Interpretation and application of UK GAAP collings

Standard-Setting Body xviIssuance of the New UK GAAP xvii Structure of the New UK GAAP xix Smaller Companies and the Financial Reporting Standard for INTRODUCTION Interpretation and App

for Accounting Periods Commencing on or After

1 January 2015

Interpretation and Application of UK GAAP for Accounting Periods Commencing

on or After 1 January 2015

Steven Collings

This edition first published 2015

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Foreword ix Preface xi Acknowledgements xiii Introduction xv

2 The Statutory Audit Requirement and Accounting Principles 27

3 The Primary Financial Statements and Disclosure Notes 43

5 Summary of the Key Differences between FRS 102 and ‘Old’ UK GAAP 83

6 Consolidated and Separate Financial Statements 103

23 Investments in Associates and Joint Ventures 365

CONTENTS

29 Small Company Abbreviated Financial Statements 467

ABOUT THE AUTHOR

Steve Collings FMAAT FCCA is the audit and technical partner at Leavitt Walmsley ciates Ltd, a firm of Chartered Certified Accountants based in Sale, Cheshire, in the United Kingdom, where Steve trained and qualified Steve was admitted as a member of the Associa-tion of Accounting Technicians (AAT) in 2001 and went on to qualify as a Chartered Certified Accountant (ACCA) in 2005 He was admitted as a Fellow Member of the AAT in 2006 and became a Fellow Member of ACCA in 2010 Steve also holds ACCA’s Diploma in Interna-tional Financial Reporting Standards, Diploma in International Financial Reporting Standards for Small–Medium Entities as well as ACCA’s Certificates in IFRS and International Auditing Standards and holds Senior Statutory Auditor status in the UK

Asso-Steve is the author of several books on the subjects of accounting and auditing,

includ-ing Interpretation and Application of International Standards on Auditinclud-ing (Wiley, March 2011), IFRS For Dummies (Wiley, March 2012), Frequently Asked Questions in IFRS (Wiley, April 2013), Financial Accounting for Dummies (Wiley, April 2013) and Corporate Finance for Dummies (Wiley, October 2013) He has had many articles published in the professional

accounting media, most notably AccountingWEB.co.uk and much of Steve’s work can be seen

on his website at www.stevecollings.co.uk

Steve lectures professionally qualified accountants on the areas of accounting,

audit-ing and Solicitors Accounts Rules and was named Accountaudit-ing Technician of the Year at the British Accountancy Awards in 2011 He was also awarded Outstanding Contribution to the Accountancy Profession by the Association of International Accountants in 2013 In 2014 he was shortlisted for Practitioner of the Year at the 2014 British Accountancy Awards

FOREWORD

When thinking about new UK GAAP the Chinese curse comes to mind, ‘May you live in interesting times’, because applying new UK GAAP will be interesting times Many people will underestimate the size of the learning curve ahead of them Yes, the standards are much shorter, easier to read and there are many exemptions but that does not mean that there are not many differences from the previous UK standards

In my professional career there have been lots of changes to the UK accounting standards; indeed I trained under SSAP 2! The difference this time is that everything is changing at the same time This is a ‘big bang’ move to a new you approach There are lots of exciting head-line changes in areas such as financial instruments and investment properties but perhaps more importantly there is plenty of ‘devil in the detail’

Ultimately, this is not a change to old UK GAAP, it is a move to something completely different, based upon standards written by a standard setting committee based outside of the

UK The new standards are not a ‘copy and paste’ job from what went before, so concentrating

on what has changed can be futile Instead, focus on the new standards in their entirety

I say all of this not to spread doom and gloom but to calibrate your expectations of the journey ahead

However, having said that, I have assumed that you are only familiar with old UK GAAP If you are a child of IFRS then your learning curve will be much shorter and less steep After all, new UK GAAP is based upon IFRS Luckily for you, your author is an IFRS man Because new UK GAAP is so brief, knowledge of full IFRS is very useful indeed to interpret standards like FRS 102 Sometimes the standard in new UK GAAP only gives you half the story and in this book Steve uses his understanding of IFRS to fill in the GAAPs (excuse the accounting pun)

I always tell accountants to ‘read the standards’ and this remains true for new UK GAAP However, the aforementioned brevity of the standards means that this will sometimes raise

as many questions as it answers That is why books like this will be more essential than ever under new UK GAAP Sometimes people use textbooks as a short cut to find out what the standard says This book does more than that It does what the standard sometimes does not do;

it helps you understand what the standard means and how it applies in practice

I have admired the clarity of Steve’s writing for some time, particularly on the subject

of IFRS, where many writers assume that the only business that exists is big business More recently I have had the pleasure of working with Steve on joint projects writing on new UK GAAP and I was honoured to be asked to write this foreword I like the way that Steve starts with the basics and uses clear examples to build on this and illustrate how new UK GAAP works

I hope that you find Steve’s wisdom useful on your journey up the new UK GAAP ing curve I have been speaking about and writing about new UK GAAP for what seems like

learn-a long time now learn-and learn-as I write this I think I learn-am stlearn-arting to get towlearn-ards the top of thlearn-at lelearn-arning curve, but I am not there yet So as a fellow traveller on the journey to understanding new UK GAAP, I wish you the best of luck and I finish as I started with a Chinese proverb, albeit this time a more positive one ‘Be not afraid of going slowly, be only afraid of standing still.’

John Selwood ACALecturer and writer

The FRC are to be commended on their efforts in scaling down the UK GAAP from some 3,000+ pages down to approximately 360 FRS 102 brings with it a much more user-friendly set of standards, organised by Section numbers as opposed to FRS/SSAP/UITF numbers, as was previously the case in the UK GAAP Certain accounting treatments have been modern-ised, reflecting the ways in which businesses operate in today’s climate as well as serving to reduce diversity in the ways in which preparers will account for, and disclose, certain items within the financial statements.

At the time of writing the small companies regime had been exposed for consultation by both the Department for Business Innovation and Skills and the FRC following the introduc-tion of the EU Accounting Directive (Chapter 4 looks in more detail about this issue) Relevant chapters in this publication have incorporated the consultations but no decision had been made

as to how the small companies regime will take effect in the UK at the time this book went to print and hence readers are encouraged to keep up to date with developments in this area by regularly reviewing the Department for Business Innovation and Skills website and the FRC website

Most chapters in this book contain real-life practical examples in order to aid understanding

My wish is that readers find this book informative and helpful in their day-to-day dealing with the new UK GAAP As a practitioner myself, I recognise the needs of accountants and appreciate the complexities that we face within the profession Financial reporting has evolved considerably over recent years and more emphasis is placed on producing high-quality finan-cial information that meets users’ needs I hope that this book serves to meet those needs and feedback is welcome via the publishers that can be incorporated in any future editions

Steve Collings, FMAAT FCCA

September 2014

ACKNOWLEDGEMENTS

Writing a book is a huge project and one in which an author needs to have a strong and supportive team behind them I would like to offer my sincere thanks to Gemma Valler, the commissioning editor for this title, for the support offered during the writing process and also extending the deadline so I could take account of sweeping changes currently taking place with the small companies regime

I would also like to thank my technical editor Caroline Fox, BA FCA, who has, once again, done a remarkable job on ensuring the technical accuracy of this publication

Finally, I would like to thank you the reader, who has picked up this book, and I hope that

it offers a helpful insight into the world of the UK GAAP and aids in the application of the new reporting regime

Standard-Setting Body xvi

Issuance of the New UK GAAP xvii

Structure of the New UK GAAP xix Smaller Companies and the Financial Reporting Standard for

INTRODUCTION

Interpretation and Application of UK GAAP for Accounting Periods Commencing on or After 1 January 2015 is aimed at providing preparers of financial statements with compre-

hensive guidance and information that will allow financial statements prepared under the new

UK GAAP to conform to the new regime This publication brings to life much of the theory contained in UK GAAP and offers a practical approach to understanding the requirements of

UK GAAP from a real-life perspective

Standard-setting around the world has evolved considerably over recent years and national Financial Reporting Standards (IFRS) have gathered faster pace, with many countries adopting an international-based framework At the time of writing the introduction of FRS

Inter-102 The Financial Reporting Standard applicable in the UK and Republic of Ireland was part

of a significant overhaul of UK GAAP At the time of going to print, the UK and Republic of Ireland were about to have a four-tiered structure to financial reporting, which is shown in the following table:

Class of entity

EU-endorsed IFRS

Mainstream UK GAAP (FRS 102)

Small companies regime (the FRSSE)*

Micro-entities regime (the FRSME)

Listed and

AIM listed

√ Medium and

of 2014/early 2015, with final standards expected in the summer of 2015 For ‘micro-entities’, which are dealt with in Chapter 4, such entities can apply the micro-entities legislation if they so wish

The main objective of standard-setters around the globe is to enhance transparency Adopting an international-based financial reporting framework has the intended objective of producing financial statements that are based on high-quality financial reporting standards, which, in turn, strengthens understandability and transparency across all entities Accounting has evolved considerably over the years, with the concept of fair value accounting moving higher up the ranks and as such there was a need to introduce a new UK GAAP

be achieved through two subsidiary bodies:

r
Accounting Standards Board (ASB) andr
The Financial Reporting Review Panel (FRRP)

Prior to the establishment of the ASB, standards were issued by the Accounting

Stand-ards Council (ASC) The standStand-ards issued by the ASC were known as Statements of Standard Accounting Practice (SSAPs) and between 1971 and 1990, 34 SSAPs were issued by the ASC

A number of these SSAPs were adopted by the newly formed ASB in 1990, although going forward the ASB would not issue further SSAPs; rather they would be charged with issuing Financial Reporting Standards (FRSs)

In 1991, a new department was formed to assist the ASB in carrying out their work, known

as the Urgent Issues Task Force (UITF) This department was set up to undertake investigations

in areas where conflicts with accounting standards existed or where interpretative guidance was needed following ambiguous points, or clarification was sought by financial statement

preparers The first UITF Abstract was issued on 24 July 1991 titled Convertible bonds – plemental interest/premium.

sup-Due to well-publicised corporate collapses in the United States, the government decided

in 2004 that the regulatory system in the UK needed to be further strengthened in an attempt

to restore confidence This resulted in the FRC becoming the UK’s single independent tor of the accounting and auditing profession, which would be solely responsible for issuing accounting standards and enforcing their application

regula-The ASB survived a 22-year lifespan that ended on 2 July 2012 when it was integrated with the FRC’s new Codes and Standards Division This restructuring was brought about because of the need for enhanced independence and the need to ensure effective govern-ance of the regulatory activities under the responsibility of the FRC board During this 22-year lifespan, the ASB issued 29 FRSs; however, it had become clear that due to the intention by the ASB to aid a smooth transition to an international-based financial report-ing framework, the ASB had essentially become more of an advisory body as opposed to

a standard-setting body This was due to the fact that many of the later FRSs were merely

IFRSs/IASs that had been rebadged in the UK For example, FRS 20 Share-based ment was a UK version of IFRS 2 Share-based Payment, FRS 21 Events after the Balance Sheet Date was IAS 10 Events after the Reporting Period and FRS 22 Earnings per Share was essentially IAS 33 Earnings per Share In addition to this, many of the later FRSs

Pay-had hardly any impact on private companies that make up the vast majority of the UK and

Republic of Ireland business market (such as FRS 24 Financial Reporting in tionary Economies, FRS 27 Life Assurance, FRS 29 Financial Instruments: Disclosures and FRS 30 Heritage Assets).

Hyperinfla-The Codes and Standards Committee was formed during this restructuring exercise and the objective of this committee was to advise the board of the FRC on the maintenance of an effective framework of UK codes and standards The ASB was replaced with the Account-ing Council, which provides an advisory role to the Codes and Standards Committee and the board of the FRC In addition, the UITF was disbanded as a result of the reforms Accounting standards previously issued by the ASB became the responsibility of the board of the FRC on

2 July 2012 when the restructuring was finalised

ISSUANCE OF THE NEW UK GAAP

The process of modernising the old UK GAAP was a long and arduous one The ASB had already acknowledged prior to the issuance of Exposure Drafts that the UK GAAP in its old form had become overly complex and voluminous They had also expressed a desire for the

UK and Republic of Ireland to adopt an international-based financial reporting framework to provide consistency in the way financial reporting works but within a high-quality and ‘fit for purpose’ framework This intention was further accentuated in 2009 when the ASB announced that to essentially dispose of old FRSs/SSAPs and UITF Abstracts would be a significant task, but they viewed the project as an opportunity to simplify UK GAAP with the intention of ensuring that UK GAAP produced more relevant, comparable and understandable information.FREDs 43 to 45 were published outlining the proposed changes to UK GAAP and these

FREDs were based on the International Accounting Standard Board’s IFRS for SMEs that was planned to become (and was exposed as) the Financial Reporting Standard for Mid-Sized Enti- ties in the UK The name of the proposals was coined the ‘FRSME’.

This Exposure Draft caused a significant amount of outcry amongst the accountancy profession as it was based around the concept of ‘public accountability’, which was a very difficult concept to apply or define in the UK and Republic of Ireland In addition, the Expo-sure Draft eliminated some of the more common accounting practices that have become established in the UK and Republic of Ireland (such as the withdrawal of the revaluation method for fixed assets, the writing-off of borrowing costs directly to profit or loss with no option to capitalise such costs and the requirement to calculate deferred tax using a ‘tempo-rary difference’ approach rather than a ‘timing difference’ approach, as was the case in FRS

19 Deferred Tax)

Having listened to feedback on FREDs 43 to 45, the ASB went back and redrafted the proposals that became FREDs 46 to 48 and were exposed for comment The revised Exposure Drafts:

r
Eliminated the tier system for large, small–medium and micro-companies,r
Introduced accounting treatments permitted under the old UK GAAP andr
Incorporated guidance for public benefit entities into FRED 48

FREDs 46 to 48 were to become FRSs 100, 101 and 102 respectively FRS 103 ance Contracts is an industry-specific FRS, which was published in March 2014 and which

Insur-deals with insurance contracts Due to its specialist nature, FRS 103 is outside the scope of this book

FRS 102 is part of a ‘family’ of standards, with the others being:

r
FRS 100 Application of Financial Reporting Requirements, r
FRS 101 Reduced Disclosure Framework and

r
FRS 103 Insurance Contracts

FRS 100 and FRS 101 were both issued on 22 November 2012 FRS 100 outlines which entities can use which standard Smaller companies will still continue to use the FRSSE (or the relevant small companies regime following the changes to small company financial report-ing in 2015/16) The FRSSE (effective April 2008) was updated for the consequential effects

of FRS 102 (see later in the chapter) and therefore the FRSSE was re-issued as the FRSSE (effective January 2015), which is effective for accounting periods commencing on or after 1 January 2015, with earlier adoption permissible

FRS 101 is basically EU-endorsed IFRS, but with reduced disclosure requirements for fying entities The standard outlines the reduced disclosure framework, which is available for

by the ‘IAS Regulation’ more flexibility to change their accounting framework to FRS 101 or FRS

102 The advantage here was in relation to groups with a 31 December 2012 year-end who were being encouraged to adopt the standard early and take advantage of the reduced disclosures avail-able, given that the disclosure requirements in EU-adopted IFRS are fairly vast

In the press release, the FRC announced that they planned for FRS 102 to become tive for accounting periods commencing on or after 1 January 2015, with earlier adoption per-missible (which did occur) There were two limited amendments that the FRC had recognised which related to:

effec-r
Accounting for multi-employer pensions andr
Service concession arrangements

In relation to the accounting for multi-employer pensions, the amendments related to the situations where there was an agreement to fund a deficit in a multi-employer pension plan The FRC issued the proposed amendment following them, obtaining evidence of diversity in

practice where the previous FRS 17 Retirement Benefits was applied.

FRS 17 permitted entities who were not able to identify their share of the underlying assets and liabilities of a multi-employer pension plan on a ‘consistent and reasonable basis’ to account for such a scheme as if it were a defined contribution scheme and make additional dis-closures within the financial statements Where the scheme was a defined contribution scheme, FRS 17 required contributions to be recognised as an expense in the profit and loss account

As a consequence, FRS 17 did not explicitly require entities that were involved in a employer scheme, which was accounted for as a defined contribution scheme and which had not entered into a funding agreement for future payments, to recognise a liability on the bal-ance sheet (statement of financial position) that represented obligations to pay pension benefits

multi-in their fmulti-inancial statements

The FRC took the decision not to amend FRS 17 to require entities that accounted for a multi-employer scheme as a defined contribution scheme to recognise a liability to pay pen-sion benefits in their financial statements on the grounds that FRS 17 was to have a very short life going forward Instead, the FRC decided to amend draft FRS 102 in order to clarify that a liability should be recognised in such situations to represent a requirement to make payments

to fund a deficit relating to past service where the entity has entered into an agreement to make those payments

In addition, the FRC also acknowledged that paragraph 9(b) (v) in FRS 17 will be cable in the period prior to FRS 102 becoming effective This paragraph requires disclosure of any implications for an employer of a deficit in a multi-employer scheme The FRC said that where a reporting entity has an agreed schedule for the funding of a deficit, they will need to give careful consideration to this requirement and that they consider that information about an agreement with the multi-employer scheme that determines how it will fund a deficit should

appli-be disclosed with this requirement and would more than likely include:

r
The existence of the agreement,r
The period over which the payments will be made andr
Any available information about the expected amount of the payments

The FRC clarified in the Exposure Draft that the above will not apply to individual employers that participate in a group scheme due to the fact that different accounting require-ments apply to the recognition of a surplus or deficit in a group scheme

The second amendment related to service concession arrangements and the accounting,

by grantors, for service concession arrangements Draft FRS 102 only included requirements for operators of service concessions and it was flagged that grantors may also be within the scope of FRS 102 As a result, the amendment requires grantors to recognise the infrastructure assets and liabilities for service concession arrangements, with the accounting requirements based on a finance lease liability model

Following this Exposure Draft containing the two limited amendments, FRS 102 was finally issued as a standard by the FRC on 5 March 2013 and marked the end of a long and arduous project to overhaul accounting standards in the UK The end result was a standard that was clear, transparent and much less voluminous (a total of 335 pages including the Appendi-ces as opposed to 3,000+ in old UK GAAP)

FRS 102 was re-published in August 2014 to take account of the changes in relation

to financial instruments and hedge accounting as well as dealing with some typographical issues

STRUCTURE OF THE NEW UK GAAP

The old UK GAAP was structured by FRS number order – for example, FRS 1 Cash Flow Statements, FRS 2 Accounting for Subsidiary Undertakings, FRS 3 Reporting Financial Performance and so forth SSAPs and UITF Abstracts also followed a numerical

sequence

The structure of the new UK GAAP is markedly different in that it is structured as a series

of FRSs (FRS 100, 101, 102 and 103)

FRS 100 Application of Financial Reporting Requirements

This is structured as follows:

r
Summaryr
Financial Reporting Standard 100r
Application of Financial Reporting Requirements

r
Objectiver
Scoper
Abbreviations and definitionsr
Basis of preparation of financial statementsr
Application of statements of recommended practicer
Statement of compliance

r
Date from which effective and transitional arrangementsr
Withdrawal of current accounting standards

r
Consequential amendments to the FRSSE

r
Application Guidance

r
The interpretation of equivalence

r
Approval by the FRCr
The Accounting Council’s Advice to the FRC to Issue FRS 100r
Appendices

r
Glossaryr
Note on legal requirementsr
Previous consultationsr
Republic of Ireland (RoI) legal references

FRS 101 Reduced Disclosure Framework

r
Summaryr
Financial Reporting Standard 101r
Reduced Disclosure Framework

r
Objectiver
Scoper
Abbreviations and definitionsr
Reduced disclosures for subsidiaries and ultimate parentsr
Statement of compliance

r
Date from which effective and transitional arrangements

r
Application Guidance

r
Amendments to International Financial Reporting Standards as adopted in the European Union for compliance with the Act and the Regulations

r
Approval by the FRCr
The Accounting Council’s Advice to the FRC to Issue FRS 101r
Appendices

r
Glossaryr
Note on legal requirementsr
Previous consultationsr
Republic of Ireland (RoI) legal references

FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland

r
Summaryr
Financial Reporting Standard 102r
Financial Reporting Standard applicable in the UK and Republic of Ireland

1 Scope

2 Concepts and Pervasive Principles

3 Financial Statement Presentation

4 Statement of Financial Position

5 Statement of Comprehensive Income and Income Statement Appendix: Example showing presentation of discontinued operations

6 Statement of Changes in Equity and Statement of Income and Retained Earnings

7 Statement of Cash Flows

8 Notes to the Financial Statements

9 Consolidated and Separate Financial Statements

10 Accounting Policies, Estimates and Errors

11 Basic Financial Instruments

12 Other Financial Instruments Issues

13 Inventories

14 Investments in Associates

15 Investments in Joint Ventures

16 Investment Property

17 Property, Plant and Equipment

18 Intangible Assets other than Goodwill

32 Events after the End of the Reporting Period

33 Related Party Disclosures

34 Specialised Activitiesr
Agriculture

r
Extractive Activitiesr
Service Concession Arrangementsr
Financial Institutions

r
Retirement Benefit Plans: Financial Statementsr
Heritage Assets

r
Funding Commitmentsr
Incoming Resources from Non-exchange Transactionsr
Public Benefit Entity Combinations

r
Public Benefit Entity Concessionary Loansr
Appendix A: Guidance on funding commitmentsr
Appendix B: Guidance on incoming resources from non-exchange transactions

35 Transition to this FRS

r
Approval by the FRCr
The Accounting Council’s Advice to the FRC to issue FRS 102

r
The Accounting Council’s Advice to the FRC to issue Amendments to FRS 102 – Basic financial instruments and hedge accounting

r
Appendices

r
Glossaryr
Significant Differences between FRS 102 and the IFRS for SMEsr
Table of Equivalence for UK Companies Act Terminologyr
Note on Legal Requirements

r
Previous Consultationsr
Republic of Ireland (RoI) Legal References

compa-at the time of writing this had not yet taken place)

Smaller companies are eligible to use the Financial Reporting Standard for Smaller ties (the FRSSE) The FRSSE has been amended because of FRS 102 and the latest version (at the time of writing) issued by the FRC was the FRSSE (effective January 2015), which is effective for accounting periods commencing on or after 1 January 2015, with earlier adoption permissible

Enti-The Small Companies (Micro-Entities Accounts) Regulations 2013 (SI 2013/3008)

brought the European Union’s directive on ‘micro-company’ reporting into effect in ber 2013 For the purposes of this statutory instrument, an entity can qualify as a micro-entity

Novem-if two, or more, of the following are not exceeded in a year:

r
Turnover £632,000r
Balance sheet total £316,000r
Employee head count 10Companies that fail to meet two out of the above three criteria for two consecutive years will fail to meet the qualifying criteria for micro-entities

Under the micro-entities regime, a micro-entity will prepare a balance sheet, which will present (where applicable):

Format 1 balance sheet

r
Called up share capital not paidr
Fixed assets

r
Current assetsr
Prepayments and accrued incomer
Creditors due within one yearr
Net current assets (liabilities)r
Total assets less current liabilitiesr
Creditors due after more than one yearr
Provisions for liabilities

r
Accruals and deferred incomer
Capital and reserves

Format 2 balance sheet

Assets:

r
Called up share capital not paidr
Fixed assets

r
Current assetsr
Prepayments and accrued income

Liabilities:

r
Capital and reservesr
Provisions for liabilitiesr
Creditors (those due within and more than one year are separated)r
Accruals and deferred income

Profit and loss account:

r
Turnoverr
Other incomer
Cost of raw materials and consumablesr
Staff costs

r
Depreciation and other amounts written off assetsr
Other charges

r
Taxr
Profit or loss

Notes to the micro-entity’s financial statements

Notes will be placed at the foot of the balance sheet and will merely consist of:

r
Guarantees and other financial commitments andr
Directors’ benefits: advances, credits and guarantees

The micro-entities regulations are effective for financial years ending on or after 30 September 2013 for companies filing their accounts on or after 1 December 2013 An impor-tant point to emphasise is the fact that the new regime will not affect the recognition or meas-urement of amounts included in a micro-entity’s financial statements In addition, the reduced disclosure regime will only affect companies who apply the FRSSE Companies that will qual-ify to report under the micro-entities regulations will still apply the FRSSE but are eligible to apply the reduced disclosures in the new Regulations

As part of the overhaul of the small companies regime, the FRC announced their

inten-tion to issue a separate standard for micro-entities, namely the Financial Reporting ard for Micro-Entities (FRSME), which will also offer further simplifications to micro-entity

Stand-accounts Companies not eligible to apply the FRSME or who choose not to apply the FRSME may have the option of applying FRS 102 ‘Light’, which will be an amended version of FRS

102 for small companies, and the FRC have suggested including a Section 1A Small Entities

in FRS 102 that will set out the framework and presentation and disclosure requirements for small entities

Financial reporting has developed considerably over the last few years and it is likely to

be further developed as new accounting practices emerge or existing practices are amended to keep up with the ways in which entities conduct their business

COMPANIES ACT 2006

Introduction 1

Accounting Requirements under

True and Fair and Adequate

INTRODUCTION

In the United Kingdom and Republic of Ireland (RoI), financial statements are prepared using Generally Accepted Accounting Practice (GAAP) and legisla-tion prescribed in the form of the Companies Act 2006 Additional legislation also applies to certain financial statements (for example, the Charities Act) but this publication will only consider the Companies Act 2006 in relation to accounting by companies At the outset of this chapter it is important to emphasise that the small companies regime in the UK is planned for significant change and these changes are discussed in more detail in Chapter 4 Readers are advised to keep up to date with all developments in this area by regularly reviewing the Department for Busi-ness Innovation and Skills’ website as well as the Financial Reporting Council’s website, as consultation documents were issued in September 2014 outlining pro-posals to overhaul the small companies regime in the light of the EU Accounting Directive This chapter examines some of the proposals, with more detail being examined in Chapter 4, but at the time of writing, no final framework had been issued by the Department for Business Innovation and Skills nor the Financial Reporting Council

Accounting standards are issued and amended by the Financial Reporting Council

(FRC) The Regulations consist of the Small Companies and Groups (Accounts and

Directors’ Report) Regulations 2008 (SI 2008/409) and the Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 (SI 2008/410)

The application of accounting standards and the requirements of the Companies Act

2006 have the objective of enabling financial statements to give a true and fair view

of the state of a company’s financial affairs as at the reporting date, satisfying the directors’ duty

The Consultative Committee of Accountancy Bodies (CCAB) are committed

to the promotion and compliance with accounting standards by their members, whether they are auditors or preparers of financial information The CCAB is made up of:

r
The Association of Chartered Certified Accountants (ACCA)r
The Chartered Institute of Public Finance and Accountancy (CIPFA)r
The Institute of Chartered Accountants in England and Wales (ICAEW)r
The Institute of Chartered Accountants in Ireland (ICAI)

r
The Institute of Chartered Accountants in Scotland (ICAS)Whilst the Chartered Institute of Management Accountants (CIMA) is no longer part of the CCAB, it also expects conformance and compliance with accounting stand-ards by its members

Significant departures from accounting standards and the requirements of the Companies Act 2006 must be adequately disclosed within the financial statements

in order that the users can have an understanding of the reasons why the departure

is considered to be appropriate This can arise in certain issues where fair value accounting is concerned Investment properties, for example, are required to be carried in a company’s balance sheet (statement of financial position) at fair value

at each reporting date under GAAP The Companies Act 2006 requires fixed assets

to be depreciated on a systematic basis; however, where investment properties are concerned the requirement to depreciate such properties is overridden (known as the ‘true and fair override’) because to carry such properties in the balance sheet

at open market value as at the balance sheet date is considered to give more vant and reliable information Such a departure from the requirements of the Com-panies Act 2006 should be disclosed within the notes to the financial statements (often within the Accounting Policies section) An example of such a disclosure is

rele-as follows:

Example – Illustrative disclosure when the true and fair override is invoked

No depreciation is provided for in respect of investment properties as they are accounted for under the provisions in Section 16 of FRS 102 Such properties are held for their investment potential and not for consumption within the business This is a depar-ture from the Companies Act 2006 which requires all properties to be depreciated and the directors consider that to depreciate them would not enable the financial statements

to give a true and fair view Investment properties are stated at their market value at the reporting date

ACCOUNTING REQUIREMENTS UNDER THE COMPANIES ACT 2006

Part 15 of the Companies Act 2006 deals with Accounts and Reports related to a company’s financial statements It outlines the distinction between companies that are subject to the small companies regime and those that are not

Every company prepares financial statements to a reporting date (a financial year) The Companies Act 2006 says that a company’s financial year:

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Begins with the first day of its first accounting reference period andr
Ends with the last day of that period or such other date, not more than seven days before or after the end of that period, as the directors may determine For subsequent financial years, these will:

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Begin with the day immediately following the end of the company’s previous financial year and

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End with the last day of its next accounting reference period or such other date, not more than seven days before or after the end of that period, as the direc-tors may determine

The requirement to prepare annual financial statements is laid down in Chapter

4 to Part 15 of the Companies Act 2006 Section 394 requires the directors of every company to prepare financial statements for the company for each of its financial years, unless the company is exempt from that requirement under section 394A These financial statements are referred to as the company’s ‘individual accounts’ Under sec-tion 394A, a company is exempt from the requirement to prepare individual accounts for a financial year if:

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It is itself a subsidiary undertaking,r
It has been dormant throughout the whole of that year andr
Its parent undertaking is established under the law of an EEA state

The section then goes on to say that exemption is conditional upon compliance with all of the following conditions:

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All members of the company must agree to the exemption in respect of the financial year in question,

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The parent undertaking must give a guarantee under section 394(C) in respect

of that year,r
The company must be included in the consolidated accounts drawn up for that year or to an earlier date in that year by the parent undertaking in accordance with:

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The provisions of the Seventh Directive (83/349/EEC) orr
International Accounting Standards,

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The parent undertaking must disclose in the notes to the consolidated accounts that the company is exempt from the requirement to prepare individual accounts

by virtue of this section andr
The directors of the company must deliver to the registrar within the period for filing the company’s accounts and reports for that year:

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A written notice of the agreement referred to in subsection (2) (a),r
The statement referred to in section 394(C) (1),

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A copy of the consolidated accounts referred to in subsection (2) (C),

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A copy of the auditor’s report on those accounts andr
A copy of the consolidated annual report drawn up by the parent undertaking.The filing requirements are also laid down in the Companies Act Private com-panies must file their financial statements with the Registrar of Companies (Compa-nies House) within nine months after the financial year-end (although different filing requirements apply to a newly incorporated entity) Public companies must file their financial statements within six months after the financial year-end

Thresholds for small and medium-sized companies and groups

A company is deemed to be ‘small’ and hence can apply the small companies regime if it satisfies the small company thresholds for two out of three consecutive

years The thresholds are as follows (note that these thresholds are planned to be

changed in 2015 – see Chapter 4 for further details of these changes).

Size Turnover Balance sheet total Employees

Where reference to ‘net’ or ‘gross’ is made this relates to intra-group trading

‘Net’ means that intra-group trading (and the effects thereof) have been eliminated, whilst ‘gross’ means that intra-group trading (and the effects thereof) have not been eliminated A point to note is that a company may satisfy the qualifying criteria using gross or net figures and it is permissible to mix the use of gross and net figures in any year Rather than eliminating intra-group transactions, the gross criteria should be checked first and the net size criteria checked only if required

Financial statement content

A small company has a choice of preparing full UK GAAP financial statements without taking advantage of any of the concessions In reality this is uncommon as small companies will often take advantage of the small companies regime in the Companies Act 2006 Where advantage is taken to prepare financial statements in accordance with the small companies regime, the company will use the Financial Reporting Standard for Smaller Entities (FRSSE) (or another alternative regime if the FRSSE is withdrawn following the overhaul of the small companies regime) Small companies must also file abbreviated financial statements with the Registrar

of Companies The fact that a company may file abbreviated financial statements with Companies House does not absolve them from any other responsibility for preparation of full financial statements for the shareholders or any other regulatory body to whom the financial statements may be submitted (for example, the Charities Commission)

Where the financial statements contain an auditor’s report, the audit report is the special audit report contained in section 449 of the Companies Act 2006 This audi-tor’s report states that in the auditor’s opinion:

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The company is entitled to deliver abbreviated accounts in accordance with the section in question and

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The abbreviated accounts to be delivered are properly prepared in accordance with regulations on that section

If the auditor’s report is qualified, section 449(3) (a) requires the special report to set out the qualified auditor’s report in full as well as outlining any further material deemed necessary so that users are able to understand the reasons for the audit quali-fication In addition, where the auditor’s report contains a statement under:

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Section 498(2) (a) or (b) (accounts, records or returns inadequate or accounts not agreeing with records and returns) or

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Section 498(3) (failure to obtain necessary information and explanations),the special report must set out that statement in full

A table outlining the financial statement requirements is shown below:

Full financial statements

Full balance sheet only

Abbreviated financial statements

Abbreviated balance sheet only

Option available for both

Option not available for IAS accounts

Option available for both Statement in a

prominent position

on balance sheet

Yes – Companies Act 2006, section 414(3)

Yes – Companies Act 2006, section 444(5)

Yes – SI 2008/409 Schedule 4, paragraph 2

Yes – Companies Act 2006, section 444(5) Copy of profit and

Yes – Companies Act 2006, section 495

Yes – Companies Act 2006, section

449 (special auditors’

report)

Yes – Companies Act 2006, section 495 Notes to the

financial statements

Yes Yes Yes, although limited

to those referred to under SI 2008/409 Schedule 4

Yes, although limited to those referred to under

SI 2008/409 Schedule 4

The balance sheet formats are set out in Schedule 1 to SI 2008/409 and take the form of Format 1 and Format 2 Format 1 is the most commonly used format for the balance sheet and is referred to below, although Format 2 permits identical combina-tions of headings

Format 1 balance sheet (Large and Medium

Companies and Groups (Accounts and Directors’

Report) Regulations 2008)

Format 1 balance sheet (Small Companies and Group (Accounts and Directors’ Report)

Regulations 2008)

A Called up share capital not paid A Called up share capital not paid

2 Other intangible assets

B II Tangible assets

1 Land and buildings

2 Plant and machinery

3 Fixtures and fittings

4 Payments on account

B II Tangible assets

1 Land and buildings

2 Plant and machinery, etc.

B III Investments

1 Shares in group undertakings

2 Participating interests

3 Loans to group undertakings

4 Loans to undertakings, etc

5 Other investments other than loans

undertak-3 Other investments other than loans

2 Amounts owed by group undertakings

3 Amounts owed by undertakings in which the company has a participating interest

4 Other debtors

5 Called up share capital not paid

6 Prepayments and accrued income

C II Debtors

1 Trade debtors

2 Amounts owed by group undertakings and undertakings in which the company has a participating interest

C IV Cash at bank and in hand C IV Cash at bank and in hand

D Prepayments and accrued income D Prepayments and accrued income

E Creditors: amounts falling due within one year

1 Bank loans and overdrafts

2 Trade creditors

3 Amounts owed to group undertakings

4 Amounts owed to undertakings in which the company has a participating interest

5 Debenture loans

6 Payments received on account

7 Bills of exchange payable

8 Other creditors including taxation and social security

9 Accruals and deferred income

E Creditors: amounts falling due within one year

1 Bank loans and overdrafts

2 Trade creditors

3 Amounts owed to group undertakings and undertakings in which the company has a participating interest

4 Other creditors

F Net current assets (liabilities) F Net current assets (liabilities)

G Total assets less current liabilities G Total assets less current liabilities

H Creditors: amounts falling due after one year

1 Bank loans and overdrafts

2 Trade creditors

3 Amounts owed to group undertakings

4 Debenture loans

5 Payments received on account

6 Bills of exchange payable

7 Other creditors including taxation and social security

8 Accruals and deferred income

H Creditors: amounts falling due after one year

1 Bank loans and overdrafts

2 Trade creditors

3 Amounts owed to group undertakings and undertakings in which the company has a participating interest

4 Other creditors

I Provisions for liabilities

1 Pensions and similar obligations

2 Taxation, etc.

3 Other provisions

I Provisions for liabilities

J Accruals and deferred income J Accruals and deferred income

K Capital and reserves K Capital and reserves

K I Called up share capital K I Called up share capital

K II Share premium account K II Share premium account

K III Revaluation reserve K III Revaluation reserve

K IV Other reserves

1 Capital redemption reserve

2 Reserves for own shares

3 Reserves provided for by articles

4 Other reserves

K IV Other reserves

K V Profit and loss account K V Profit and loss account

The formats above will remain relevant under FRS 102 because the Financial Reporting Council decided that company law formats could continue to apply under the new regime and hence preparers will not see much change in the overall format of the financial statements themselves under FRS 102

The Companies Act 2006 allows small companies to adopt the use of any of the four alternative formats of the profit and loss account, which are set out in Schedule

1 to SI 2008/409

Format 1 profit and loss account

Turnover XCost of sales XGross profit or loss X Distribution costs X

Administrative expenses XOther operating income XIncome from shares in group undertakings XIncome from participating interests XIncome from other fixed asset investments XOther interest receivable and similar income XAmounts written off investments XInterest payable and similar charges XTax on profit or loss on ordinary activities XProfit or loss on ordinary activities after taxation XExtraordinary income XExtraordinary charges XExtraordinary profit or loss XTax on extraordinary profit or loss XOther taxes not shown under the above items XProfit or loss for the financial year X

Format 2 profit and loss account

Turnover XChange in stocks of finished goods and in work in progress XOwn work capitalised XOther operating income XRaw materials and consumables XOther external charges XStaff costs

Wages and salaries XSocial security costs XOther pension costs XDepreciation and other amounts written off tangible andintangible fixed assets X

Exceptional amounts written off current assets XOther operating charges XIncome from shares in group undertakings XIncome from participating interests XIncome from other fixed asset investments XOther interest receivable and similar income XAmounts written off investments XInterest payable and similar charges XTax on profit or loss on ordinary activities XProfit or loss on ordinary activities after taxation XExtraordinary income XExtraordinary charges XExtraordinary profit or loss XTax on extraordinary profit or loss XOther taxes not shown under the above items XProfit or loss for the financial year X

Format 3 profit and loss account

ChargesCost of sales XDistribution costs XAdministrative expenses XAmounts written off investments XInterest payable and similar charges XTax on profit or loss on ordinary activities XProfit or loss on ordinary activities after taxation XExtraordinary charges XTax on extraordinary profit or loss XOther taxes not shown under the above items XProfit or loss for the financial year XIncome

Turnover XOther operating income XIncome from shares in group undertakings XIncome from participating interests XIncome from other fixed asset investments XOther interest receivable and similar income XProfit or loss on ordinary activities after taxation XExtraordinary income XProfit or loss for the financial year X

Format 4 profit and loss account

ChargesReduction in stocks of finished goods and work-in-progress XRaw materials and consumables XOther external charges X Staff costs

Wages and salaries X

Social security costs XOther pension costs XDepreciation and amounts written off tangible

and intangible fixed assets XExceptional amounts written off current assets XOther operating charges XAmounts written off investments XInterest payable and similar charges XTax on profit or loss on ordinary activities XProfit or loss on ordinary activities after taxation XExtraordinary charges XTax on extraordinary profit or loss XOther taxes not shown under the above items XProfit or loss for the financial year XIncome

Turnover XIncrease in stocks of finished goods and work-in-

progress XOwn work capitalised XOther operating income XIncome from shares in group undertakings XIncome from participating interests XIncome from other fixed asset investments XOther interest receivable and similar income XProfit or loss on ordinary activities after taxation XExtraordinary income XProfit or loss for the financial year X

At the time of writing, the Department for Business Innovation and Skills were consulting on only having Format 1 and Format 2 for the profit and loss account as Formats 3 and 4 are rarely used, although no final decision had been made

TRUE AND FAIR AND ADEQUATE ACCOUNTING RECORDS

The directors of a company are required, in law, to prepare financial statements that give a true and fair view of the state of the company’s affairs as at the reporting

date The concept of true and fair has been enshrined in company law for many years and the directors are prohibited from approving financial statements that do not give

a true and fair view

Section 396 of the Companies Act 2006 outlines that financial statements must:

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In the case of the balance sheet, give a true and fair view of the state of affairs

of the company as at the end of the financial year and, in the case of the profit and loss account, give a true and fair view of the profit or loss of the company for the financial year

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Comply with the provisions made by the Secretary of State by regulations as

to the form and content of the balance sheet and profit and loss account and additional information to be provided by way of notes to the accounts

In many cases, companies will achieve compliance with both sections 396(2) and (3) by the application of accounting standards and compliance with legislation How-ever, there are some instances where the requirements of the Companies Act 2006 may be overridden (the true and fair override) Section 396(4) says:

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If compliance with the regulations and any other provision made by or under this Act as to the matters to be included in a company’s individual accounts or in notes

to those accounts, would not be sufficient to give a true and fair view, the sary additional information must be given in the accounts or in a note to them Section 396(5) also requires the particulars of such departures from the Compa-nies Act 2006, together with the reasons for such a departure and its effect The major-ity of departures from the requirements of the Companies Act 2006 derive from the provisions laid down in accounting standards where the applicable accounting stand-ard is inconsistent with the requirements of the Companies Act 2006 An example

neces-of such a departure would be the non-depreciation neces-of investment properties that are carried in the balance sheet (statement of financial position) at open market value (fair value) at each reporting date; hence no depreciation would be charged on such prop-erties despite the Companies Act 2006 requiring depreciation to be charged against fixed assets

The term ‘adequate accounting records’ is derived from the Companies Act 2006 and it is the duty of every company to keep adequate accounting records Section 396(2) defines the constitution of adequate accounting records and says that adequate accounting records means records that are sufficient:

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To show and explain the company’s transactions,r
To disclose with reasonable accuracy, at any time, the financial position of the company at that time and

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To enable the directors to ensure that any accounts required to be prepared comply with the requirements of this Act (and, where applicable, of Article

4 of the IAS Regulation)

Companies are required to maintain accounting records that record the pany’s assets and liabilities as well as containing records that detail the day-to-day

com-transactions (monies received and expended by the company) and the matters in respect of which the receipt and expenditure takes place When a company is involved

in the buying and selling of goods, the accounting records must contain:

(a) A statement of stock held by the company at the end of each financial year of the company,

(b) All statements of stocktakings from which any statement of stock as is tioned in paragraph (a) has been or is to be prepared and

men-(c) Except in the case of goods sold by way or ordinary retail trade, statements of all goods sold and purchased, showing the goods and the buyers and sellers in sufficient detail to enable all these to be identified

When it is evident that a company has failed to maintain adequate accounting records, every officer of the company is guilty of an offence under section 387(1) Where an officer(s) of a company is proved guilty, the punishments outlined in section 387(3) (a) and (b) are:

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On conviction on indictment, to imprisonment for a term not exceeding two years or a fine (or both)

Retention of accounting records

Accounting records have to be kept either at the company’s registered office or at

an alternative location as the directors think fit Wherever these accounting records are held, provisions exist in the Companies Act 2006 at section 388(b), which says that these records must be open to inspection by the company’s officers If such account-ing records are retained at a place that is outside the United Kingdom, it is mandatory under legislation for accounts and returns in relation to the business dealt with in those accounting records to be sent to, and kept at, a place in the United Kingdom and for such information to be available for inspection This requirement is embellished in section 388(3) (a) and (b), which says that the accounts and returns to be sent to the United Kingdom must be such as to:

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Disclose with reasonable accuracy the financial position of the business in question at intervals of not more than six months and

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Enable the directors to ensure that the accounts required to be prepared under this Part comply with the requirements of this Act (and, where applicable, Article 4 of the IAS Regulation)

Accounting records in respect of a private company are to be retained for a period

of three years from the date on which they are made For public companies, ing records must be retained for a period of six years from the date on which they are made

account-The officers of a company will be committing a criminal offence if they fail

to maintain adequate accounting records for the prescribed levels of time and in

a place required under the Companies Act 2006 An offence is committed by an officer if he:

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Fails to take all reasonable steps for securing compliance by the company with subsection (4) of that section (period for which records to be preserved) orr
Intentionally causes any default by the company under that subsection

Section 389(4) outlines the punishments to be levied by the courts in the event that

a person is found guilty:

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On conviction on indictment, to imprisonment for a term not exceeding two years or a fine (or both);

if, in the auditor’s opinion, adequate accounting records have not been kept or returns adequate for the audit have not been received from branches that have not been visited

by the auditor

INTERNATIONAL FINANCIAL REPORTING STANDARDS

International financial reporting standards (IFRS) have become more widespread over recent years Many countries have chosen to adopt IFRS as their financial report-ing framework on the grounds that such standards offer consistency in financial reporting for reporting entities Many commentators also believe that the adoption

of IFRS opens up wider potential to access more capital markets The International Accounting Standards Board (IASB) is very keen to promote the adoption of IFRS across the globe and their stated goal is to develop, in the public interest, a single set

of high-quality, understandable, enforceable and globally accepted financial reporting standards based upon clearly articulated principles

IFRS began to gather pace in 2005 as 27 European Union member states and many other countries adopted the use of IFRS Countries such as Argentina, Brazil and Canada have since followed suit and adopted IFRS as their financial reporting framework

In the United Kingdom, listed companies were mandated to present their financial statements under EU-adopted IFRS for accounting periods commencing on or after

1 January 2005 This was closely followed by companies listed on the Alternative Investment Market (AIM) in 2007

The adoption of IFRS around the world has not been without controversy Indeed,

in the UK, the legality of IFRS in the UK was brought into question and a legal ion was given by George Bompas QC on 8 April 2013 who concluded that since the true and fair view is paramount, company directors have a duty to override IFRS in order to comply with it In his opinion, Bompas took issue with an earlier legal opin-ion on the same issue, which was commissioned by the Financial Reporting Council (FRC), and this opinion was provided by Martin Moore QC This acknowledged the FRC’s approach, which is that the true and fair requirement is integral to the prepara-tion of financial statements in the UK, whether they are prepared under UK GAAP

opin-or IFRS Moopin-ore also said that companies could depart from the relevant standard but only in ‘extremely rare’ or ‘exceptional’ circumstances

On 3 October 2013, the Department for Business Innovation and Skills released a government response to the concerns raised in which it states:

‘The Department for Business has given serious consideration to concerns raised by some stakeholders that accounts prepared over the past 30 years, in accordance with UK or international financial reporting standards, have not been properly prepared under UK and EU law

However, it is entirely satisfied that the concerns expressed are misconceived and that the existing legal framework, including international financial reporting standards, is binding under European law.’

On the same day as the Department for Business issued this response, the FRC issued a press release confirming that it shared the view of the Department for Business

Smaller companies and IFRS

In the UK, listed companies are required to report under EU-endorsed IFRS and it

is rare to find any smaller companies (other than listed companies) reporting under the IFRS framework This is due, in large part, to the significant disclosure requirements that IFRS mandates and such disclosure requirements are not considered to be ‘fit for purpose’ for companies at the smaller end of the scale

In July 2009, the IASB issued the IFRS for SMEs The overall objective of the

IFRS for SMEs is essentially to provide a framework under IFRS, but with a much

less burdensome disclosure regime The standard itself is a stand-alone document, which only contains one optional cross-reference to mainstream IFRS in relation to financial instruments (which provides a choice concerning the treatment of financial

instruments) The IASB issued IFRS for SMEs for those entities that do not have

‘public accountability’ The concept of public accountability has been extremely ficult to define in the UK and Republic of Ireland and the concept was withdrawn in the second round of Exposure Drafts that the FRC issued to explain their intention

dif-to replace UK GAAP The IFRS for SMEs was not compatible with UK companies’

legislation and this is the reason why it was never adopted in its entirety in the UK Notwithstanding its incompatibility with UK company law, FRS 102 is based on

IFRS for SMEs, which has been amended to be compatible with UK legislation and

EU Directives