources and assessment of performance. This may be termed the management approach, since the basis of segmentation is the internal management reporting structure irrespective of whether that
prejudicial to the interests of the company and that fact is so stated. A class of business is a distinguishable component that provides a separate group of related products or services. A geographical segment is a geographical area comprising a group of countries in which a company operates (a segment by origin). These definitions are intended to differentiate segments that are subject to differing returns, risks, growth and future potential. There are 10% de minimis levels of segment revenue, net assets and results but, unlike IASs and US GAAP, these are given as guidance rather than as a mandatory requirement.
service groups nor on geography then the basis should instead be identified by looking to the next lower level of internal organisation that divides up the company into products/ services- or geographybased components subject to the following proviso; each such component must be subject to risks and returns that differ from other components. This proviso does not apply in other cases. Thus provided that product/ service or geographical components are reported directly to the board then these components need not be groupings based on risks and returns distinctions. In addition, whichever of products/ services or geography is the dominant board reporting format will be the primary basis and the other the secondary basis, for which there are different disclosures. If the internal reporting is on only one of those bases it is not clear how the segmentation for the secondary basis should be arrived at. Broadly, any component so identified that accounts for 10% or more of the companys revenue, results of operating activities or total assets is a disclosable segment. Otherwise the components may be combined with other components on a risk and returns basis to form disclosable segments.
reflects differences in risks and returns of operations. Segmental information is given about any operating segment that, broadly, accounts for 10% or more of all segments revenue, results of operating activities or total assets.
Disclosures The following disclosures, analysing the amounts reported in the financial statements, are required by SSAP 25 for each class of business and geographical segment (by origin): turnover, distinguishing between external customers and inter-segment sales; result, generally before interest; net assets, generally excluding interest bearing assets and liabilities; and
Disclosures The amounts disclosed do not follow the management approach. Instead the amounts are an analysis of the relevant figures as stated in the financial statements. For the primary basis the following are required for each segment: revenue, distinguishing between external customers and inter-segment sales;
Disclosures First of all, general information, such as factors used to identify the reportable segments and the types of products and services from which reportable segments derives their revenues, are required to be disclosed. The numerical information is required to be stated on the basis upon which it is reported internally to the chief operating decisionmaker, even if this does not accord with the basis adopted for external reporting in the financial
149
UK I AS US
UK
I AS
US
150
the turnover of the whole company should be analysed by geographical destination. The Companies Act requirements are similar to the first and second points (but for class of business only) and to the fourth point. results of operations (ie, broadly before interest, tax and associates); depreciation, impairment, reversal of impairment and other non-cash expenses (unless cash flow information is given); operating, investing and financing cash flows (as an alternative to the previous item); the share of results and carrying value of equity accounted investments for any such investments that can be allocated substantially to a single segment; total assets; total liabilities; and capital expenditure. There are supplementary requirements if the primary basis is geography in order that information about both location of operations and location of customers is given. For the secondary basis, revenue (external and inter-segment separately), total assets and capital expenditure are required to be analysed. statements. In other words, the management approach extends to the figures also. The total amounts so disclosed are required to be reconciled to the equivalent amounts in the financial statements. The numerical information required for each segment is: profit or loss; total assets; the following if they are included in the above two measures or are otherwise reviewed by the chief operating decision-maker: revenue, distinguishing between external customers and inter-segment sales; interest income and expense; unusual items; tax; extraordinary items; capital expenditure and depreciation and other significant non-cash items; and the share of income and net assets of equity method investees. In addition there are supplementary disclosures of revenue by product/ service group or geographical region if the management approach segments are not on such bases. Significant Customer If a single external customer accounts for 10% or more of the companys revenue, this fact together with the amount of that revenue and the segment in which it arose, must be disclosed. Concentrations of business risk Where, at the balance sheet date, there exist concentrations of business risk making the company vulnerable to significant business disruption, then disclosures sufficient to inform readers of the nature of these risks may be required. This category always
Significant customer There is no requirement to disclose a significant customer.
Significant customer There is no requirement to disclose a significant customer.
Concentrations of business risk There is no UK equivalent of the US requirement regarding general business risks.
Concentrations of business risk There is no IAS equivalent of the US requirement regarding general business risk.
includes concentrations of business volume with a particular customer and concentrations of operations in countries outside the companys home country. Concentrations with a particular supplier, source of supply (including labour), product, market or lender are also disclosed where it is reasonably possible that a future event in connection with that concentration could have a severe impact on the company (eg, the price of a critical raw material could escalate).
8.2
Disclosures about financial instruments (FRS 13)
8.2
Disclosures about financial instruments (IAS 32, IAS 39)
8.2
Disclosures about financial instruments (SFAS 105, SFAS 107, SFAS 115,
SFAS 119, SFAS 133, F25, I80, Regulation S-K)
The qualitative disclosures cover all financial instruments. There are no general terms and conditions disclosures. Disclosures are required for interest and currency risk but only encouraged for other market risks. There are no credit risk disclosures. Numerical disclosures are required of all hedges other than of net investments.
The qualitative disclosures cover only those financial instruments held for risk management. Terms and conditions are disclosed for all financial instruments. There are no disclosures for market risk other than interest and general terms and conditions. Concentrations of credit risk and all (unconcentrated) financial instruments credit risks are disclosed. Numerical disclosures are required of cash flow hedges only.
The qualitative disclosures cover all financial instruments. Contract terms would be disclosed under one of the disclosure options. Market risk disclosures are required for interest, currency, commodity and other market risks. Concentrations of credit risk are disclosed. Numerical disclosures are required largely in respect of cash flow hedges.
The disclosure requirements differ depending on whether the company is a bank, another financial institution (although insurance companies are completely exempt) or any other company. This book deals only with the latter non-specialised
The disclosure requirements apply to all companies and there is no exemption for short-term debtors and creditors.
The issue of SFAS 133 has modified the financial instruments disclosures somewhat. The text set out below reflects the new requirements, which are mandatory for years beginning after 15 June 2000.
151
UK I AS US
UK
I AS
US
152
category. The standard applies to such companies only if they have any of their capital instruments publicly traded. A company may choose to exclude all of its short-term debtors and creditors from the disclosures, save for the currency risk disclosures. The various disclosures arise from different sources (more than one standard, SEC rules) and have different applicabilities. All of the requirements apply to SEC registrants. Where other entities are exempt from a particular disclosure this is noted in the relevant section below. Trade debtors and creditors may be excluded from the fair value disclosures where their effect thereon is not material. Although not dealt with in this book, there are further disclosure requirements for banks. Qualitative disclosures - management objectives, policies and strategies Disclosure is required of managements financial risk management objectives and policies including, but not limited to, the policies for hedging each class of forecast transaction. This is perhaps narrower than the UK and US disclosures in that it focuses on risk management policies rather than all risks from financial instruments. Qualitative disclosure - management objectives, polices and strategies Qualitative disclosure is required outside of the financial statements (eg, in the managements discussion and analysis) of the primary market risk exposures at the year end together with how they are managed, eg a description of the objectives, strategies and instruments used to manage the exposures. Changes in the exposures or their management over the year are also required to be disclosed. Primary market risk exposure refers to the primary risks of loss on financial instruments and derivative commodity instruments in respect of each of interest rate risk, currency risk, commodity risk or other market price risk such as equity prices. The disclosures should distinguish between instruments for trading and non-trading purposes. However, for companies that are not SEC registrants, disclosure is required only of the companys objectives for holding or issuing derivatives and for holding hedges (distinguishing between fair value, cash flow and net investment hedges) whether derivatives or not, together with the context necessary to understand those objectives and the strategies for achieving them. Qualitative disclosures - management objectives, policies and strategies The standard puts some stress on these disclosures as being perhaps more important than the numerical disclosures. It requires an explanation to be given of the role that financial instruments have had in creating or changing the risks that the company faces, including the directors objectives, policies and strategies for holding or issuing financial instruments; hedging is particularly mentioned in this context.
Fair value The fair and book value of all financial assets and liabilities, whether on or off balance sheet, must be disclosed. In doing so the assets and liabilities must be put into appropriate categories. The standard suggests that derivatives should be in separate categories from non-derivatives. Assets should generally not be netted off with liabilities, save that, for example, all interest rate swaps could be grouped together to the extent that they are all used for the same purpose even though some have positive and some negative values. There must be a separate category for assets held for trading and another for liabilities held for trading. If it is not practical to estimate with sufficient reliability the fair value of an instrument that is not traded on an organised market in a standard form, then that fact should be disclosed together with the instruments principal characteristics relevant to its fair value.
Fair value The fair and book values of all classes of financial asset and liability, whether on or off balance sheet, must be disclosed. On and off balance sheet items should be classified separately and no items should be offset unless they meet the normal offset criteria (see 5.5). Hedges should be separately identified. If it is not practical to estimate the fair value of an instrument with sufficient reliability then that fact should be disclosed together with the instruments principal characteristics relevant to its fair value. In addition, if any financial asset is carried at above fair value then the reason for not writing it down thereto must be stated.
Fair value The fair value requirements do not apply to a company with none of its (or its groups) debt or equity securities publicly traded (or in the process of being so offered), which meets a certain size limit and which has no derivatives. All other companies must disclose the fair value of all on and off balance sheet financial instruments for which it is practicable to estimate that value. The disclosure should distinguish assets from liabilities. The fair values of instruments cannot be netted against each other (except in limited circumstances). Further sub-classification of instruments will be necessary where an SEC registrant has used the tabular format for market risk disclosure. If it is not practicable to estimate the fair value of a particular instrument (or class of instruments) then the reasons why it is not practicable should be disclosed together with information pertinent to estimating the fair value (eg, carrying value, effective interest rate and maturity).
Market risk The UK does not have a general market risk disclosure but has specific requirements for interest rate and currency risk (see below). Compared with IAS, there is no general requirement to disclose terms and conditions, although there are a few disclosure requirements for convertible debt and for non-equity shares.
Market risk The specific IAS requirements are confined to interest rate risk (see below) rather than market risk generally. However, for each class of financial asset and liability, whether on or off balance sheet, a company is required to disclose information about the extent and nature of those instruments, including significant terms and conditions. This will give some information for all instruments that may be similar to that under the tabular option is the US. There is no mandated level of detail for this
Market risk SFAS 119 encourages, but does not require, the disclosure of quantitative information about market risk of derivatives. However, this is in effect superseded by the SECs requirements for its registrants. These SEC disclosures must be located outside the financial statements (eg, in the managements discussion and analysis). The SEC requires disclosure of quantitative information about year end market risk on instruments that are sensitive to such risk. Market risk refers to interest rate risk, currency risk,
153
UK I AS US
UK
I AS
US
154
disclosure, although the standard suggests that the following (and others) may be necessary: the principal, notional or otherwise; maturity; amount and timing of future cash flows; stated rate of interest or return; currency; settlement information (eg, early, or by conversion into or transfer of another instrument); and collateral held or pledged. commodity risk and other market price risk such as equity prices. Each of these must be dealt with separately and within each a distinction must be made between instruments for trading and for nontrading purposes. The information may be given in one of three forms: tabular; sensitivity analysis; or value-at-risk. A company is not required to use the same format for each risk. In all cases the inherent limitations of the disclosure must be explained. The three formats are as follows: The tabular format requires tables of contracted terms such as to allow the reader to determine the expected cash flows in each of the next five years and (in aggregate) thereafter. Instruments must be grouped together in an appropriate way to reflect common characteristics. For derivatives, contract and notional principals may be required. A sensitivity analysis shows the potential loss of earnings, fair value or cash flows resulting from one or more hypothetical changes in rates or prices. The figures given may be the year end sensitivities or the average, high and low during the year. Various disclosures are required of the basis of the sensitivity models data, assumptions and parameters. Value-at-risk refers to the potential loss of earnings, fair value or cash flow over a selected period of time having a selected likelihood of occurrence. The format reports either the year end or average, high and low value-at-risk during the year. In addition, information must be given comparing actual data with value-at-risk, for example the number of times in the year that actual losses have exceeded value-at-risk. Various disclosures are required of the basis of the value-at-risk models assumptions and data.
Interest rate risk Analyses must be given for all financial assets and for all financial liabilities showing the book amounts by currency and then by interest basis, ie whether fixed, floating or non-interest bearing. For the fixed interest categories the weighted average rate and fixed period must be given. These disclosures are to be given after taking into account any derivatives used to manage the currency or interest basis of the assets or liabilities.
Interest rate risk For each class of financial asset and liability, whether on or off balance sheet, a company should disclose the earlier of the contractual repricing dates or maturity dates together with the effective interest rate. This disclosure should also distinguish between those items at fixed rates, those at floating rates and those not interest bearing. It should give the effective rates before taking into account the effect of derivatives held to manage the interest rate risk and should state separately the effect of such derivatives.
Interest rate risk If the tabular format is selected the disclosure must distinguish between different categories of instrument eg, assets distinguished from liabilities, nonderivatives from derivatives, fixed rate from variable rate, swaps from options or fixed-to-floating from floating-to-fixed swaps and will distinguish between instruments in different currencies. The detail given for these instrument categories is not mandated it must simply meet the general requirements to give readers information about the timing of future cash flows and so will inevitably include maturity information but the SEC gives examples of things that may be required, including the following: principal amounts; notional principals; contact amounts; and effective interest rates of debt instruments, payable legs of swaps and receivable legs of swaps. This tabular format would probably have a reasonable degree of similarity to the IAS disclosures but less with respect to the UK disclosures since it does not permit the disclosure of interest rate risk after giving effect to hedges.
Currency risk A table must be presented that shows the extent to which the companys different functional currency units have any net monetary positions in currencies other than their functional currencies, after taking account of that units hedges. That is, if a Sterling-reporting group has a US dollar functional currency operation (eg, a US subsidiary) then it must disclose in respect of that operation its net exposure to currencies other than the US dollar, eg to Sterling, euro etc; for its Sterling functional currency operations it must disclose its net
Currency risk There are no requirements similar to those of the UK. The general terms and conditions requirements may warrant disclosure of the currency in which instruments are denominated, contract amounts, maturity and the timing of other cash payments; the effect may be similar to the US tabular format.
Currency risk When using the tabular format information must be given separately for each functional currency within the group, ie, in the same way as in the UK disclosures but also for the group exposure to those foreign entities (between the group reporting currency and the functional currencies). The same general requirement to distinguish different types of instrument apply for currency disclosure as for interest risk disclosure; one particular instrument type that is relevant here is those held to manage risks in future transactions. There is one exception however: where a currency swap eliminates all
155
UK I AS US
UK
I AS
US
156
exposure to currencies other than Sterling, eg to US dollar, euro etc. currency exposure in the cash flows of a foreign currency debt then neither need appear in these currency disclosures. If the sensitivity analysis is used (which is the usual case) the hypothetical change in rate must usually be at least 10%. Sensitivity must be given both between the currency of the instrument and the relevant functional currency of the foreign entity having the exposure (ie, which affects the income statement) and between the functional currency and the reporting currency (which affects OCI on translation of the foreign entitys financial statements). Other market risk There are no mandatory requirements regarding other market price risk. However, the UK standard encourages companies to give such information on the same basis as they manage that risk. Value-atrisk and a sensitivity analysis are two techniques given as examples. Hedging For all hedges the company must disclose the risks or transactions hedged, the period of time until the transaction will occur, the hedging instrument used and whether hedge accounting has been adopted. The numerical disclosures cover all hedges other than those of net investments in foreign entities. They therefore cover hedges of existing assets and liabilities (eg, hedges of the interest basis of a loan) as well as of future transactions. The requirement is to disclose, in respect of the hedging instruments: the unrecognised and, separately, deferred gains and losses at the balance sheet date; Other market risk There are no specific requirements regarding other market price risk, although the general terms and conditions disclosures may result in something similar to the US tabular format. Other market risks Commodity and other market risks, such as equity price risk, are also required to be disclosed in one of the three formats.
Hedging For all hedges the risk hedged and the instrument used to hedge it should be disclosed. In respect of cash flow hedges the following should be given: the timing of any hedged uncommitted but highly probable future transaction and of its hedge gains or losses flowing through the income statement; and hedge gains and losses reported equity and also those recycled out (distinguishing between recycling into the income statement and as an adjustment to the cost of a hedged acquired asset).
Hedging The main hedging requirements are in respect of cash flow hedges, including the following: the maximum period of a forecast transaction (other than floating rate interest payments on existing financial instruments); a description of the transactions or events hedged that will cause gains and losses held in accumulated OCI to be recycled, and how much is expected to be recycled next year; and the movements and balances of hedge gains and losses in accumulated OCI over the year. However, it should be noted that numerous other, lesser disclosures are also required.
the extent to which these will flow through the profit and loss account next year; and the extent to which unrecognised and deferred gains and losses at the start of the year have flowed through the profit and loss account this year. Credit risk In the UK there are no requirements in respect of credit risk. Credit risk For each class of financial asset, whether on or off balance sheet, a company must disclose the maximum loss that it would suffer if the other party failed to perform, without taking account of any collateral. The nature of any collateral is not specifically required to be disclosed although it may be necessary to do so under the general terms and conditions disclosures (see above). In addition, any concentration of this credit risk should be disclosed, ie the amount attributable to counterparties that share similar characteristics, together with the nature of that concentration characteristic, eg the particular activity, region or creditworthiness. Credit risk The following should be disclosed for all concentrations of credit risk arising from financial instruments whether on or off the balance sheet: information about the activity, region, or economic characteristic that identifies the concentration; the maximum loss that the company would suffer, without taking account of any collateral or other security, if the parties in the concentration failed completely to perform the contracts; the nature and a brief description of the collateral, information about the companys access to it and the companys policy for requiring collateral or other security to support financial instruments subject to credit risk; the companys policy for entering into master netting agreements to mitigate credit risk and information about such agreements actually entered into, including their effect in reducing the credit risk loss disclosed above. Liquidity risk For appropriate groupings of each of held-to-maturity and available-for-sale securities information should be disclosed about maturity. There are no maturity disclosures for financial liabilities (other than the basic current and long-term distinction and other than specialised disclosures for banks) unless the tabular format has been used (see above).
Liquidity risk All financial liabilities must be analysed by maturity, as must committed undrawn facilities.
Liquidity risk Information about the maturity of borrowings will usually need to be given to satisfy the terms and conditions disclosure requirements above. Maturity information on committed facilities may not be necessary.
157
UK I AS US
UK
I AS
US
158
Gains and losses on trading If a company trades in financial instruments it must disclose the net gain or loss in the profit and loss account from doing so, analysed in some appropriate form (eg, by instrument type). If the period-end fair values of the trading instruments (disclosed under the above fair value requirement) are materially unrepresentative of the typical position in the period then the average fair values over the period should also be given. There is no available-for-sale category in the UK. Gains and losses on available-for-sale and trading assets The amount of the years fair value adjustments of available-for-sale assets reported directly in equity, and the amounts removed therefrom in the year, should be disclosed. The gains and losses from derecognition of available-for-sale assets (which must necessarily be those for which fair value adjustments were not previously taken through the income statement) should be reported separately from the gains and losses from fair value adjustments of (other) assets and liabilities. In our view this implies that the net gain or loss from trading assets and liabilities, being the only other fair value adjustments in the income statement under IAS 39 in such circumstances, is necessarily required to be disclosed. Gains and losses on available-for-sale and trading securities The amounts of gains and losses on available-forsale securities reported in OCI (ie, fair value adjustments required to be reported there) should be disclosed along with the gains and losses reclassified out of accumulated OCI during the year. Where available-for-sale securities have been sold the gross realised gains and losses in the income statement should be disclosed together with the bases on which were determined their cost and the amounts reclassified out of accumulated OCI. The amount of gains and losses in the year in respect of trading securities, where those securities are still held at the year end, should be disclosed. Further disclosures may be required for transfers between SFAS 155 categories (including held-tomaturity).
8.3
Related party transactions (CA 85,

The Listing Rules, UITF 10, FRS 8)
8.3
Related party transactions (IAS 24)
8.3
Related party transactions (SFAS 57,

R36)
The Companies Act and The Listing Rules require extensive disclosure of transactions with directors (eg, shareholdings, options, remuneration, loans, quasi-loans, credit transactions and any other arrangement in which a director has a material interest) and in some cases with persons connected with directors. They also require certain disclosures with regard to ownership of the company (eg, ultimate holding company, transactions and balances with fellow group members, substantial shareholders of the company and transactions with substantial shareholders).
Related party disclosures are not required in wholly owned subsidiaries provided that the parent is incorporated in the same country and publishes in that country consolidated financial statements including the subsidiary. The standard provides a general definition that two parties are related if one has the ability to control the other or if one has significant influence over the other. However, it then goes on to specify that, apparently notwithstanding this definition, the following only are related parties of the reporting entity:
Related parties include management, principal owners and their immediate families, affiliates, entities for which investments are accounted for under the equity method, subsidiaries of a common parent and other parties with which the company may deal if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests.
The accounting standard on this subject, FRS 8, is of more general application, although substantially wholly owned subsidiaries are exempt from many of its requirements. It specifically defines directors (and in some cases their close family), subsidiaries, parent companies, associates/ joint ventures and their investors and pension funds as related parties. However, its more general definition is that two parties are related if: one controls the other; or they are subject to common control; or one party has influence over the other such that the other party might be inhibited from pursuing its own separate interest; or they are subject to a common influence such that one party has subordinated its own separate interest. Certain disclosures, similar to those in the US, are required of any transaction between related parties; the related parties names are required also. Some aggregation of disclosures is allowed. If a party controls the company, then this fact (including the partys name) should be disclosed in all cases.
enterprises controlling it, under common control with it or controlled by it; its associates; individuals, and their close family, with voting power giving them significant influence over it; key management (eg, directors) and their close family; and enterprises in which the last two mentioned categories have substantial voting power or significant influence. Thus where control of the company is by an individual, rather than an enterprise, the relationship is apparently not caught by the standard; however, since significant influence by an individual would be caught, in our view control by an individual, being a still higher power, is also caught. All transactions with related parties require disclosure. The details to be given are similar to those of the US. If a party, whether an enterprise or, in our view, an individual, controls the company that relationship should be disclosed in all cases.
The following information should generally be disclosed in the notes to the financial statements about each material related party transaction for each of the periods for which income statements are presented except in respect of compensation arrangements, expense allowances and other similar items in the ordinary course of business: the nature of the relationship; a description of the transaction (including transactions to which no amounts or nominal amounts were ascribed); the monetary amount of the transaction; and amounts due from or to related parties as of each balance sheet date and, if not otherwise apparent, the terms and manner of settlement. In some cases, aggregation of similar transactions by type of related party may be appropriate. Sometimes the effect of the relationship between the parties may be so pervasive that disclosure of the relationship alone will be sufficient. If several entities are under common control and the existence of that control could result in significantly different operating results, or financial position, from those that would have been obtained had each entity been autonomous, the nature of the control relationship should be disclosed even if there are no transactions between the entities.
159
UK I AS US
UK
I AS
US
160
Appendix I - Common differences in accounting terminology
Terms with different meanings

The following terms have different meanings in UK, US or IAS usage.
Contingent liability An obligation, or a possible obligation, that does not meet the recognition criteria. Equity All shares whether equity or non-equity are shown in shareholders funds. Non-equity shares are those which, eg, have limited payments or are redeemable according to their terms; others are equity shares. Joint venture An investee that carries on an in-substance independent trade from that of its investors that jointly control it. It is (gross) equity accounted on consolidation.
Appendix I
Contingent liability An obligation, or a possible obligation, that does not meet the recognition criteria. Equity All of shareholders, or stockholders funds.
Loss contingency An uncertain loss whether meeting recognition criteria or not. Equity Equity is sometimes used to denote stockholders funds.
Joint venture Any investee that is jointly controlled. Depending on legal form it may be either: i) equity accounted on consolidation or proportionately consolidated, in either case being known a jointly controlled entity; or ii) proportionately included directly in the companys own financial statements. Post-employment benefits Benefits receivable by an employee after leaving service, including on retirement. Provision An amount recognised in the balance sheet in respect of a liability of uncertain amount or timing.
Joint venture The term has no strict meaning in the US.
Post-employment benefits The term is not used in the UK.
Post-employment benefits Benefits receivable by an employee after leaving service but before retirement. Provision A charge made in the income statement.
Provision An amount recognised in the balance sheet in respect of a liability of uncertain amount or timing.
Reserve That part of shareholders funds that is not capital (thus shareholders funds is sometime called capital & reserves). Stock Stock, as in inventory.
Reserve That part of equity that is not capital. (The term is not often used).
Reserve A valuation allowance deducted from an asset.
Stock The term is not used in IASs.
Stock Stock, as in shares.
Different terms for the same meaning

In UK, IAS or US usage different terms are used for the same meaning.
Accounts
Appendix I
Financial statements Purchase accounting n/a (depends on the terminology of the country of incorporation)
Financial statements Purchase accounting By-laws
Acquisition accounting Articles of association
Associated undertaking, or associate Capital and reserves (alternative term for shareholders funds) Completion (of a legal process)
Associate Equity
20 - 50% owned investee Stockholders equity
n/a (depends on the terminology of the country of incorporation)
Consummation (of a legal process)
Creditors Debtors
Payables Receivables
Payables (of accounts payable) Receivables (or accounts receivable)
161
UK I AS US
UK
I AS
US
162
Finance lease Financial year Fixed tangible assets Freehold land Gearing Group, or consolidated, accounts Hire purchase Holiday pay Land and buildings Shareholders (or members) Memorandum of association
Appendix I
Finance lease Reporting period Property, plant and equipment n/a (no particular term is in use for this in IASs) n/a (no particular term is in use for this in IASs) Consolidated financial statements Hire purchase Compensated absence Land and buildings Shareholders n/a (depends on the terminology of the country of incorporation)
Capital lease Fiscal year Property, plant and equipment Land owned Leverage Consolidated financial statements Lease with purchase option Compensated absence Real estate Stockholders Articles of incorporation
Merger accounting Ordinary share Pension scheme Preference share Profit Profit and loss account Profit and loss reserve (sometimes, retained profit)
Uniting-in-interests accounting Ordinary share Retirement benefit plan Preference share Profit Income statement Retained profit
Pooling-of-interests accounting Common stock/ share Pension plan Preferred stock Income (or earnings) Income statement Retained earnings
Profit for the financial year Reconciliation of movements in shareholders funds Share Shareholders funds Share option scheme Share premium
Net profit Statement of changes in equity
Net income Statement of changes in stockholders equity
Share Equity Equity compensation plan n/a (depends on the terminology of the country of incorporation)
Stock Stockholders equity Stock option plan Additional paid-in capital relating to proceeds of sale of stock in excess of par value Special purpose entity Inventory Income tax Revenues (or sales) Appraisal Expensed
Special purpose vehicle Stock Taxation Turnover (or sales) Valuation Written off
Appendix I
Special purpose entity Inventory Income tax Revenue Valuation Written off, or expensed
163
UK I AS US
UK
I AS
US
164
Appendix II Common accounting abbreviations
Act, The Sometimes used for the Companies Act 1985. The legislation providing the framework for, inter alia, the accounting and financial requirements for companies. APB Auditing Practices Board. A board established by the principal professional accountancy bodies of the UK and Eire, whose role is, amongst other things, to establish standards of auditing. ASB Accounting Standards Board. The ASB develops, issues and withdraws accounting standards. CA 85 Companies Act 1985. The legislation providing the framework for, inter alia, the accounting and financial requirements for companies. FRC Financial Reporting Council. The Council is the parent body of the ASB and the FRRP. Its chief function is to guide the ASB on work programmes and issues of public concern. It also ensures that the work on accounting standards is properly financed.
CGU Cash Generating Unit. The units into which a company is divided for the purpose of impairment testing. Framework The Framework for the preparation and presentation of financial statements. The IASCs conceptual framework. IAPC International Auditing Practices Committee. A subcommittee of IFAC that develops and issues ISAs. IAS(s) International Accounting Standard(s). IASC International Accounting Standards Committee. The international independent foundation, the board of which develops, issues and withdraws IASs. IFAC International Federation of Accountants. An international professional body. IGC IAS 39 Implementation Guidance Committee. An IASC sub-committee that develops guidance on the
AICPA American Institute of Certified Public Accountants APB Accounting Principles Board. It is the immediate predecessor of the FASB as issuer of authoritative accounting pronouncements; the abbreviation is also sometimes used to mean same as APBO (see below). APBO Accounting Principles Board Opinion (the abbreviation APB is also sometimes used). Authoritative accounting pronouncements issued by the APB. ARB Accounting Research Bulletin. Authoritative accounting pronouncements issued prior to APBOs. CON FASB Statements of Financial Accounting Concepts, forming a conceptual framework. DIG Derivatives Implementation Group. A FASB group that develops guidance on the implementation of SFAS 133 Accounting for derivative instruments and hedging activities.
Appendix II
FRED Financial Reporting Exposure Draft. A draft FRS issued by the ASB for comment. FRRP Financial Reporting Review Panel. The panel inquires into company accounts where it appears that the requirements of the Companies Act 1985, including the requirement to show a true and fair view, might have been breached. It can also seek to have defective accounts remedied. FRS Financial Reporting Standard. An accounting standard developed and issued by the ASB. FSA Financial Services Authority. The regulatory body responsible for all aspects of financial services, including securities regulation. GAAP Generally Accepted Accounting Practices (an unofficial term). IGU Income Generating Unit. The units into which a company is divided for the purpose of impairment testing. Listing Rules, The The rules issued by the FSA as part of the regulation of the listing of companies securities. OFR Operating and Financial Review. A non-mandatory statement accompanying accounts and explaining them.
implementation of IAS 39 Financial instruments: recognition and measurement. ISA International Standard on Auditing. Auditing standards issued by the IAPC. SIC Standing Interpretations Committee. An IASC subcommittee that develops guidance in cases where IASs are unclear or silent. Its interpretations are issued by the IASC board and are also known as SICs. SPE Special Purpose Entity.
EITF Emerging Issues Task Force. Interpretative guidance is developed by this task force and published by the FASB. FAS Statement of Financial Accounting Standards. Authoritative accounting pronouncements developed and issued by the FASB (also known as SFAS). FASB Financial Accounting Standards Board. It develops, issues and withdraws accounting standards. FIN FASB Interpretations. Form 10-K Annual report filed by US domestic SEC registrants. Form 10-Q Quarterly report filed by US domestic SEC registrants. Form 20-F Annual report filed by foreign registrants with the SEC. FTB FASB Technical Bulletin. GAAP Generally Accepted Accounting Principles. GAAS Generally Accepted Auditing Standards. MD&A Managements Discussion and Analysis (of
Appendix II
165
UK I AS US
UK
I AS
US
166
SAS Statement of Auditing Standards. Such standards are issued by the APB. SORP Statement of Recommended Practice. SORPs are developed by certain recognised bodies representing industries or sectors to which the SORP applies. SORPs are issued by those bodies once the ASB is satisfied that certain limited criteria are met by the SORP. It will require a negative assurance statement to that effect to be appended to it. SPV Special Purpose Vehicle SSAP Statement of Standard Accounting Practice. SSAPs are accounting standards developed by the ASBs predecessor body, the ASC. The ASB adopted the ASCs extant SSAPs, although many have been subsequently replaced by FRSs. STRGL Statement of total recognised gains and losses. This statement reports the profits and losses shown in the profit and loss account together with other profits and losses not reported in the profit and loss account (eg, on translation of foreign entities financial statements). UITF Urgent Issues Task Force. The UITFs main role is to assist the ASB in areas where an accounting standard or Companies Act 1985 provision exists, but where unsatisfactory or conflicting interpretations have developed or seem likely to develop. The UITF reaches a consensus as to the appropriate accounting treatment and the ASB issues an abstract to that effect. (Abstracts are also generally known as UITFs, ie UITF 9.) financial conditions and results of operations). That part of the 10-K or 20-F filing that discusses the results etc. OCI Other comprehensive income. A statement that reports income not reported in the income statement (eg, on translation of foreign entities financial statements). Regulation S-K Disclosure rules for information outside of financial statements. Regulation S-X Disclosure rules for information within of financial statements. SAB Staff Accounting Bulletins. Interpretative guidance issued by the SEC. SAS Statement on Auditing Standards, issued by the Auditing Standards Board of the AICPA. SEC Securities and Exchange Commission. SFAS Statement of Financial Accounting Standards. (Sometimes known as FASs.) SOP Statement of Position. Guidance issued by the AICPA as another source of established accounting principles. SPE Special Purpose Entity.
Appendix II

Comparatie Ias - Ukgaap-Us Gaap

Загружено:

Сведения о документе

Оригинальное название

Авторское право

Доступные форматы

Поделиться этим документом

Поделиться или встроить документ

Параметры публикации

Этот документ был вам полезен?

Это неприемлемый материал?

Авторское право:

Доступные форматы

Comparatie Ias - Ukgaap-Us Gaap

Загружено:

Авторское право:

Доступные форматы

Global accounting

Global accounting UK, IAS and US compared

UK, IAS and US compared

UK, IAS and US compared

Appendices I Common differences in accounting terminology...................................... II Common accounting abbreviations ...........................................................

Specific balance sheet items

Specific profit and loss account items

Specific major disclosure items

Generally accepted accounting principles

Generally accepted accounting principles

Generally accepted accounting principles

Legal and listing requirements

Legal and listing requirements

Legal and listing requirements

4. Financial statement requirements

Form of the financial statements

Form of the financial statements

Form of the financial statements

4. Financial statement requirements

4. Financial statement requirements

Accompanying financial and other information

Accompanying financial and other information

Accompanying financial and other information

4. Financial statement requirements

Classification and presentation within the financial statements

Classification and presentation within the financial statements

Classification and presentation within the financial statements

Prior period adjustments and other accounting changes

Prior period adjustments and other accounting changes

Prior period adjustments and other accounting changes

Changes in accounting policy and method

Changes in accounting policy and method

Statement of cash flows

Statement of cash flows

Statement of cash flows

Conceptual framework (Statement of Principles,

Conceptual framework (CON 1, CON 2, CON 3, CON

The modified historical cost convention

Financial reporting and changing prices

Reporting the substance of transactions

Reporting the substance of transactions

Reporting the substance of transactions

Foreign currency translation

Foreign currency translation

Foreign currency translation

5.10 Interim financial reporting

5.10 Interim financial reporting

5.10 Interim financial reporting

6. Specific balance sheet items

6. Specific balance sheet items

Research and development

Research and development

6. Specific balance sheet items

6. Specific balance sheet items

Other intangible assets and goodwill

Other intangible assets and goodwill

Other intangibles including goodwill

6. Specific balance sheet items

Fixed tangible assets (CA 85, FRS 3,

Property, plant and equipment

Property, plant and equipment

6. Specific balance sheet items

6. Specific balance sheet items