The Regulatory Framework of AccountingCopyright, 2002 M C Pratt

M C PrattSt Martins CollegeLancaster

Unincorporated UK businesses can prepare their financial statements in any form they chooseCompanies must comply with the provisions of:the Companies Act 1985 SSAPsAccounting standardsFRSsIntroduction 1

Introduction 2Accounting standards apply to all financial statements whose purpose is to give a true and fair viewtherefore, they apply to every UK companys financial statements Introduction 2

Introduction 3Therefore, regulatory framework based on:company lawaccounting standardsInternational accounting standards and other national standard setting bodies influenceStock Exchange requirementsIntroduction 3

Company law 1Companies Act 1985 consolidated most previous UK company legislation and subsequently amended by Companies Act 1989 EU: UK obliged to comply with EU legislation by enacting UK laws to implement EU directives. Companies Act 1989 in part enacted to implement provisions of EUs 7th and 8th DirectivesCompany law 1

Company law 2Some accounting principles are embodied in law. Others are regulated by accounting standards

Accounting standards 1rules or sets of rules prescribing the method(s) by which accounts (financial statements) should be prepared and presented. These are working regulations and are issued by a national or international body of the accountancy profession.

Accounting standards 2previously known as SSAP sformulated by Accounting Standards Committee (ASC)now known as FRS sformulated by the Accounting Standards Board (ASB)ASB is the successor to the ASCAccounting standards 2

Accounting standards 2SSAPs formulated by ASC, and not been replaced by an FRS, are still in forceaccounting standards interact with company law:final accounts (financial statements) must state whether accounting standards provisions have been followed or give reasons for any departuresAccounting standards 3

Stock Exchange insists on member organizations (listed companies) following accounting standardsfailure to comply with accounting standards will lead to auditors qualifying their report which companies will wish to avoid!Accounting standards 4

UK standards setting process (1)Dearing Committee Report 1988 led to ASC being disbandedReplaced by following:F R Cguides the standards setting body (ASB) on policy and sees that its work is properly financed

UK standards setting process (2)A S Bdevises the accounting standards issues standards on its own authorityfull-time chair and technical directortwo-thirds majority required to approve (and issue) new accounting standardlegal backing to accounting standards

UK standards setting process (3)U I T FOffshoot of ASBFunction:to tackle urgent matters not covered by accounting standards and for which, given the urgency, the normal standards-setting process would not be practicable. (Sir Ron Dearing)

UK standards setting process (4)U I T F contdpronouncements called abstractsand intended to become effective quicklytend to become effective within approx. 1 month of pub. dateabstracts then superseded by FRSs and FREDsabstracts close loopholes, thus halting abuses when they become widespread

UK standards setting process (5)Review Panel1chaired by barristerconcerned with examining and questioning departures from accounting standards by large companiesCompanies Act 1985s provisions - financial statements must give reasons for any departures - triggers cases for investigation by Review Panel

UK standards setting process (6)Review Panel2revised accounts have to be circulated to all persons likely to rely on the previous accounts companies are becoming more cautious in their attempts to break or bend the rulesmost disciplined companies have obeyed Panel decisions without any real argument

UK standards setting process (7)Review Panel3discussion with company should resolve most referrals, but Panel has power to apply to courts for revisions of companys accounts court costs potentially payable by directorsauditors can also be disciplined if audit report was not qualified due to departure from accounting standards

International Accounting standards (IASs)Produced by IASCI A S C 1set up in 1973works for improvement and harmonisation of financial reportingdevelops IAS s through an international process, involving:

International Accounting standards (IASs)IASC 2involving:world-wide accounting profession,preparers and users of financial statements national standard setting bodies

International Accounting standards (IASs)IASC 3Objectives:formulate and publish accounting standards (in public interest) for companies to observe in presenting financial statements, and promote world-wide acceptance and observanceworks generally for improvement and harmonisation of regulations, accounting standards and procedures relating to financial statements presentation

International Accounting standards (IASs)IASC 4impact on ASB:IASCs Framework for preparation and presentation of financial statements was introduced to:set out the concepts that underlie the preparation and presentation of financial statements for external users

International Accounting standards (IASs)IASC 5ASB has adopted same conceptualapproach to financial reporting as theIASC, because:ASB has based own Statement of Principles on the IASCs FrameworkASB states in its FRS s that they complywith IAS s or IAS exposure drafts

The Stock Exchange 1In UK, two different securities markets:Stock ExchangeAlternative Investment Market shares quoted on Stock Exchange are said to be listedto obtain listing, company must conform with Stock Exchange rules in Yellow Book issued by Stock Exchanges Council

The Stock Exchange 2firms commit themselves to obey certain procedures and standards, including rules on accounting information disclosurerules are more stringent than Companies ActsYellow Book requirements not backed by law,Stock Exchange can withdraw companys securities from its market/listing, so companys shares would not be traded on Stock Exchange

G A A P(1)Means all rules from whatever source which govern accounting.In UK, combination of:Company law, mainly Companies Act 1985Accounting standards Stock Exchange requirements

G A A P(2)Also includes:International Accounting standards Laws in other countries, particularly in USANot backed by law in UK. No UK legal definitionHas US legal definition/authority

G A A P(3)dynamic changes with circumstances: legal, accounting standards and practice changesthis recognised in ASBs Statement of Aims: changes:evolving business practices, new economic developments and deficiencies identified in current practice

G A A P(4)emphasis has shifted from principles to practice in UK GAAPNot easy to settle generally accepted so is: whether practice addressed by UK accounting standards, laws, international equivalents, whether other companies have adopted practice. Especially: is practice consistent with needs of users and objectives of financial reporting and is it consistent with true and fair concept

GAAP and Conceptual Framework of Accounting(1)FASB (USA) has defined Conceptual Framework.Conceptual Framework:(1)a constitution, a coherent system of interrelated objectives and fundamentals that can lead to consistent (accounting) standards and that prescribes the nature, function and limits of financial accounting and financial statements.

GAAP and Conceptual Framework of Accounting(2)avoids fire fighting in SSAP approachaim to develop underlying philosophy as basis for consistent accounting principles so each SSAP/FRS structured into whole frameworklot of work on conceptual framework carried outby IASCs Framework for preparation and presentation of financial statements, published 1989

GAAP and Conceptual Framework of Accounting(3)Professor David Solomons 1989 discussion paper addressed to:ASCs Guidelines for Financial Reporting Standards paper known as Solomons Report

GAAP and Conceptual Framework of Accounting(4)IASCs Framework not mandatory. Deals with:Objectives of financial statements Qualitative characteristics that decide usefulness of information in financial statements Definition, recognition and measurement of elements from which financial statements builtConcepts of capital and capital maintenance

GAAP and Conceptual Framework of Accounting(5)IASC believe international harmonisation of accounting methods possible by focussing on aboveSolomons Report is similar and deals with: purpose of financial reportingfinancial statements and their elementsqualitative characteristics of accounting informationrecognition and measurementchoice of a general purpose accounting model.

GAAP and Conceptual Framework of Accounting(6)Solomons Report: Recognises unsatisfactory nature of then current fire fighting approach to UK standard setting andProduced his own set of guidelines he felt could provide an explicit statement of agreed financial accounting concepts

GAAP and Conceptual Framework of Accounting(7)Advantages :(1)SSAPs were on patchwork basisCertain SSAPs were subject to considerable political interference from interested partiesSome external pressure was too strong for ASC to withstandPolicies derived from conceptual framework would be less open to criticism leading to strong external pressure

GAAP and Conceptual Framework of Accounting(8)Advantages :(2)Some SSAPs concentrated on Income Statement. Others concentrated on Balance Sheet. An unambiguous definition of income and value would ensure that all financial statements have equal usefulness to different user groups.

GAAP and Conceptual Framework of Accounting(9)Disadvantages :(1)Counter argument might be:Financial statements intended for variety of users and may not be possible to devise single conceptual framework suiting all users.May need variety of accounting standards, each produced for different purpose (and with different concepts as basis)

Accounting Standards Board (ASB)(1)ASC set up in 1970joint committee of 6 major UK accountancy bodies, members of CCAB Produced SSAPs after consultationNot all consultation was satisfactory and some SSAPs criticised for being unrealistic and unfair.SSAPs applied to all financial statements intended to give a true and fair view, including overseas companies incorporated in UK company accounts

Accounting Standards Board (ASB)(2)Some SSAPs only applied to listed companies Some areas of SSAPs overlap with company law but intention is to cover areas where law is silentUK accountancy bodies prefer self-regulation, not lawsDeparture from Companies Act 1985 allowable if consistent with giving true and fair view, so SSAPs may recommend departure from the law

Accounting Standards Board (ASB)(3)SSAPs and FRSs generally apply to UK private companies accounting standard will choose one particular treatment deemed to be best practiceBut is it?SSAPs have been developed haphazardly

Accounting Standards Board (ASB)(4)FRS sDraft for Discussion (DD) is first producedThen converted into F R E D sOther ASB published documents known as Exposure Drafts

Accounting Standards Board (ASB)(5)Statement of AimsTo establish and improve (accounting) standards of financial accounting and reporting by :developing principles issuing new accounting standards addressing urgent issues promptly

Urgent Issues Task Force (UITF)offshoot of Accounting Standards Boardurgent matters not covered by existing standards, and for which, given... urgency, normal standard setting process ...not ...practicable (Dearing)abstracts intended to come into force quicklyat least 22 abstracts so far; some turned into FRSs or FREDshas closed many loopholes

Big GAAP/Little GAAP (1)Most UK companies small, generally owned and managed by one person or familyNo outside shareholdersLarge companies with outside shareholders needing protection so larger companies need tougher rulesCould have 2 types of company accounts:Simple ones with fewer rules and requirementsComplicated ones for large companies with stringent rules and requirements

Big GAAP/Little GAAP (2)Therefore, been that suggested small companies should be exempt from all accounting standards, except certain (5) core onesThis seen as too radical at first, now idea is being more acceptedan FRS for small companies/entities (FRSSE) has been developed

Big GAAP/Little GAAP (3)FRSSE(1)retains all basic principles of accounting standards but discards detailed explanatory notesapplicable to all companies meeting definition of small companycompany complying with FRSSE then exempt from all other accounting standards FRSSE contains, in simplified form, requirements from existing accounting standards relevant to most small entities

Big GAAP/Little GAAP (4)FRSSE(2)large companies must prepare cash flow statementsmall companies do not need to, but recommended to produce simplified version by FRSSEa commendable summary of UK GAAP succint and to the point. (Barry Johnson, Certified Accountant, Feb. 1996)

Big GAAP/Little GAAP (4)FRSSE(3)However:FRSSE not likely to make preparing financial statements easier or cheaperexemption from disclosure, not measurementNot everybody convinced of case for relaxing measurement for smaller companiesSome say it should say, in each FRS or SSAP, what not applicable to smaller companies

Big GAAP/Little GAAP (4)FRSSE(4)questionable whether accounts produced under FRSSE will give true and fair view (which applies to all companies) under the Companies Actsusers would still have to refer to mainstream accounting standards in order to give a true and fair viewbalance between those favouring no accounting standards for small companies and those wanting to retain present system

Big GAAP/Little GAAP (4)FRSSE(5)FRSSE will be periodically updated and revised to reflect future developments in financial reporting FRSSE will probably be carefully monitored and reviewed after 2 years in operation

Key(1)AIMAlternative Investment Market ASBAccounting Standards BoardASCAccounting Standards CommitteeCACompanies Act(s) (eg CA 1985)CCABConsultative Committee of Accounting BodiesDDsDrafts for Discussion/Discussion DraftsDTIDept. of Trade and IndustryEDsExposure DraftsEUEuropean UnionFASBThe Financial Accounting Standards Board (USA)FRCFinancial Reporting Council

Key(2)FREDsFinancial Reporting Exposure DraftsFRRP(Financial Reporting) Review PanelFRSsFinancial Reporting StandardsFRSSEFRS for Small EntitiesGAAPGenerally Accepted Accounting PracticeIASCInternational Accounting Standards CommitteeIASsInternational Accounting StandardsSORPsStatements of Recommended PracticeSSAPsStatements of Standard Accounting PracticeUITFUrgent Issues Task ForceUKUnited Kingdom