27 Feb 2012

The future of UK GAAP - a necessary change?

Is UK GAAP broken? Two experts from Grant Thornton consider the proposed transition to FRS, and why it is a step in the right direction

The Accounting Standards Board (the ASB) has issued its revised proposals for the Future of UK GAAP which will see many privately owned entities within the UK transition to the Financial Reporting Standard applicable in the UK and Republic of Ireland (the FRS).

These proposals have again raised questions about the need for change. Is the wholesale withdrawal of all current UK accounting standards and the introduction of a new single standard necessary or justified?

This is of course not a new question and since the consultation paper back in August 2009. many have been asking whether there is anything wrong with current UK GAAP. It seems to work perfectly well at the moment, goes the argument, and frankly, if it ain't broke, don't fix it!

This view is, superficially at least, strengthened by many of the changes made to the proposals, which have brought the FRS closer to current UK GAAP. Examples include allowing the revaluation of property and the capitalisation of development costs.

With these changes, the differences between current UK GAAP and the FRS reduce, and it may seem that there is no longer any need for a new standard. However opinion is more divided than some believe, on whether UK GAAP is still fit for purpose. Business practices have moved on since the last major change to UK GAAP, the introduction of FRS 25 on the presentation and disclosure of financial instruments in 2005.

In that time, we have seen increased globalisation of businesses, a proliferation of banks selling complex financial instruments and a global financial meltdown. When advising our clients, it becomes apparent that many SMEs are now operating internationally and facing new and complicated transactions in this new economic order, and that many areas of UK GAAP simply cannot cope with this brave new world.

The people who say 'why bother to change?' are simply asking themselves the wrong question. UK GAAP is broken and instead, we should ask ourselves whether we will be proud of the decisions we take now in five years' time as it becomes increasingly evident that current GAAP is not fit for purpose.

Is UK GAAP really broken?

Some of the problems with current UK GAAP can be demonstrated with a simple example. Take two companies trading with overseas partners, where both enter into forward currency contracts to hedge exposure to these relationships.

Current UK GAAP allows these companies to adopt entirely different accounting treatments, which lead to differences in reported profit (see example).

Allowing this kind of diversity to continue must be inappropriate because the underlying identical performance of these business is obscured by the accounting, and this is just one example of why change to UK GAAP is required. Under the ASB's proposals, derivatives, such as forward currency contracts, will be on the balance sheet at fair value and therefore, their use and effects will be more obvious to users of those financial statements.

Financial instruments, such as foreign exchange forward contracts, remain one of the big changes to be faced on transition from current UK GAAP to the FRS. However, the accounting for financial instruments is one area of the new standard which is still very uncertain.

The problem with financial instruments The ASB is proposing to replace parts of the financial instruments sections of the FRS with requirements based on IFRS 9, the new international standard on financial instruments currently under development by the IASB. Part of the justification for this is that the requirements currently in the FRS, which derive from the IFRS for SMEs, are based on the old 'flawed' approach in IAS 39.

This justification is debatable, as the requirements in the IFRS for SMEs are very different from IAS 39 and were written from scratch to be suitable for privately-held SME businesses.

Also, the 'flaws' identified in IAS 39 only affected, to any real degree, banks, insurers and other large financial institutions, and IFRS 9 is being written to address their needs. In bringing the FRS in line with IFRS 9, the ASB risks introducing complex, un-tried requirements for SME businesses even before they have been implemented by banks and listed groups. 

We believe that the ASB should not rush to incorporate IFRS 9 into the accounting literature for UK privately held businesses.

A step in the right direction

So, are the ASB's proposals a perfect solution? Of course not. There are still issues to resolve, especially on the financial instruments accounting.

But, despite the flaws in what the ASB has proposed we believe these proposals are a step in the right direction.

If we wait until everyone is content with the proposals we may never move forward and that is not a decision (or lack of one) anyone would be happy looking back at in five years' time.



Example Case:

Two UK registered companies, Company A and Company B, purchase stock for $4,000 when the exchange rate is $1.5: £1.

The creditor is due to be settled in 60 days and to manage the foreign currency risk associated with settlement of this liability both Companies A and B take out a forward exchange contract with a forward rate of $1.4: £1.

Both Company A and B sell the stock purchased for £3,500.

At the year-end Company A adopts a policy of retranslating the creditor at the year-end spot rate ($1.4: £1). Company B adopts a policy of recording the purchase and the creditor at the rate in the matching forward contract. Both these policies are currently allowed under SSAP 20 Foreign currency translation.

The impact of these accounting policy choices on the profit and loss account are shown in the following extracts:

Company A

Company B

Profit and loss account (extract)

Profit and loss account (extract)





Cost of sales


Cost of sales


Exchange difference


Exchange difference


Profit or loss


Profit or loss


Both companies will ultimately make a profit of £643. Company A will make a further loss of £99 on settlement of the creditor and foreign exchange contract.



Jake Green is financial reporting technical director at Grant Thornton, and Katherine Martin is a manager in the National Assurance Services team