Subsequently to the collapse of Enron, the UK government set up a high level group of regulators and ministers to co-ordinate a review of the UK regulatory framework, especially the key area of auditor independence. The Accountancy Foundation Review Board, which was in charge of the independent supervision of the UK accountancy professional bodies, took the leading role in the auditor independence review.
On the other side, The Generally Accepted Accounting Principles in the UK is the general body of regulation establishing how company accounts must be prepared in the UK. This includes accounting standards and UK company law. Accounting standards are set by the Accounting Standards Board (ASB), which issues standards called Financial Reporting Standards (FRSs). Early concepts are issued as Discussion Papers, released to the public and comments invited. A new standard is to be proposed, a Financial Reporting Exposure Draft (FRED) is released for comment. Issues that require an immediate solution are considered by the Urgent Issues Task Force (UITF). The principal legislation governing reporting in the UK is laid down in the Companies Act 1985 and the Companies Act 1989. The legislation sets out certain minimum reporting requirements for companies. From this year is changing as a result of the European Commission requiring that all listed European companies report under International Accounting Standards (IAS) instead of their existing accounting policies.
Increased need for regulation is as a result of liquidity standards, loan concentration, and capital standards. Current trends in regulation: more formal regulation and international coordination.
Most of the factors affecting the financial statements are regulatory. Market forces such as the capital, labour, and corporate control market can also have an effect on the content of financial statement disclosures. For example under UK law, private companies’ financial statements must be audited and must comply with the same accounting standards and tax laws as public companies. But the evidence shows that private company earnings have lower quality on average even though being prepared under the same regulations. Balla and Shivakumarb interpret ”quality” as the usefulness of financial statements to investors, creditors, managers and all parties contracting with the firm.
Other factors are management’s decision influenced by the relations with the stakeholders to the company, quality of external (audit companies) and internal governance mechanisms (board of directors), and different regulations. Regulation requires firms to prepare financial accounts according to GAAP. But management decides what accounting procedure to use such as LIFO or FIFO, timing of assets disposals. GAAP should be followed but however it is not a strict set of principals. There is a concern that managers do not follow GAAP, use the ‘created’ flexibility and misrepresent the financial information. Regulation itself is influenced by the prepares and users of financial statements.
In the light of this topic, very important standard is accounting standard 18. FRS 18’Accounting policies’ emphases on the four key characters of useful financial information: relevance, reliable, comparability, and understandability. The previous accounting standard dealing with accounting policies issued 30 years ago, SSAP 2, identified four accounting concepts: going concern, accruals, consistency, and prudence. FRS 18 says that a change of accounting policy has occurred where there has been a change to any of the components of the definition” recognition criteria, measurement basis, and method of presentation.
The FRS requires an entity to select whichever of those accounting policies is judged to be most appropriate to its particular circumstances for the purpose of giving a true and fair view. The constraints that an entity should take into account are the need to balance the different objectives, and the need to balance the cost of providing information with the likely benefit of such information to users of the entity’s financial statements. An entity’s accounting policies should be reviewed regularly to ensure they remain the most appropriate to its particular circumstances. An entity should implement a new accounting policy if it is judged more appropriate to the entity’s particular circumstances.
Your second client, Prosser plc, has asked for your advice for each of the following problems:
- There has been a major fire at one of their premises that has destroyed fixed assets and stock. Their year end is 30 September and the fire took place on 18 October 2005. These losses amounted to 980,000 pounds and there were not covered by the company’s insurance. This amount the directors consider to be a material loss to the company.
This is an event happened after the balance sheet date(FRS 12 ‘Provisions, Contingent Liabilities and Contingent Assets’) so it will be included for the next financial year and currently it will be registered as material loss in the loss account.
- Legal proceedings have been started against the company because of faulty products supplied to a customer. The company’s lawyers advise that it is probable that the entity will be found liable for damages of 450,000 pounds.
Project A: A new adhesive product which is expected to cost a total of 2,000,000 to complete. Future revenues from the sale of the project are expected to exceed 4,000,000. The completion date of the project is uncertain because external funding will have to be obtained before the work can be completed.
This can be presented by ‘Linked-presentation’ which requires to give a true and fair view on the entity’s position-profits and losses should be recognised in the period in which they arise and they have to be included in the profit or loss account. Another option is separate presentation of assets and liabilities. It is very important to remember that even where a transaction does not result in any items being recognised in the balance sheet, the need for disclosure should still be considered.(FRS 5 ‘Reporting the Substance of Transactions’)
One option is to register this as an Inventory (current assets) and more specifically work-in-progress (WIP) stage. But there is a risk with assets because the future benefits inherent in the asset are never certain in amount. The general criteria require than an asset or liability should be recognised only where it can be measured with sufficient certainty. Another option is to present this transaction with ‘linked-presentation’. The third option is to register both transactions- Project A and B as an investment (current expenses) for future research and developments.