Caroline Biebuyck 7 Mar 2018 12:48pm

The future of UK GAAP

Among the many unknowns in the process of divorce with the EU is what will happen to UK GAAP after Brexit. Among the stakeholders, there’s both the scope – and appetite – for change, as Caroline Biebuyck reports
Caption: Illustration: Adam Avery

Today’s financial reporting regime for UK private companies comes from different sources. Much UK company law is rooted in EU legislation, with many of the changes to the small and micro-entity reporting driven by Brussels. Meanwhile, private companies use FRS 102, a UK standard based on the IFRS for SMEs. How might these different components change after Brexit?

Calls for a full review of FRS 102 because of Brexit are unlikely to be heeded. The standard, only introduced a couple of years ago, does not have its roots in EU law. What’s more, the Financial Reporting Council (FRC) recently carried out a triennial review of the standard (see right), which has sorted some of the main problem areas for preparers.

But there’s still serious disquiet about some parts of FRS 102. One of the biggest bugbears is how section 1A, for small companies, puts constraints on the number of disclosures that small companies can make in their financial statements – constraints that come directly from the EU’s accounting directive of 2013 rather than from the IFRS.

Maximum disclosures

Section 1A includes many areas in which the FRC recommends disclosures but cannot mandate them. The FRC’s hands were tied by the maximum number of disclosures permitted by the accounting directive, explains Paul Creasey, partner at Wilkins Kennedy. “We now have a situation in which small companies can produce accounts that are much shorter than they were under the FRSSE. And bear in mind that many more companies than previously fall into this category, given the increase in thresholds.”

Matt Howells, head of the national assurance technical group at Smith & Williamson, points out that the FRC’s view was always that the minimum number of disclosures permitted by section 1A was too low: this is why the regulator included recommended disclosures in the standard. “In areas like this, where up to now they have been hamstrung by EU legislation, I can see the FRC being happy to set its own requirements and making more disclosures mandatory.”

At the moment the onus is on small company directors to work out whether various disclosures are needed to give a true and fair view, says Nigel Sleigh-Johnson, head of ICAEW’s Financial Reporting Faculty.

“This isn’t helpful. Enabling the FRC to mandate more disclosures could reduce the burden on small company directors by giving them more clarity over the section 1A requirements. These would not be new disclosures, but could enable the FRC to say: this is what we think the minimum requirement is for every company.”

Back to basics

Longer term, Brexit could provide a chance for the UK to think about the direction its financial reporting is taking, says Howells. “This may be an opportunity for the UK to go back to its statement of principles for financial statements and ask: what are we trying to achieve with a set of accounts? How can we best communicate key messages to stakeholders? This debate is already happening at the IFRS level: this might be a good time to consider the question for UK GAAP too.”

He gives the example of financial instruments. “When you’re trying to communicate about these often complex issues to users, is that better done through disclosures rather than with fair value accounting, where you can end up with numbers that are almost meaningless in themselves?”

Brexit might also allow for a more detailed review of how information should be published, says Jonathan Compton, director, BDO financial reporting advisory.

“This might be the time for us to look at filing and disclosure requirements to see what should go into an annual report and what might be better published elsewhere. As technology moves on, we might even consider the relevance of the annual report. The accounts we prepare and read today are still based on the original format. Perhaps this is the opportunity to see whether that form of reporting can be brought into the 21st century and whether the UK can lead the way here.”

A first step could be in trying to reduce proliferation and conflict where there are many different sources of reporting requirements, says Howells.

“While this is worse for large, listed companies, it’s an issue for smaller companies too. There’s the interaction between company law and FRS 102, also possibly section 1A, and then companies can be caught by other legislation such as payment practices and narrative reporting requirements. All these lead to complexity, duplication, confusion and a greater burden – and cost – for preparers.

“There’s a case to be made for a thorough review of the whole financial reporting system and regulation to see if it could be done in a more coherent way.”

What are preparers’ priorities for GAAP? Not surprisingly, they are less concerned with accounting and legal rules and far more focused on the impact that Brexit will have on their businesses, and how that will be reflected in the accounts.

It’s not about how accounting will change, but how to account for the change, says Compton. “Companies’ concerns will be more on the operational and economic side. Practical issues like taxation, exports and access to labour will have an indirect impact on the accounts.”

Manage risk

Companies need to disclose judgements and estimates in their financial statements, says Creasey. “The biggest of these is: what impact will Brexit have on my business? Account
users will want to know what the company is doing to manage that risk, and how this might roll into going concern issues.

“Large, public companies are better placed to adapt and deal with this; it’s more difficult for smaller, private companies to plan for something if they don’t yet know what they’re planning for.”

Smith & Williamson has had a number of conversations with clients concerned about potential impacts. Howells says: “A number of companies who do a lot of trade within the EU think they might need to renegotiate contracts,” says Howells.

“Could that have an effect on revenue recognition? A company that has intellectual property in other EU nations is unsure whether this will still be protected after Brexit; does this mean they will suffer an impairment? And a UK holding companies with EU subsidiaries is looking at possible changes to dividend taxation and withholding taxes after Brexit, as these could have deferred tax implications in the accounts.”

More choice in FRS 102

The Financial Reporting Council has completed a consultation and review process on FRS 102. The result was a series of changes that covered some of the bigger issues companies and their accountants had faced with it.

The measurement of directors’ loans to small companies, simplified under interim relief that the FRC had granted earlier in the year, has now been confirmed. There are now more instances in which a financial instrument can be measured at amortised cost rather than fair value. Investment properties rented to another group company can also be measured with reference to cost. And fewer intangible assets need to be separated from goodwill in a business combination.

The reissued FRS 102 takes effect for accounting periods starting on or after 1 January 2019. However, “companies can take advantage of the dispensations immediately if they choose to”, says Paul George, executive director of the FRC.

It was not surprising that issues became apparent with the new accounting framework once it was in place, says Nigel Sleigh-Johnson. “The FRC changes are generally common-sense simplifications that balance efforts to reduce cost and complexity in financial reporting with the need to maintain usefulness of the accounts.”

Most medium-sized companies will welcome the changes to FRS 102, says Paul Creasey. But did the changes go far enough? “For instance, no one really likes the treatment of loans with group companies and related parties that are below market rate.”

The FRC does not intend to go through a thorough review for another four or five years, says George. “However, if something gets drawn to our attention which we believe needs urgent action, we could consider a single-issue amendment.”