GT - Financial reporting. Unravelling the future before the future unravels your business

Unravellingthefuture

before the

business

futureunravelsyourAN FD’S GUIDE TO FINANCIAL REPORTING

2 AN FD’S GUIDE TO FINANCIAL REPORTING

Introduction

Financial reporting is changing

Key outputs from the International Accounting Standards Board’s major work programme are now appearing and more are on the way. 2013 will see major changes to international requirements on consolidated accounts, joint ventures and fair value disclosures. Big changes to international requirements are on the way for revenue recognition, fi nancial instruments and leasing, which are expected to begin taking effect from 2015 onwards. After several years of relative stability, the biggest shake-up in UK GAAP for a generation is due to take effect in 2015 when existing UK accounting standards are replaced by new requirements based more closely on IFRS. The front end of the annual report and accounts is set for an overhaul too as the Government plans to replace the existing directors’ report with a new strategic report and annual directors’ statement.

Grant Thornton’s FD’s guide to the future of fi nancial reporting puts these impending developments into the context of key issues facing your business and highlights the key questions you need to be asking about how the changes will impact on your business. To help you focus on what is most relevant to you, we have fl agged these issues according to whether they are relevant where you prepare your annual report and accounts under IFRS, UK GAAP or both.

Dynamic organisations know they need to apply both reason and instinct to decision making. At Grant Thornton, this is how we advise our clients every day. We combine award-winning technical expertise with the intuition, insight and confi dence gained from our extensive sector experience and a deep understanding of our clients. We can help you unlock the potential for growth in your business by providing world-class advice on how the changing fi nancial reporting landscape will impact on your business and its key stakeholders.

This guide is based on standards and exposure drafts in issue at 30 June 2012.

Joyce GrantPartnerNational Assurance Services

Contents

03 Whatisyourfinancingstrategy?

09 Risk and Capital management – does your narrative reporting tell thestory?

13 What will forthcoming changes in accounting standards and regulation do to your company’sfinancialpositionandperformance?

19 Are you seeking new opportunities through organic growth or through acquisition?

23 Is your business structured so as to optimise management and shareholderobjectives?

27 Are you geared up to make the right choices given the proposed changes to legislation and the accountingregimeintheUK?

31 How might your business operations be affected by market andregulatorychanges?

34 Navigation

38 Contact us

AN FD’S GUIDE TO FINANCIAL REPORTING 3

Challenging economic conditions make access to traditional sourcesoffundingdifficult.Managementmightneedtolookto alternative sources of funding to achieve growth or sustain business and should be aware of any accounting considerations. Expected changes in accounting standards could also impact onaccountingforexistingandnewsourcesoffinance,aswellasfinancialcovenants.Manytransactionsmayhaveprofitimplications which in turn could impact on the amount of tax that your business has to pay. The tax consequences of financialarrangementsenteredintomay,therefore,needcarefulconsideration.

?1 What is yourfi nancing strategy


Existing sources of fi nance

IFRS

IFRS

UK GAAP

Do you have any leasing arrangements? Many companies typically enter into operating lease arrangements. Under IAS 17 Leases the accounting treatment for an operating lease is straightforward and results in the recognition of an operating lease expense through profi t or loss. No asset or liability is recognised.

Under proposals to replace IAS 17, accounting for an operating lease will change. At the time of writing the timing of the changes to the leasing standard is not yet certain, though it is not expected to be before 2015.

Very simply, if planned changes go ahead, operating leases will be brought onto the balance sheet. A liability to make lease payments will be recognised as well as a right of use asset. Liabilities and assets will therefore increase. Profi t or loss may also be impacted. Instead of recognising operating lease charges, an interest expense on the liability to make lease payments and amortisation of the right-of-use asset will be recognised. There may also be impairment losses and revaluation gains, if relevant, arising on the right-of-use asset. The amounts ultimately recognised in profi t or loss and the timing of their recognition may therefore be very different compared to the existing accounting treatment.

Do you have fi nancial covenants and how sensitive are they to changes?Lenders often require the inclusion of fi nancial covenants to protect themselves and the borrower. You may have covenants in place that relate to the maintenance of specifi ed ratios or the maintenance of the value of certain assets and liabilities above or below specifi ed levels. Changes in accounting standards can inadvertently have an impact on fi nancial covenants.

If your company is subject to loan covenants, you will need to assess the potential impact of changes in accounting standards on the measurement, recognition and presentation of amounts in the fi nancial statements on those covenants. This may necessitate early discussion with your lenders. It might also be worth talking to them about whether stable GAAP covenants could be developed such that covenants are ‘protected’ against the effects of future GAAP changes.

Areas of future potential impact include: • Defi ned benefi t pension scheme obligations:

Changes to IAS 19 Employee Benefi ts will impact on the presentation of the net interest cost and may affect the recognition of actuarial gains and losses. This may impact on profi t or loss and fi nancial position. For example, the net interest charged in the income statement under

the amended IAS 19 from 2013 could be greater than under the current IAS 19. Immediate recognition of actuarial gains and losses could also affect the net defi ned benefi t asset or liability if you have previously deferred the recognition of actuarial gains and losses.

• Future of UK GAAP: For those expecting to adopt the new Financial Reporting Standard applicable in the UK and the Republic of Ireland (Draft FRS 102) there are numerous changes that will not only impact on profi t or loss but also fi nancial position. Some of the key differences between existing UK GAAP and the proposed FRS 102 are discussed in more detail in Section 3.

• Potential changes in the recognition and measurement of revenue as a result of the proposed IFRS Revenue from Contracts with Customers could affect your company’s profi tability and fi nancial position. The amount and timing of revenue recognised could change, as could the amount recognised in respect of trade receivables.

• Operating lease agreements: Proposals to replace IAS 17 will impact on fi nancial position and profi t and loss, as described above. It is likely that both an asset and a liability will be recognised on the balance sheet, and amounts recognised in profi t or loss will also change.

Potential impact of future standards


Have you considered ways in which you could manage the exposure of your business to fi nancial risk? Entering into any fi nancial arrangement can lead to exposure to fi nancial risk. For example, entering into long term variable rate loan arrangements can lead to volatility in interest charges, particularly given the inevitable future rise in interest rates. Some companies may consider entering into an interest rate swap to manage the exposure to the future variability in interest rates. However, careful consideration will be necessary as swaps do not always work to the advantage of the party seeking to manage risk, and can be costly to exit before the contractual maturity date has been reached. Further, under IFRS and for those applying FRS 26 Financial Instruments: Recognition and Measurement under UK GAAP, these fi nancial instruments are classed as derivative instruments and need to be carried at fair value

with changes recognised through profi t or loss. This will also be the case for those expecting to adopt the proposed FRS 102. At present under UK GAAP, non-small companies that do not apply FRS 26 still need to disclose the fair value of derivative instruments, even if the derivative instrument is not recognised in the fi nancial statements. A fair value would therefore needto be obtained which could involve a professional valuation.

Entities may also enter into other derivative contracts such as foreign currency forward contracts, which would normally be accounted for at fair value through profi t or loss under IAS 39 Financial Instruments: Recognition and Measurement (or its UK GAAP equivalent FRS 26) and cause profi t volatility. In some cases, the profi t volatility can be managed through the use of hedge accounting, although this can be complex and requires action on formal documentation and effectiveness tests on a strict time critical basis.


Do you have plans to raise funds from a listing? Companies seeking to expand and grow their business often look to achieve this through a public offering of their shares. If your company has a growth strategy which includes listing on a public exchange, depending on the nature of fi nancial instruments issued, there may be fi nancial instrument classifi cation and measurement complications whether or not you prepare your accounts under IFRS or UK GAAP. This applies not only to an issue of shares, but also listed debt.

Do you intend to issue new types of fi nancial instruments? In order to raise fi nance, entities may issue fi nancial instrument contracts such as share capital with non-standard terms, options, warrants or some types of loans which include ‘embedded derivatives’. These terms can lead to complex accounting treatments.

For instance, some warrants and options over own share capital would be accounted for as derivative liabilities, depending on what is called the ‘fi xed-for-fi xed’ test. Under IAS 39, or its UK GAAP equivalent FRS 26, fair value movements in such derivatives may impact on profi t or loss. This can lead to volatility in results.

Volatility can also arise in non-derivative liabilities such as some types of loans, where those loans have potentially variable cash fl ows (such as contingent premiums). The treatment of fees paid in connection with raising fi nance should also be examined carefully.

The classifi cation of fi nancial instruments under FRS 25 Financial Instruments: Presentation (and its international equivalent IAS 32) can be diffi cult to determine, for example non-standard share capital. For those not familiar with FRS 25, there can be some surprises. Another issue is that if more than one instrument is issued in combination to the same investor (eg equity shares and loans), the accounting allocation of the proceeds received might not necessarily follow the legal form, particularly if one of the instruments

has been contractually allocated on non-arm’s length terms. In order to consider the accounting substance, it can sometimes be necessary to use a valuation expert in order to arrive at an appropriate allocation of proceeds. This can have a consequential impact on future fi nance costs.

Do you have working capital balances which could be used to secure asset-based fi nance? In some cases traditional bank funding is proving harder to fi nd given the capital constraints currently in place. One solution available to companies is to use the increasingly popular working capital facilities collectively known as asset-based lending. Receivables, or other assets (eg inventories) against which fi nance is raised, remain on balance sheet unless derecognition criteria are met and fi nance obtained against assets is presented as a fi nancial liability and classifi ed as either current or non-current. The associated fi nance charges will impact on profi t or loss.

Do you have intra-group funding arrangements? Funding arrangements may involve the creation of intra-group balances, for example, where a company in a group has access to external funding and lends to another group company. Where accounts are prepared under IFRS (and FRS 26 under UK GAAP), there can be valuation complications. Under IAS 39/FRS 26 loans will need to be recognised initially at fair value, which may not be the same value as the actual amounts loaned between the group companies. This is often the case where the terms of the group arrangement are different to those that could otherwise be obtained in the open market. For example intra group loans can often attract interest at rates which are preferential to those that a company could obtain from an external source of fi nance. This would have an impact on the fair value on initial recognition.

New sources of fi nance

IFRS

UK GAAP

Impact of current standards


Are you contemplating a fi nancial restructuring? You may be considering a fi nancial restructuring at some time in the future. For example you might want to improve your company’s gearing ratio or fi nancial position in anticipation of a public share offering, or the fi nancial restructuring might be due to an evolving business plan or a challenging liquidity position. A fi nancial restructuring could be achieved in a number of ways. For example, it is common for a company to issue equity instruments in return for a complete or partial extinguishment of debt. Alternatively you could agree with the lender to modify the terms of the existing debt or effectively replace the debt with a new instrument. (These two examples are discussed further below.) You could also decide to repay debt early.

It is important to be aware that the way in which a restructuring is achieved will have accounting consequences, some of which can be profi t neutral whilst others may have a signifi cant impact on profi tability, often introducing unplanned-for volatility.

Are you considering a debt-for-equity swap?Where equity instruments are issued in return for a complete or partial extinguishment of debt, often termed a ‘debt-for-equity swap’, any gain or loss arising on the difference between the carrying amount of the fi nancial liability extinguished and the fair value of the equity instruments issued in consideration will be recognised in profi t or loss. This treatment derives from IFRIC 19 Extinguishing Financial Liabilities with Equity Instruments.

If you prepare your accounts under UK GAAP a similar treatment is required for companies which apply FRS 26. UITF Abstract 47 Extinguishing Financial Liabilities with Equity Instruments repeats the guidance contained in IFRIC 19.

However if your company does not prepare accounts under IFRS and does not apply FRS 26, there could still be implications for your accounts. In certain situations it may be appropriate to adopt a no gain/no loss policy in which case the value of the equity issued is deemed to match the debt given up. However in other cases, where the equity is of little value and in substance the debt has been waived, it may be more appropriate to recognise a gain in profi t or loss. In either case there are likely to be tax implications.

Are you considering a change in the terms of your existing debt?Where debt is modifi ed, the accounting treatment will depend on whether the modifi cation is substantial or non-substantial and this will depend on the facts and circumstances of the modifi cation. IAS 39 contains guidance. If the modifi cation is substantial, then extinguishment accounting under IAS 39 will result in the immediate recognition of a gain or loss. In substantial modifi cations, IAS 39 requires all fees to be expensed including those incurred during the restructuring. This can sometimes appear harsh where companies feel that at least some element of the fees relate to the future debt. However carry forward of those fees might only be possible in some very narrow circumstances. This contrasts with non-substantial modifi cations where, typically, no gain or loss need be recognised immediately.

Where debt is modifi ed, companies under UK GAAP which apply FRS 26 will need to follow similar rules to those contained in IAS 39 described above.

However if your company does not apply FRS 26, again there could still be implications under FRS 4 Capital Instruments.


Do you intend to issue new types of fi nancial instruments? Companies under UK GAAP will also have to think about the impact of the proposed FRS 102 on their fi nancial instruments. Derivative instruments that are currently off balance sheet may now have to be recognised at fair value through profi t or loss. As well as causing profi t volatility this may also require the use of valuation experts.

Under the proposed FRS 102, all fi nancial assets and fi nancial liabilities will need to be analysed between ‘basic’ and ‘other’. Financial assets and

fi nancial liabilities that are classifi ed as ‘other’ will need to be carried at fair value. This category will include derivatives, but might also include some other non-derivative items such as some non-standard loans.

Under the plans for FRS 102, basic instruments will be carried at amortised cost. The methods used to apply amortised cost are similar to FRS 26 and IAS 39, which can lead to more volatility compared to FRS 4 Capital Instruments in existing UK GAAP, particularly where there is potential for variation on the future cash fl ows of the fi nancial instrument.

Potential impact of future standards

Key actions/considerations• Ifyourcompanyissubjecttofinancialcovenants,reviewthemfor

the potential impact of changes in accounting standards or business decisions

• Discusspotentialimpactoncovenantswithlenders

• Ifyouareplanningtoissuenewfinancialinstrumentsconsiderthepotential accounting impact of their terms

• Considertheimpactoffinancialinstrumentsthatarecurrentlyoffbalancesheet,whichcouldrequirerecognitionundertheproposedFRS 102

• Forexistingfinancialinstruments,ifthecompanyusesUKGAAPthen FRS 102 should be carefully considered in terms of whether an instrument is ‘basic’ or ‘other’

UK GAAP


Changes to your company’s business model arising from the continuing economic uncertainty mean that exposure to and concentrationofriskisconstantlychanging.Consequently,theadequacyofcapitalandfinancialcapitalmanagementpoliciesand objectives are also likely to be of increased importance. Shareholdersandotherusersofthefinancialstatementscould misunderstand the company’s exposure to risk if it is not communicated properly. There is also the possibility that if the sharesinyourcompanyarepubliclytraded,marketexpectationsofriskmayhaveanegativeimpactonyourshareprice,inwhichcase better communication of risk can enhance the value of your company. You have the opportunity to manage the possibility that shareholders and other users may misunderstand your company’s exposure to risk by ensuring that relevant material risks and how they are being mitigated and managed are explained clearly in theannualreport,andthatshareholdersandotherusersarekeptuptodateasdevelopmentsoccur.Therefore,whatareyoucommunicating with shareholders about how you identify and manageriskandhowyouaremanagingcapital?

?2 Risk and Capital management– does your narrative reporting tell the story


Do you know what your investors want to know about?Much of the content of the front end of the annual report is determined by statute or other regulatory requirements. However your key stakeholders, investors, may want to see other information presented. It may therefore be useful to seek current views from your investors as to the kind of information that they want to read about in your annual report and accounts.

Are the key messages regarding risk and capital management clear? Does the front end of your annual report and accounts concentrate on the key messages and ‘tell the story’ or are key messages obscured by immaterial detail. In other words, is there unnecessary ‘clutter’ that could be removed?

Proposed changes to narrative reporting will mean that the current Business Review and Directors’ Report will be replaced with a Strategic Report and an Annual Directors’ Statement. The strategic report will provide key strategic information about the company including key risks and forward looking analysis. It will incorporate the content from the business review that is required by the Companies Act 2006 (CA2006). This is where companies will ‘tell their story’ and should provide enough information for users to make an assessment of the company’s historic performance and future prospects. The most signifi cant changes will apply to the largest companies - quoted companies as defi ned by CA2006, but any company that is required to produce a business review will be affected. At the time of writing, the changes are expected to take effect in 2013, though this may change.

Now may be a good time to rethink the narrative reporting section of your annual report, including the discussion of key risks together with the steps taken by management to mitigate the effect of these risks. Sometimes it can appear that words used in previous years have simply been updated rather than a fresh approach to the narrative having been applied.

Is the company’s business model explained clearly? The continuing economic uncertainty may have led to changes in your company’s business model. It is important that stakeholders are kept informed and have confi dence that your company is able to adapt to changing circumstances.

A description of the business is necessary to provide stakeholders with an understanding of the industry or industries in which the company operates, its main products, services, customers, business processes and distribution methods, the structure of the business and its economic model, including an overview of the main operating facilities and their location.

Discussion of external factors such as the company’s major markets and competitive position within those markets and the signifi cant features of the legal, regulatory, macro-economic and social environment that infl uence the business may also be relevant.

IFRS

UK GAAP


Have you considered recently what your key business risks actually are? Key business risks are likely to evolve over time and are often infl uenced by changes in the external environment. It is important that the narrative disclosures relating to these risks are updated regularly. As mentioned above, the way in which business risks are disclosed can have an impact on the way in which the company is perceived externally. The following list may help you identify key issues which are relevant to the continuing economic climate, and which may therefore be relevant to your discussion in the annual report. The key risks that should be disclosed are those that specifi cally affect the company and not those that are generic to any company. The description of the risk should enable the user to understand the harm to the company that the risk may cause:• Foreign currency exposure: The current

volatility of exchange rates and trade with European countries that may be forced to, or choose to, leave the Euro.

• Reliance on trade with customers in countries facing local austerity measures: Overseas countries may be subject to measures which could impact on their ability to trade overseas.

• Financial instruments: Fair value of fi nancial instruments may be volatile and impairment may be an issue.

• Direct or indirect reliance on public contracts for business: Government spending cuts could have a signifi cant impact on your business.

• Economic stagnation continuing indefi nitely: There appears to be no immediate end to the recession. How far into the future have you forecast and how sensitive are your fi gures to potential changes in circumstances?

• Impact on business if interest rates increase: In the UK we are currently experiencing low interest rates but this cannot continue and eventually they are likely to rise. Will your business be able to accommodate an increase in rates?

• Ability to meet banking covenants: Continuing pressures on property values, impairment and fair value losses can impact on the ability to meet banking covenants and will have a knock-on effect on liquidity and the company’s ability to secure more fi nance. Potential changes to the way in which leases are accounted for will also bring more liabilities onto the balance sheet.


Key actions/considerations• Seekinvestorviewsregardingthecontentoftheannualreport

• Reviewnarrativereportingwithintheannualreportforunnecessaryclutter

• Reflectonthecurrentkeyriskswithinthebusiness

• Performsensitivityanalysisonprofitandcashflowforecastsintheeventofthedifficulteconomicconditionscontinuingforaprolongedperiod

• Consideradequacyofprincipalrisksanduncertaintiesandcapitalmanagement disclosures

Have you communicated your plan to mitigate the impact of identifi ed business risks? As well as communicating the key risks, it is important that you explain how you manage those risks. Users of the accounts need to know that the company has procedures or controls in place to manage the impact of those risks. The statutory business review requirements also anticipate that this explanation will be given, and regulators such as the Conduct Committee of the Financial Reporting Council (formerly the Financial Reporting Review Panel) will also expect to see this discussed. The way in which the company is perceived externally will also be affected by how clearly these plans are communicated. In the current environment, it is unlikely that business risks will remain unchanged from one year to the next so it is important that you revise your explanations at each reporting date.

Have you refl ected recently on what the business regards as capital and what adequate levels of capital are considered to be? If your company prepares accounts under IFRS (or applies FRS 26 Financial Instruments: Recognition and Measurement under UK GAAP) then there are specifi c requirements regarding the disclosure of capital management policies and processes. However even where accounts are prepared under UK GAAP, disclosures about capital and how it is managed are considered necessary for a balanced and comprehensive business review, which is a statutory requirement in the UK. Things to consider and what shareholders want to know include: • the nature of capital: equity, preference shares,

term loans, leases etc• dividend policy: including an indication of

constraints on future dividend growth • return on capital employed• capital headroom, eg against banking covenants,

and the availability of additional capital • long-term funding plans designed to implement

business strategy.


?Forthcoming changes in accounting standards and regulation are likely to affect your existing business so you will need to be aware of what those changes are and what they could mean for your company’sfinancialpositionandfinancialperformance.Changeswillhaveaneffectonthefinancialstatementsofcompanies,evenwheresignificantchangestothebusinessmodelarenotanticipated. You will also need to communicate with shareholders andotherusersofyourcompany’sfinancialstatementswhattheimpact of the changes is likely to be.

3 What will forthcoming changes in accounting standards and regulationdo to your company’s fi nancial position and performance


Do you have any operating lease agreements in place?We have already mentioned in Section 1 that the IASB is proposing to replace IAS 17 Leases although the effective date is not yet certain. However under the proposed new standard, accounting for operating leases will change. Therefore, if you have operating lease arrangements, you need to be aware that there could be significant changes in the accounting treatment. See Section 1 for more details.

Does your company operate a defined benefit pension scheme? If you have a defined benefit pension scheme your company will be affected by amendments to IAS 19 Employee Benefits which take effect for financial years commencing on or after 1 January 2013.

The amendments will impact on the income statement and financial position as a result of changes to the way in which interest on the scheme deficit or surplus is calculated and depending on how you currently recognise actuarial gains and losses.

At present the finance cost in profit or loss typically includes the interest cost which represents the increase in the present value of the defined benefit obligation due to the time value of money and the expected return on plan assets. Under the amended standard, the discount rate currently used to determine the interest cost on the defined benefit obligation will be used to calculate the net interest on the defined benefit liability (or asset). In effect, the expected return on plan assets will be based on the market yields on high-quality corporate bonds rather than the higher rate the market would expect to be achieved on the plan assets themselves. Reported profit is likely to reduce as a result of using a different method for measuring the net interest charge/credit.

There is also less flexibility in how components of the defined benefit expense are categorised in the income statement.

Do you currently defer actuarial gains and losses using the ‘corridor method’?Under the amended IAS 19, all actuarial gains and losses will be recognised immediately in other comprehensive income. If you currently apply the corridor method and defer certain actuarial gains and losses, this method will no longer be permitted. The good news is that all actuarial gains and losses will be recognised in other comprehensive income and hence profit or loss will not be affected by the volatility of actuarial assumptions and experience gains and losses.

What sort of sales contracts do you have in place with your customers? It might be a good time to review your contracts with customers to ensure that the timing of recognition and measurement of revenue will not be adversely affected by the proposed new revenue recognition standard. The impact of the proposed changes to revenue recognition will vary from business to business. The proposed new IFRS, Revenue from Contracts with Customers is expected to take effect for financial years commencing on or after 1 January 2015.

Does your sales model require you to provide a range of services over a period of time?The proposed revenue recognition standard will require identification of separate performance obligations within a contract, determination of the transaction price which includes the consideration of factors such as variable consideration, the time value of money and collectability, and the allocation of the transaction price to distinct performance obligations. These changes could affect the timing and amount of revenue recognised, particularly in situations where contracts are complex and involve the performance of obligations over a period of time.

IFRS


Do you prepare group accounts? There are many changes that will affect companies which prepare group accounts as three new accounting standards take effect for financial years commencing on or after 1 January 2013, subject to adoption by the European Union (EU). Changes in the definition of control under IFRS 10 Consolidated Financial Statements and the classification of joint arrangements under IFRS 11 Joint Arrangements may have an impact on accounting, presentation and disclosures. IFRS 12 Disclosure of Interests in Other Entities will require enhanced disclosures, in particular in judgemental situations. You need to be thinking about their impact now as although the new standards apply to financial years commencing on or after 1 January 2013, changes are retrospective and so the restatement of balances at 1 January 2012 may be required.

Do you have investments in subsidiaries? If your company has subsidiaries and prepares consolidated accounts, IFRS 10 will be relevant to you. IFRS 10 provides a framework to assess when one entity controls another. In most cases the decision as to whether an investment is a subsidiary is straightforward but borderline consolidation decisions taken under IAS 27 Consolidated and Separate Financial Statements or SIC-12 Consolidation – Special Purpose Entities will need to be reassessed and this may lead to changes in accounting. Investments previously accounted for as a subsidiary may fail to meet the control definition under IFRS 10 and vice versa. The definition of control under IFRS 10 consists of three elements and requires all three to be present for control to exist – power over the investee, exposure, or rights, to variable returns from involvement with the investee and the ability to use power over the investee to affect the amount of investor’s returns. In some cases, the analysis behind each element will require judgement, in particular with regard to the determination of whether the company has exposure to variable returns, which has the potential to be interpreted widely.

Do you have any investments which are not treated as subsidiaries under IAS 27 but which could be under IFRS 10?The criteria for determining control under IFRS 10 are different to those under IAS 27. This could mean that in certain cases a different conclusion would be reached as to whether an investment is accounted for as a subsidiary.

For example, if your company holds a significant minority shareholding in an investment, but other shareholdings are widely dispersed, this could result in control under IFRS 10. If your company holds potential voting rights in an investment which are substantive, either alone or in combination with other rights, this could indicate that power exists over the investee which in turn would contribute to the determination of control. Under IAS 27 there is a different assessment of whether potential voting rights contribute to control. Under IAS 27 the existence and effect of potential voting rights that are currently exercisable or convertible are considered when assessing control. Under IFRS 10, potential voting rights are not required to be currently exercisable but would need to be exercisable when decisions regarding the activities of the investee that significantly affect the investee’s returns (‘relevant activities’) need to be made.

Do you have any joint arrangements?If you have joint arrangements, IFRS 11 will apply. IFRS 11 replaces the three categories of joint arrangement under IAS 31 Interests in Joint Ventures (‘jointly controlled entities’, ‘jointly controlled operations’ and ‘jointly controlled assets’) with two new categories: ‘joint operations’ and ‘joint ventures’.

Joint arrangements classified under IAS 31 as jointly controlled entities will generally fall into the category of joint venture under IFRS 11 in which case the accounting will be unchanged, unless proportionate consolidation was previously applied (see below).

However there are situations where jointly controlled entities under IAS 31 will be classified as a joint operation under IFRS 11. If a jointly


controlled entity was previously accounted for under the equity method under IAS 31 but the investment is classified as a joint operation under IFRS 11, the accounting will be significantly different. Under equity accounting, an investment is presented as one line within the balance sheet and income statement reflecting the investor’s share of the investee’s net assets and profit or loss for the year. An investment in a joint operation under IFRS 11 will be incorporated into the balance sheet and income statement on a line-by-line basis, reflecting the joint operator’s share of assets, liabilities, income and expenses of the joint arrangement.

Do you proportionately consolidate your jointly controlled entities? If you proportionately consolidate jointly controlled entities under IAS 31, this will no longer be permitted. Joint ventures will be equity accounted under IFRS 11. The effect of this on the balance sheet will be to collapse the various assets and liabilities currently included in the balance sheet into a single line item as described above. Similarly, the investor’s share of income and expenses will be reflected as a single line item in the income statement, representing the investor’s share of the joint venture’s profit or loss for the year.

Do your investee relationships expose you to any significant risks? IFRS 12 integrates and makes consistent the disclosure requirements for subsidiaries, joint arrangements, associates and unconsolidated structured entities. IFRS 12 specifies minimum disclosures that an entity must provide. Some of this information will be new and its preparation will require careful planning. This includes disclosure of the nature of, and changes in, the risks associated with any of these types of investment.

Are there significant non-controlling interests in your subsidiaries?Where a non-controlling interest in a subsidiary is material to the reporting entity, there is a new requirement in IFRS 12 to provide summarised financial information about the assets, liabilities, profit or loss and cash flows of that subsidiary.

Does your balance sheet contain substantial financial assets?The IASB is gradually replacing IAS 39 Financial Instruments: Recognition and Measurement for financial instruments measurement with IFRS 9 Financial Instruments. However, IFRS 9 is being completed in stages. The effective date of IFRS 9 is for periods commencing on or after 1 January 2015, subject to EU adoption. However, EU adoption of IFRS 9 has not yet taken place. In most cases, financial liability accounting in IFRS 9 is the same as IAS 39. The classification of financial assets in IFRS 9 is different compared to IAS 39. IAS 39 had four main classes, whereas IFRS 9 has only two main classes of financial assets, one being at fair value, and the other at amortised cost. Derivative assets will generally remain at fair value. Amortised cost will apply where both (i) the asset is held within a business model whose objective is to hold assets in order to collect contractual cash flows and (ii) the contractual terms of the financial asset give rise to cash flows which are solely payments of principal and interest.

The above changes will generally mean that for non-financial services businesses, derivative assets will be at fair value through profit or loss, while most other financial assets such as trade receivables will be at amortised cost, hence little change compared to IAS 39. However, if the business involves lending, then the business model and contractual terms of the financial assets will require very careful consideration. The changes to IFRS 9 are therefore of key interest to banks and other financial institutions.


Do you already apply or have you considered applying hedge accounting?Many entities take out derivatives such as interest rate swaps for hedging purposes. Those derivatives can cause profit volatility. Hedge accounting exists in IAS 39 in order to mitigate that profit volatility, but is subject to strict rules. Those rules have sometimes acted as a reason for entities not to apply hedge accounting.

As part of the IFRS 9 project, the IASB plans to amend the hedge accounting model, although these proposals are not yet finalised at the time of writing. These proposals could provide more opportunity than under IAS 39 for entities to apply hedge accounting. In particular, the IASB plans to remove the ‘highly effective’ test which only allows hedge accounting in IAS 39 to continue on a hedging relationship if that hedge has been highly effective. Instead, hedge accounting could continue even if effectiveness reduces, but with a rebalancing of the hedging relationship leading to a greater potential for volatility in reported profit or loss and increased complexity in the accounting. We anticipate that whilst the plans for IFRS 9 would make hedge accounting more accessible and more attractive, there will still be complexity. In particular, actual ineffectiveness will be required to be taken to

profit and loss, and so there will be complexity in arriving at the accounting entries.

As in IAS 39, the plans for IFRS 9 will only allow hedge accounting where formal documentation has been prepared in advance.

Does the company have significant items accounted for at fair value?The IASB have issued IFRS 13 Fair Value Measurement effective for periods commencing on or after 1 January 2013. IFRS 13 does not alter which items are carried at fair value but seeks to provide principles and guidance for measuring fair value. This is therefore relevant to any entities which have items carried at fair value such as some financial instruments and investment property. It is also relevant where fair value is determined at particular times such as in fair value calculations for the purpose of impairment reviews and relating to business combinations.

IFRS 13 may in some cases alter how fair value has been determined compared to the past. Fair value is based on ‘exit’ value and a market-based view. In many cases, application of IFRS 13 will not lead to any changes. However there are numerous points of detail where IFRS 13 could lead to a change from past practice. Entities that have significant items measured at fair value should therefore consider whether IFRS 13 has any impact.

Do companies within your group prepare their accounts under UK GAAP? The Accounting Standards Board (ASB) is proposing changes to UK GAAP. Revised proposals were issued in January 2012 with an effective date expected to be for accounting periods beginning on or after 1 January 2015. If your company is intending to prepare its accounts under (Draft) FRS 102 The Financial Reporting Standard applicable in the UK and the Republic of Ireland (see Section 6 for accounting choices) there are some significant differences between the proposed FRS 102 and current UK GAAP that need to be considered. Key areas of difference include the useful life of goodwill, the recognition

and measurement of financial instruments (see Section 1), accounting for lease incentives, the recognition of valuation movements in investment property through profit or loss, accounting for and presentation of defined benefit schemes and the calculation of deferred tax.

An alternative to the proposed FRS 102 is the proposed FRS 101 Reduced Disclosure Framework. This is an option of IFRS recognition and measurement with reduced disclosures for qualifying parent company and subsidiary individual accounts.

You will need to be aware of how the changes could affect your business. You will also need to communicate changes to key users of the financial statements.

UK GAAP


Is your company required to prepare a business review? The content and structure of the front end of the annual report and accounts will be changing. The Government proposes to replace the current requirements under the Companies Act 2006 (CA2006) for a Business Review and Directors’ Report with a Strategic Report and an Annual Directors’ Statement. If your company is required to prepare a business review, now might be a good time to review the front end of your annual report. If your company is a quoted company, as defi ned in CA2006, the changes will be greater.

The purpose of the Strategic Report will be to provide key strategic information about the company including key risks and forward looking analysis. It will incorporate the content from the business review that is required currently by CA2006. It will be prepared for shareholders and describe the company’s performance, principal risks and uncertainties, key performance indicators and key fi nancial information.

For quoted companies, the Strategic Report will also include information on strategy, the business model, social, environmental and human rights

matters (where necessary), key information on corporate governance and remuneration. This is where companies will ‘tell their story’ and should provide enough information for users to make an assessment of the company’s historic performance and future prospects.

The Annual Directors’ Statement will consist of detailed disclosures that are required regardless of materiality or impact on the business as a whole, as well as information provided voluntarily. The Statement will have a prescribed structure with a set layout and standard headings. For quoted companies, it will include the Directors’ Remuneration Report, Corporate Governance Statement and the Audit Committee Report.

Do you issue summary fi nancial statements or is this something that you might consider?Companies are currently able to ask shareholders if they would like to receive Summary Financial Statements in place of the annual report. Under the Government proposals for narrative reporting, Summary Financial Statements will be incorporated into the Strategic Report.

IFRS

UK GAAP

Key actions/considerations• Considertheimpactofchangesinstandardsonexistingbalancesand

transactions

• ReviewsalescontractsfortheimpactofthenewIFRSonrecognitionof revenue

• ConsiderthepotentialclassificationofyourinvestmentsunderthenewIFRSconsolidationstandards,egassubsidiariesorjointventures

• Considerwhetheryouraccountingsystemswillbeabletocapturetheinformation required to be disclosed by IFRS 12

• ConsiderhowyouraccountsmightlookundertheproposedfutureUK GAAP

• Reviewandupdateyourbusinessreview


The challenging business environment is driving businesses to refresh their business models and to seek new opportunities. Rather than viewing the current economic climate as a barrier to growth,manycompaniesseeitasanopportunitytorefreshtheirbusiness model and pursue new business ventures. This may be throughorganicgrowth,enteringintonewarrangements,joiningforces with third parties or through business acquisitions.

?4 Are you seeking new opportunities through organic growth or through acquisition


Is your company considering diversifying its range of products or services? If you are intending to pursue new revenue streams, you will need to be aware of the proposed new IFRS Revenue from Contracts with Customers. The proposed revenue recognition standard will require identification of separate performance obligations within a contract, determination of the transaction price which includes the consideration of factors such as variable consideration, the time value of money and collectability, and the allocation of the transaction price to distinct performance obligations. These changes could affect the timing and amount of revenue recognised, particularly in situations where contracts are complex. You therefore need to ensure that new sources of revenue will be accounted for as anticipated.

Even where you prepare your accounts under UK GAAP, the way in which new sources of revenue are measured and recognised will need to be assessed in conjunction with UK Accounting Standards, principally FRS 5 Reporting the Substance of Transactions, Application Note G and the proposed FRS 102 The Financial Reporting Standard applicable in the UK and the Republic of Ireland.

Is your company considering revising the terms on which it trades with customers? The current economic environment has forced companies to be creative in terms of how they seek to retain the trade of existing customers and pursue new opportunities. For example, changes in settlement terms with customers who might otherwise be unable to settle their debts could have implications under both the existing and proposed revenue standards. Some changes in terms could even be akin to financing transactions which could alter the way in which the financial instruments standards apply. There may also be net present value implications, depending on the timescales agreed with customers for payment.

Are you considering trading in new geographical locations? If you are looking to trade in new geographical locations, do you understand the environment in which you plan to operate? There may be economic barriers such as those linked to currency and local trading practices. For example trade with countries with a volatile currency will impact directly on your results unless you have a clear plan to minimise the impact. Entering into forward currency contracts and possibly the adoption of hedge accounting under IAS 39 Financial Instruments: Recognition and Measurement (and FRS 26, where adopted under UK GAAP) may therefore be a consideration. Local austerity measures may impact on your ability to trade freely with that market. There may also be restrictions on the movement of resources out of a particular location such as assets and profits. There may be unforeseen tax consequences or complex tax systems to negotiate. There may also be cultural differences to consider.

Have you considered hedging any potential exposure to foreign exchange volatility? In order to minimise exposure to foreign exchange volatility, IAS 39 (and FRS 26, where adopted under UK GAAP) permits the option of hedge accounting. An example of where hedge accounting might be useful is in connection with a foreign currency forward contract which may be used to hedge the foreign exchange risks relating to future sales or purchases. IAS 39 requires such derivative contracts to be included in the balance sheet at fair value. In the absence of hedge accounting, changes in fair value would be recognised immediately in profit or loss. Cash flow hedge accounting allows gains or losses on the forward contract to be included in other comprehensive income until the time of the related sales or purchase transactions. IAS 39 contains detailed rules in determining when hedge accounting is available in which case the adoption of hedge accounting will require careful and timely consideration.

Organic growth

IFRS

UK GAAP


Is your business able to benefit from the outsourcing of public services to the private sector?As part of the Government’s drive to increase efficiency and reduce costs in the public sector, opportunities exist for private companies to enter into contracts with local authorities to provide services. If relevant, are you aware of any opportunities which might be available to your business? Where there are opportunities to take advantage of government contracts, you will need to consider factors such as the way in which contract revenue is recognised and whether or not assets and liabilities used in or generated by the arrangement should sit on or off balance sheet. Furthermore, in some situations IFRIC 12 Service Concession Arrangements may also be relevant.

IFRIC 12 will apply where contracts for servicing the infrastructure of public services such as roads, bridges, tunnels, prisons and hospitals are entered into between private sector providers and government authorities.

Are you considering capital investment? In order to meet your plans for organic growth, you may be considering investment in property, plant and equipment. This may therefore involve decisions as to how you finance the investment. As we have already discussed in Section 1, the proposed new IFRS on leasing could influence your decision as to whether to lease new assets or to choose another method of financing your capital additions.

IFRS

IFRSAre you contemplating entering into strategic business arrangements with third parties? If your plans for growth include entering into new arrangements with third parties you need to consider if and how these arrangements fit in to the new consolidation standards and how they will need to be accounted for. These have been discussed in Section 3.

Does your business strategy involve the acquisition of other businesses?If your plans for growth include the acquisition of other businesses you need to ensure that you understand the implications of the new consolidation standards and that the accounting treatment is as expected.

You may be planning on acquiring subsidiary companies but changes in the definition of control under IFRS 10 Consolidated Financial Statements may affect whether or not your investment is accounted for as a subsidiary undertaking. In most cases it will still be evident that control exists but in other situations it may not be so clear. For example, new specific guidance on arrangements involving special purpose vehicles, large minority shareholdings, potential voting rights which are not currently exercisable and principal and agent arrangements may lead to unexpected accounting consequences.

The way in which acquisitions are structured can have an impact on the accounting. You will therefore need to ensure that acquisition agreements carefully reflect the intended nature of the arrangement such that the appropriate accounting treatment is clear.

Other methods of growth


Do your plans for growth include a listing on a public exchange? If your plans for growth include a listing on a public exchange, for example as a means of raising fi nance to facilitate growth and expansion, there will be a range of issues to consider such as specifi c legal requirements, the regulatory requirements of the relevant exchange and any accounting consequences such as the requirement to prepare group accounts under IFRS. This is likely to be relevant where your current business consists of a group of companies which prepare consolidated accounts under UK GAAP. For example, where a parent is listed on AIM or has a listing on the London Stock Exchange and prepares group

accounts, the group accounts must be prepared under IFRS. This could lead to signifi cant differences in the recognition, measurement and disclosures of amounts included in the fi nancial statements. You may therefore need to obtain advice on where the biggest accounting differences are likely to arise in your specifi c circumstances.

However, even where a future listing is a medium to long term plan, you may be considering voluntary adoption of IFRS to improve your prospects for external investment. Conversion to IFRS can be a time-consuming exercise and will therefore require careful planning. Given the anticipated changes to UK GAAP now may be a good time to consider this. Accounting choices are discussed in Section 6.

IFRS

UK GAAP

Key actions/considerations• Understandthemarketsinwhichyouintendtooperate

• Considertheimpactoftheproposednewrevenuestandardonneworrevised revenue streams

• EnsurethatyouunderstandtheimpactofthenewIFRSconsolidationstandards on new business arrangements and investments

• UnderstandtheaccountingconsequencesofatransitiontoIFRS


The structure of a business can impact on the potential for management and owners to realise strategic business objectives. Now may be a good time to review the existing group structure withaviewtosimplificationordemergingdistinctstrandsofthebusiness. However in all cases you will need to consider whether there are any tax implications.

?5 Is your business

structuredso as to optimise management and shareholder objectives


Is your group structure unnecessarily complex? Historically groups may have been set up with a large number of companies. Whilst there may have been legitimate business reasons for creating a particular group structure, changes in circumstances may mean that companies within a group are no longer required. For example certain companies within a group may have little trade, or may be dormant. These companies, however, will still require a certain amount of management time and involve some administrative tasks, which may lead to unnecessary costs. It may therefore be a good time to streamline the structure of your group, for example through the transfer of trade and assets, the paying up of dividends from subsidiaries to parent and the winding up of companies no longer required. However it is likely that there will be legal and regulatory implications to consider, as well as a need to determine the necessary accounting entries to reflect the transactions.

Could your business benefit from a demerger? In contrast to the situation described above, there may be advantages to splitting out an existing business into component operations. This could be useful where there is an intention to sell off part of the business or to isolate less profitable parts of the business which may be having an adverse impact on the more profitable parts. For example, access to funding may be hindered where unprofitable parts of the business are masking those parts of the business which are profitable.

Do the owners of the business intend to exit from the business at some point in the future?If the owners intend to exit from the business at some point in the future then time needs to be spent now in planning for that exit and maximising the value obtained for the business. It is important to remember that a potential purchaser will be looking to minimise the amount that he or she is required to pay for the business so will be challenging areas that could suggest that the worth

of the business has been overstated. Steps that can be taken now to prepare for a future exit could include: • a review of the current accounting policies

to ensure that they are the most appropriate and reflect current best practice: A potential purchaser may challenge policies adopted, especially where they indicate that profits may be overstated

• consideration of the value of off balance sheet assets: Arrangements or assets may exist which have value to the business, but due to accounting requirements are not recognised in the accounts. For example there may be intangible assets or business contracts in place. It may therefore be worth considering which unrecognised arrangements and transactions exist and how they could be valued if necessary

• improving the balance sheet position: Now could be a good time to review the balance sheet and key financial ratios. For example, are credit control procedures as tight as they could be? Are all debtor balances collectible? Are stock provisions adequate? Is there sufficient liquidity? Does the fixed asset register reflect assets actually used within the business?

• simplifying the corporate structure: A complicated group structure can obscure the underlying business potential. As discussed above, streamlining the group structure could make concentration of business activity and value more transparent. This could involve the consolidation of parts of the business or a demerger.

Is the business highly geared? A highly geared business can be unattractive to potential investors, purchasers, creditors and lenders for example. If your debt to equity ratio is high, then it may be time to consider ways to redress the balance. For example there may be scope to convert debt to equity (See Section 1 where debt-for-equity swaps are discussed further) or to issue new shares using the funds obtained to partially or fully pay off any outstanding debt.

Financial instruments which are legally shares can sometimes be required under accounting standards to be presented as debt due to the terms of the instruments. This can adversely affect the gearing ratio. It may therefore be possible to alter

IFRS

UK GAAP


the terms of the instruments such that they meet the definition of equity, although care would need to be taken to ensure that the relevant accounting requirements were met. Additionally care should be taken when issuing new classes of shares to ensure that the terms on which they are issued do not lead to an unintended classification as debt, rather than equity.

Is there surplus equity in the business?On the other hand, surplus equity may exist in the business. A capital reduction could be used to remove dividend blocks within a group. For example, negative reserves in a subsidiary company could be preventing a profitable subsidiary lower down in the group from paying dividends. A capital reduction could therefore create realised profits, which in turn absorb the negative reserves in the subsidiary company thus removing the dividend block. However statutory requirements apply to a capital reduction and will vary depending on whether the company is a private company or a public company. The Companies Act 2006 simplified the capital reduction process for private companies, although

there are still specific legal steps which need to be followed, including the requirement for the directors to issue a solvency statement. Where a company is a public company, a capital reduction is still possible although the rules are tighter and include the requirement to obtain Court approval.

Where there are significant distributable reserves, a special dividend could be paid. A special dividend is generally a ‘one-off’ dividend payment, separate to any normal recurring interim or annual dividends.

Are you considering bringing in new investors? If there are plans to broaden the investor base in your business, have you considered how this will be achieved? For example, in order to differentiate the rights of the existing shareholders and new investors it may be necessary to issue new shares with different terms. As noted in Section 1, the way in which the terms of shares issued are contractually constructed, for example in the articles of association or shareholders agreements, can impact on the way in which they are accounted for, in which case care will be needed to ensure that there are no unintended consequences.

Key actions/considerations• Ensurethatthestrategicobjectivesforthebusinessanditsowners

are clear

• Establishaclearplantoachievethestrategicobjectives

• Considerwhetheracorporaterestructuringmightbebeneficial

• Considerwaystoimprovethefinancialpositionofthebusiness



TheDepartmentforBusiness,InnovationandSkills(BIS)isproposing to widen the scope of the statutory audit exemption and big changes to UK GAAP are also expected. These proposed changes to legislation and the accounting regime in the UK will therefore require management to balance stakeholders’ needs withpreparers’costs.Inmanycases,managementwillhaveachoice whether or not they take up these changes. You therefore need to be able to make an informed decision and understand the consequences of the choices made.

?6 Are you geared up to

make the right choicesgiven the proposed changes to legislation and the accounting regime in the UK


Does your group contain subsidiaries which currently require a statutory audit? BIS has issued a consultation setting out proposals to widen the scope of audit exemption under the Companies Act 2006. If implemented, the proposals will permit subsidiaries, regardless of their size, not to have an audit as long as certain conditions were met.

For example, the parent company will need to be registered in the UK, the parent will have to declare that it guarantees the subsidiary’s debts (this guarantee will need to be fi led at Companies House) and the subsidiary’s shareholders will need to consent unanimously to the exemption on an annual basis.

Would you consider taking up the proposed audit exemptions for eligible subsidiary companies?The widening of the exemption for audit may seem an attractive option. One obvious advantage would be the saving of the individual subsidiary’s audit fee. However, you will need to think carefully before taking up such an option as there may be disadvantages.

For example, certain of your stakeholders may believe that an audit provides a level of assurance that they require. In some cases the option not to have an audit may be taken but a compilation report or an alternative will be requested. There will be a cost attached to these alternatives.

Your lenders may also require your subsidiaries to have an audit, or some form of alternative assurance, as part of the terms and conditions of funding. Similarly, the lack of audited accounts may have an impact on the cost and availability of new sources of fi nance, and more generally may have a negative effect on your company’s credit rating.

One of the conditions for the proposed audit exemption is that the parent company would need to guarantee a subsidiary’s debts. This could increase the risk to the business due to this impacting on the limited liability status which is achieved through setting up a separate subsidiary company. In addition, the fact that a company has obtained a guarantee from its parent may give the impression to third parties not familiar with the new legislative requirements that the subsidiary is in fi nancial diffi culty and cannot meet its debts, which in turn could act as a deterrent to those third parties from doing business with the subsidiary in question.

There may also be accounting implications of the guarantee in the parent company fi nancial statements. If the parent company applies IFRS or UK GAAP with FRS 26 Financial Instruments: Recognition and Measurement, the guarantee will need to be recognised on the balance sheet at fair value. This may also be the case under the ASB’s proposals for the future of UK GAAP. The need to obtain a professional valuation in these circumstances is therefore likely to give rise to an additional cost.

Future of UK GAAP – what are the options? The ASB is proposing changes to UK GAAP. The proposed new Financial Reporting Standard applicable in the UK and Republic of Ireland (Draft FRS 102), which is based on the International Financial Reporting Standard for Small and Medium-sized Entities, will replace all current UK accounting standards in 2015. Unless your accounts are prepared under the Financial Reporting Standard for Smaller Entities (FRSSE) which for the time being will remain in place, you can expect changes to your accounts. However

there are choices available in terms of which reporting regime you can follow.Broadly the options available will be:• EU adopted IFRS (ie full IFRS which at present

is a regulatory requirement for group accounts of a fully listed parent company or a parent company listed on AIM)

• EU adopted IFRS but with a reduced disclosure framework for qualifying parent or subsidiaries individual accounts (Draft FRS 101 Reduced Disclosure Framework)

• Draft FRS 102, or • the FRSSE (where permitted).

IFRS

UK GAAP

UK GAAP


If my company is entitled to apply the FRSSE, is it worth considering the adoption of an alternative GAAP? The ASB intends to retain the FRSSE for the next few years for small companies as defi ned by the Companies Act 2006. Whilst theoretically a small company could choose to apply a GAAP other than the FRSSE there would need to be sound commercial benefi ts from doing so as the costs of transition may be high. For example accounting systems would need to be able to deal with the changes in the accounting regime followed, comparative fi gures would need to be restated, there is likely to be a greater use of fair values in which case the use of valuation experts may be necessary, which will be costly, profi tability may be affected and there are likely to be tax implications due to different recognition and measurement bases.

Should we adopt EU adopted IFRS with reduced disclosures? The proposals include an option of applying EU adopted IFRS with reduced disclosures for the individual accounts of qualifying parent and subsidiary companies (Draft FRS 101). To qualify, an entity must be included in consolidated fi nancial statements which are publicly available and there must be no objection from shareholders. This option could be useful where group accounts are prepared under EU adopted IFRS. In these circumstances the individual accounts of group companies could be prepared using recognition and measurement bases consistent with those

of the EU adopted IFRS group accounts, but with relief for some of the most onerous IFRS disclosures. This would simplify the consolidation process as fewer consolidation adjustments would be necessary than would be the case for individual accounts prepared under FRS 102, but without the cost of producing the detailed IFRS disclosures in the accounts of the subsidiary. This is because the proposed FRS 102 is a simplifi ed version of EU-adopted IFRS and some of the accounting treatments differ. Furthermore it is anticipated that FRS 102 will only be updated once every three years in which case there is likely to be a time delay between changes to EU-adoptedIFRS and FRS 102 leading to further consolidation adjustments.

However it is still important to consider all the alternatives as there are likely to be commercial implications attached to each, for example in relation to tax, profi tability and the ability to pay dividends and costs.

Should we move to EU adopted IFRS?Almost any entity (other than a charity) can elect to adopt EU adopted IFRS, although the disclosure requirements will be signifi cantly more onerous than the other framework options permitted. However consideration of the future aspirations of the group may be relevant. For example, if there are plans to list on a public exchange where group accounts prepared under EU adopted IFRS are a regulatory requirement, this might be relevant to any decision.

Key actions/considerations• Considertheargumentsforandagainstauditexemptionforsubsidiaries

within your group

• Considerthecommercialimpactofguaranteeingsubsidiaries’debt

• Familiariseyourselfwiththerecognitionandmeasurementchangesthatwill arise on conversion to FRS 102 from current UK GAAP

• Appraisetheaccountingframeworkoptionsavailabletoyourbusiness



Changesinaccountingstandards,regulationandbusinessdecisions in general will have an impact on many aspects of your business operations. Will your existing operations therefore be abletodealwiththesechanges?Outlinedbelowarequestionsthat you need to consider to ensure that your business operations will be able to meet the demands of the changes.

?7 How might your business operationsbe affected by market and regulatory changes


Will your accounting systems be able to cope with the changes? You will need to ensure that your accounting systems will be able to capture the relevant data in order to meet accounting requirements which are either new or are new to your company due to changes in business activities. Accounting systems will not only need to be able to deal with the numbers, but also produce them in a format that will enable new disclosure requirements to be met. This may require changes to accounting software,

but remember that there will still be a need to ensure that financial statements are able to meet the iXBRL filing requirements.

In particular for companies which will be required to adopt the proposed new UK GAAP (Draft FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland), not only will there be changes in recognition and measurement but also in the terminology used for transactions and balances.

IFRS

UK GAAP

How will you communicate the changes to stakeholders? You will need to consider to whom you will need to communicate the expected accounting and presentational changes. Stakeholders will include shareholders, trade creditors, lenders and employees. They will need to understand the impact of changes in standards on your accounts; different stakeholders may require a different approach.

For example, we have already mentioned that changes in accounting could impact on financial covenants in which case early discussion with lenders will be essential.

Shareholders will be interested in changes that affect profitability and the return on their investment. Where changes are expected to have significant consequences for shareholders, communication may be achieved through meetings with or presentations to key shareholders.

Employees will be interested in changes that have an impact on the way in which they are remunerated and rewarded. For example, bonuses or share-based remuneration may be based on amounts recognised in the financial statements, which could be impacted by changes in accounting. Employees will therefore want to know how this will be addressed. This may also be a good time to review your employee reward package.


How much time will you need to allow for the transition process? If your business will be impacted by the adoption of FRS 102, you will need to ensure that you allow sufficient time to work through the transition process. This will involve the restatement of comparatives, both in the prior year and at the date of transition. It may be that this process could be carried out in stages, rather than all at once.

Will your finance team need to be trained? With major changes in accounting expected in 2015, a significant burden will be placed on your finance team. You will therefore need to ensure that you have the right size of finance team, with new recruitment, training and development plans in place, on a timely basis so as to help mitigate some of the risks surrounding transition.

The new standards contain some important differences compared to the current standards as well as significantly more areas where management judgement is required than has previously been the case. Disclosure requirements will change and initially may require more resources to produce, potentially at a more senior level within the finance team.

Will you need to engage valuation specialists?We have already mentioned that forthcoming changes to UK GAAP may lead to an increase in the use of fair values. Unless you have the necessary expertise within your business, it is likely that you will need to engage valuation specialists. It will therefore be worthwhile giving some consideration to the areas within your accounts where fair values are likely to be required and research the availability of specialists who will be able to assist with the valuation process.

UK GAAP

Key actions/considerations• Reviewadequacyofaccountingsystems

• Formulateatransitionplan

• Establishwherethemajorchangestoyourfinancialstatementsarelikelyto arise

• Considertheoptionsforcommunicatingthechangestoyourkeystakeholders


1 What is your financing strategy?

Do you have any leasing arrangements? 4

Do you have financial covenants and how sensitive are they to changes?

4

Have you considered ways in which you could manage the exposure of your business to financial risk?

5

Do you have plans to raise funds from a listing? 6

Do you intend to issue new types of financial instruments? 6

Do you have working capital balances which could be used to secure asset-based finance?

6

Do you have intra-group funding arrangements? 6

Are you contemplating a financial restructuring? 7

Are you considering a debt-for-equity swap? 7

Are you considering a change in the terms of your existing debt?

7

Do you intend to issue new types of financial instruments? 8

2 Risk and Capital management – does your narrative reporting tell the story?

Do you know what your investors want to know about? 10

Are the key messages regarding risk and capital management clear?

10

Is the company’s business model explained clearly? 10

Have you considered recently what your key business risks actually are?

11

Have you communicated your plan to mitigate the impact of identified business risks?

12

Have you reflected recently on what the business regards as capital and what adequate levels of capital are considered to be?

12

Navigation

IFRSUK GAAPPage


3 What will forthcoming changes in accounting standards and regulation do to your company’s financial position and performance?

Do you have any operating lease agreements in place? 14

Does your company operate a defined benefit pension scheme?

14

Do you currently defer actuarial gains and losses using the ‘corridor method’?

14

What sort of sales contracts do you have in place with your customers?

14

Does your sales model require you to provide a range of services over a period of time?

14

Do you prepare group accounts? 15

Do you have investments in subsidiaries? 15

Do you have any investments which are not treated as subsidiaries under IAS 27 but which could be under IFRS 10?

15

Do you have any joint arrangements? 15

Do you proportionately consolidate your jointly controlled entities?

16

Do your investee relationships expose you to any significant risks?

16

Are there significant non-controlling interests in your subsidiaries?

16

Does your balance sheet contain substantial financial assets?

16

Do you already apply or have you considered applying hedge accounting?

17

Does the company have significant items accounted for at fair value?

17

Do companies within your group prepare their accounts under UK GAAP?

17

Is your company required to prepare a business review? 18

Do you issue summary financial statements or is this something that you might consider?

18

IFRSUK GAAPPage


4 Are you seeking new opportunities through organic growth or through acquisition?

Is your company considering diversifying its range of products or services?

20

Is your company considering revising the terms on which it trades with customers?

20

Are you considering trading in new geographical locations? 20

Have you considered hedging any potential exposure to foreign exchange volatility?

20

Is your business able to benefit from the outsourcing of public services to the private sector?

21

Are you considering capital investment? 21

Are you contemplating entering into strategic business arrangements with third parties?

21

Does your business strategy involve the acquisition of other businesses?

21

Do your plans for growth include a listing on a public exchange?

22

5 Is your business structured so as to optimise management and shareholder objectives?

Is your group structure unnecessarily complex? 24

Could your business benefit from a demerger? 24

Do the owners of the business intend to exit from the business at some point in the future?

24

Is the business highly geared? 24

Is there surplus equity in the business? 25

Are you considering bringing in new investors? 25

IFRSUK GAAPPage


6 Are you geared up to make the right choices given the proposed changes to legislation and the accounting regime in the UK?

Does your group contain subsidiaries which currently require a statutory audit?

28

Would you consider taking up the proposed audit exemptions for eligible subsidiary companies?

28

Future of UK GAAP – what are the options? 28

If my company is entitled to apply the FRSSE, is it worth considering the adoption of an alternative GAAP?

29

Should we adopt EU adopted IFRS with reduced disclosures?

29

Should we move to EU adopted IFRS? 29

7 How might your business operations be affected by market and regulatory changes?

Will your accounting systems be able to cope with the changes?

32

How will you communicate the changes to stakeholders? 32

How much time will you need to allow for the transition process?

33

Will your finance team need to be trained? 33

Will you need to engage valuation specialists? 33

IFRSUK GAAPPage


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Sheffi eld (2 Broadfi eld Court) T (0)114 2553371

Southampton (No 1 Dorset Street) T (0)23 8038 1100


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