New UK GAAP – the legal perspective
A new suite of financial reporting standards will apply to UK companies preparing their accounts for periods starting on or after 1 January 2015. Some companies may choose to adopt the new standards early. The changes will have legal implications for companies and those that do business with them.
The accounting regime
The Companies Act 2006 requires companies to prepare annual accounts (both individual company accounts and consolidated group accounts) either in accordance with the Act and UK accounting standards or in accordance with international accounting standards as adopted by the European Union for listed companies (EU IFRS).
Individual company accounts and consolidated accounts prepared in accordance with EU IFRS will not be affected by the changes to UK accounting standards, but companies that have chosen this route may wish to reconsider whether this is still the best option.
The new UK accounting standards regime sweeps away all existing Financial Reporting Standards, Statements of Standard Accounting Practice and Urgent Issues Task Force Abstracts. In their place are four new Financial Reporting Standards and a proposed fifth one:
- FRS 100 "Application of Financial Reporting Requirements" sets out the overall framework for financial reporting, including: which standards apply to which types of company.
- FRS 101 "Reduced Disclosure Framework" sets out a reduced disclosure framework based on EU IFRS for qualifying group companies.
- FRS 102 "The Financial Reporting Standard applicable in the UK and Republic of Ireland" contains the new UK accounting standards and includes a reduced disclosure regime for qualifying group companies.
- FRS 103 "Insurance Contracts" applies to companies that apply FRS 102 and sets out the requirements relating to insurance contracts.
- Draft FRS 104 "Interim Financial Reporting" is intended to be a pronouncement on interim reporting that companies not using EU IFRS may apply under the Disclosure and Transparency Rules.
The FRS for Smaller Entities (FRSSE) has been modified and will remain available for use by small companies, although it may be incorporated within FRS 102 in due course, and a separate FRS for micro entities (FRSME) is proposed.
Companies choosing to adopt UK accounting standards (but not eligible to apply the FRSSE or FRSME) will now apply FRS 102, except for some group companies as discussed further below. FRS 102 is based on the international accounting standards for small and medium sized entities and is very different to the old regime. Examples of changes between FRS 102 and the old regime include:
- Changes in terminology, for example, "inventory" instead of "stock".
- Goodwill and intangible assets: the current rebuttable presumption of a maximum life of 20 years or less, with the possibility for a longer or indefinite life, is replaced with a requirement for a finite life and useful life will be five years or less when no reliable estimate can be made.
- Intercompany payables and receivables: currently included at historical cost reflecting outstanding amounts, these will be required to be measured initially at fair value. If a loan is at a fixed term and not at a commercial rate of interest, a difference will arise between the loan principal amount and fair value, which will be accounted for as a capital contribution or distribution, as appropriate.
Reduced disclosure frameworks for group companies
Some quoted parent companies are required to prepare consolidated group accounts in accordance with EU IFRS. Other parent companies may choose to do so, or can prepare group accounts under FRS 102.
Companies within a group will have a number of options for their individual company accounts, irrespective of how the group accounts are prepared. They can be prepared in accordance with: EU IFRS; the reduced disclosure framework based on EU IFRS in FRS 101; full compliance with FRS 102; or the reduced disclosure framework within FRS 102.
Many group companies are likely to opt for FRS 101 if their group accounts are prepared in accordance with EU IFRS, and for the FRS 102 reduced disclosure framework if their group accounts are prepared in accordance with FRS 102. However this may not always be the best approach (in particular, tax arrangements or distributable profit issues may cause different choices to be made) and the implications should be discussed with the group's accountants.
In order to qualify to use either of the reduced disclosure frameworks, a company must be included in publicly available consolidated accounts that are intended to give a true and fair view. For companies that are part of overseas groups, the true and fair view requirement will be no problem if international financial reporting standards or, for example, US accounting standards are being followed, but a judgement may need to be made in other cases.
A group company which is qualified to use a reduced disclosure framework may do so only if its shareholders have been notified about, and do not object to, this. Objections may be made by the immediate parent company, shareholders holding more than half of the shares not held by the immediate parent company, or shareholders holding 5% or more of the total allotted shares in the company. It could therefore be an issue which arises when shareholders in a joint venture company seek to agree the accounting policies to be followed by a joint venture vehicle.
Groups will therefore need to establish a process for notifying shareholders and giving them an opportunity to object. It is not clear whether this process only needs to be undertaken once, or on an annual basis, or if there is a significant change to the body of shareholders in the company.
The process will be straightforward for wholly owned subsidiaries, and it may be accepted that it need only be done once in this situation, unless and until the subsidiary ceases to be wholly owned. For subsidiaries with a significant minority shareholding, it would be sensible for the process (and whether it will be repeated) to be agreed with them: in any event, it would be prudent to repeat the process if there is a change in the minority shareholders or their holdings.
For unquoted parent companies, the approach will depend on how widely the shares are held and how frequently shares change hands. For quoted parent companies, the best approach may be to include a notification in the annual general meeting papers to allow shareholders to object in relation to the accounts to be laid before the next year's annual general meeting.
Companies will have to reconsider how they prepare their accounts and ensure that they adopt the most appropriate accounting treatment. The detailed implications of the changes in UK accounting standards and the choices that can be made should be discussed with the company's accountants. Lenders and investors should be alerted to the impact on published results.
In particular, the effect of the changes on the company's distributable profits needs to be considered and some corporate restructuring may be desirable to prevent dividend blocks.
Tax implications also need to be addressed, including the desirability of making elections for tax purposes, and HM Revenue and Customs has published guidance on this.
Companies should review their loan arrangements to check what impact there might be on financial covenants. The situation should be discussed with lenders if there is the potential for accounting changes to give rise to a technical breach.
Accounting changes might also affect existing bonus or other remuneration arrangements with directors and employees, and deferred consideration payable for businesses previously acquired on an "earn-out" basis.
The impact should be considered and addressed when entering into new arrangements with lenders, employees and others which will span the period where companies will be moving from old to new UK accounting standards. One approach would be to provide that the relevant numbers in future accounts should be adjusted back to reflect the accounting standards applied at the date of the contract or last balance sheet. This has the benefit of certainty, but also has cost implications. An alternative is to provide for the parties to re-negotiate so that they remain in the same position under the contract when the new accounting standards are applied. This is inherently less certain and would require careful drafting to make it enforceable.
Where companies are assessing potential new customers, suppliers or business partners, they will need to understand the impact the changes have on the accounts of those parties.
These changes are the most significant in UK accounting in the last ten years. All companies will need to consider the impact on their accounts, dividends and contractual arrangements and ensure they adopt the most appropriate approach from the options available under the new regime.