While IASs have been developed since 1973 by the IASC, now the IASB, in the UK the Accounting Standards Committee (ASC) and the Accounting Standards Board (ASB) were producing independent UK Statements of Standard Accounting Practice (SSAP) and Financial Reporting Standards (FRS) respectively. The changes that will be required to UK regulations, particularly SSAP and FRS to IAS to harmonise the two sets of regulations into a single set of standards, the new International Financial Reporting Standards (IFRS). This is the objective of the ‘convergence project’. Some of the changes will be to bring UK GAAP into line with current IAS, while other changes will be made to the IAS to bring them into line with UK GAAP. It will not be a one-way process.
IASs influence accounts in two ways. First, UK standard setters are increasingly attempting to produce standards that comply as much as possible with IASs. Over recent years, there has been considerable cooperation between standard setters across the world. Consequently, with some exceptions, UK GAAP is consistent with IASs. Second, companies that are quoted on stock exchanges outside UK may adopt IASs to improve their acceptability in other jurisdictions. For example, the London Stock Exchange accepts from its registrants accounts prepared under IAS GAAP.
The European Union
Harmonisation of accounting within the European Union (EU) is very different. The harmonisation programme was pursued with a great deal of enthusiasm in the 1970s, less in the 1980s and more or less came to a standstill at the time of Maastricht agreement in 1992, with a number of directives still in process. The European Commission (EC) demonstrated its awareness of the global implications of the European experiment when it announced in January 1999 that it would join the IASC’s Consultative Group. To date, the EU Council of Ministers has issued two major directives: the Fourth Directive and the Seventh Directive.
The Fourth Directive
The Fourth Directive was adopted by EU in 1978. It has two strategic objectives. First, by coordinating company law in member nations, it seeks to eliminate needless legal and bureaucratic obstacles to economic activity within the EU. Secondly, by establishing basic reporting requirements and acceptable financial statement formats, it attempts to create a minimum level of comparability among financial statements throughout the EU.
The most discussed feature of the Fourth Directive is the True and Fair View. According to the Article 2 of the directive, preparers should ignore any provision therein if compliance with that provision would conflict with presentation of a true and a fair view of a company’s financial position and income.
Although more than 20 years have passed since the adoption of the Fourth Directive, its effects are still being debated. The Directive unquestionably has had a major impact on reporting standards around Europe.
The Seventh Directive
The Seventh Directive was issued in 1983. This is another major accounting directive addressed the issue of consolidated financial statements. To comply with the Directive, member states are required to enact legislation in EU nations. As a matter of political necessity, the Seventh Directive allows member states considerable latitude in deciding who must prepare consolidated statements. Member states may exempt financial holding companies from consolidation requirements if the company to be exempted can show that it has not influenced the management decisions of its subsidiaries for the past year and has not influenced the appointment of any directors or management personnel for the past five years.
Regulatory Framework
Company financial accounting and reporting is governed by the requirements of companies’ legislation, pronouncements of professional accountancy bodies and stock exchange regulations. For EU countries, legal requirements changed consequent on EU company law directives, issued with the objective of promoting free trade among EU countries. In relation to financial statements generally, the Fourth Directive standardised the format for presentation of profit and loss accounts and balance sheets and imposed substantial disclosure requirements. In relation to group accounts in particular, the Seventh Directive has been incorporated into the legislation of all EU countries. Many professional accounting pronouncements have put flesh on the legal requirements where technical accounting terminology has been used in the legislation.
In June 2000, the EC issued a policy document proposing that all European companies listed on regulated markets (including banks and other financial institutions) should be required to prepare consolidated accounts in accordance with IASs. In June 2002, the Council of Ministers of the EU approved the Commission’s proposal. The Regulation that is now adopted will require the use of IASs and IFRSs by 1 January 2005, after a formal endorsement process. Furthermore, all EU-listed companies should be required to comply with IASs by the year 2005.
The current legal instrument ruling the accounting of UK limited companies is the Companies Act 1985 (CA1985), as amended by the Companies Act 1989 (CA1989) by influence of EU Seventh Directive. CA 1985 is known as a ‘consolidation act’, which introduced no new rules but brought together into a single statute the rules which existed previously in several different statutes. It reflects an evolution of company law since the beginning if the nineteenth century which has been overland in the 1980s by legislation to introduce the EU Directives, notably the Fourth Directive and Seventh Directive.
In 1981, the EU Fourth Directive was implemented in UK, adding statutory rules regarding formats, accounting principles, and basic accounting conventions. In general terms the Fourth Directive introduced detailed accounting rules into UK law and significantly reduced the flexibility which had previously been a characteristic of UK regulation. Although the Fourth Directive includes a number of specifically British elements such as the true and fair view, the fact that these are embodies in the law is sometimes seen as a constraint by UK regulators who perceive a need for regulation to evolve more quickly to reflect corporate practice. The main accounts of UK companies are the consolidated accounts, and the individual accounts of the parent are seen as irrelevant, even though the parent balance sheet still has to be provided alongside the group balance sheet. The biggest problem in group accounts is that of accounting for goodwill. After adoption of the Fourth Directive, this was treated as a non-depreciable asset, and subsequently the accounting standard allowed for immediate write-off at acquisition reserves. The British regulators were also took advantage of optional rules from the Seventh Directive to change the criteria for the consolidation of subsidiaries to help combat use of balance sheet in 1989. CA 1989 is important for increasing the importance of accounting standards. This was done partly by requiring that companies state that they have complied with standards and explain any departures.
UK and US Standards Setting
While UK and US accounting principles have common purposes, existing principles can produce markedly different financial statements. The US emphasises consistency among companies’ accounting principles (e.g. to facilitate the comparison of such results); its litigious environment tends to foster creating accounting rules to fit all conceivable circumstances, rather than merely to provide general implementation principles that allow great degrees of professional judgment. However, UK standards, which began to appear about 30 years after those of the US, focus on fewer principles. The US seeks to minimise the use of alternative treatments, while the UK allows a range of detailed adaptations of the principles to specific cases. Yet, the gap between the General Accepted Accounting Principles (GAAP) has narrowed recently, as evinced by the UK now dealing with such intangibles as goodwill, and the US addressing the pooling (merger) accounting area. (US and UK GAAP: Important Differences for Financial Statement Preparers and Users by Alan Reinstein, CPA, D.B.A., George R. Husband Professor of Accounting, School of Business Administration, Wayne State University, Detroit, Michigan 48202 and Thomas R. Weirich, CPA, Ph.D., Professor of Accounting, College of Business Administration, Central Michigan University, Mt. Pleasant, Michigan 48859. Also see submitted Journal Articles)
The British financial reporting in fact reflected the slightly lower degree of conservatism as compared to practices in the US. For example, the treatment of tangible fixed assets differs significantly between the UK and the US: The US requires the recording of these assets at cost whereas practice in UK permits revaluation of these assets to market value. The following presents a summary comparison of selected UK and UK GAAP:
Goodwill and Intangibles
From 1998, under UK GAAP, acquired goodwill is capitalised and its subsequent measurement is determined based on the individual circumstances of each business acquired. A portion of goodwill capitalised from 1998 is not being amortised. For US GAAP purpose this goodwill is being amortised over a period of 20 years.
Tangible Assets
The UK GAAP allows revaluating fixed, tangible assets to market values and mandates revaluing investment properties. The US mandates carrying fixed tangible assets at depreciated, historical costs. The US also requires capitalizing interest during the period of an asset’s construction period (i.e., made ready for use), which is optional in the UK.
Deferred Taxation
Under UK GAAP, no provision is made for deferred taxation if there is reasonable evidence that such deferred taxation will not be payable in the foreseeable future. Under US GAAP, deferred taxation is provided for all differences between the book and tax bases of assets and liabilities.
Cash Flow Statement
UK GAAP based on inflows and outflows of “cash” (not “cash and cash equivalents” as under IAS). Either the direct or indirect method may be used. US GAAP based on “cash receipts” and “cash payments”. The direct method is encouraged, however the indirect method is permitted. Under UK GAAP, Cash is defined as cash in hand and deposits receivable on demand, less overdrafts repayable on demand. Cash equivalents are not included in cash but are dealt with in the management of liquid resources section. But under US GAAP the definition of cash equivalents is similar to IAS, but changes in the balances of overdrafts are classified as financing cash flows, rather than being included within cash and cash equivalents.
Ordinary Dividend
Under UK GAAP, dividends are provided for in the fiscal year in respect of which they are declared by the board of directors. Under US GAAP, such dividends are not provided for until formally declared by the board of directors.
Foreign Currency Translation
US GAAP and UK GAAP require that where the operations of a foreign entity are largely independent of the reporting currency of the investing entity, amounts in the balance sheet of the foreign entity be translated using the closing (year end) rate with the exception of equity balances for which the historical rate is used. Amounts in the income statement are usually translated using the average rate for the accounting period (UK GAAP also permits the closing rate to be used).
Reconciliation of US and UK GAAP
Because British firms are frequently listed on US securities exchange, some publish a reconciliation of net income and shareholders’ equity calculated according to the accounting principles of the two countries. Appendix 3 and 4 excerpted from the Hanson Plc annual report, present a reconciliation and explanatory notes that illustrate how the differences between US and UK accounting methods may affect net income and shareholders’ equity.
The Sarbanes-Oxley Act 2002
As international accounting standards are increasingly accepted as the norm for financial reporting across the globe, then the regulation of professionals who interpret, apply and audit the application of the standards should be similar, if not identical, to maintain the confidence of international investors. But as with the tensions between US GAAP and International GAAP, so the convergence of regulation across the global accountancy profession has been dominated by a statement of intent from the US through the Sarbanes-Oxley Act which enacted in July 2002. Sarbanes-Oxley Act gives the US Securities and Exchange Commission (SEC) powers to regulate UK and other non-US companies with secondary listings in the US and by extension to review the work of non-US audit firms auditing such companies. This ‘extra-territorial’ dimension of Sarbanes-Oxley Act, not surprisingly, was met with strong criticism in the UK where the Act’s reach was seen as an unwarranted intrusion into the UK’s regulatory framework. Subsequent discussions resulted in the SEC agreeing that where a national regulatory framework was deemed to be sufficiently reliable and robust, the full impact of Sarbanes-Oxley might be mitigated. Hence at least one of the reasons for the two reports issued in the UK at the start of 2003. Into this scene steps the International Federation of Accountants (IFAC) which sets standards for professional accountants in 114 countries around the world. IFAC’s response to the post Enron debate has been to establish a task force charged with re-establishing the credibility of accountants. This committee complements the Transnational Auditors Committee (which carries out reviews of international audit firms on a peer review basis) and the IFAC Compliance Committee (which reviews the compliance of IFAC member bodies such as CIPFA, the Chartered Institute of Public Finance and Accountancy, with IFAC professional standards and guidelines).
The need for clarity of role and co-operation between national regulators, IFAC and would-be global regulators is self-evident. Part of the Sarbanes-Oxley ‘solution’ to the perceived problem of lack of external auditor independence has been to take a ‘rules based’ approach, resulting in the issue of a list of proscribed activities that auditors cannot carry out for clients. The UK approach is more ‘principles based’, giving an enhanced role to audit committees which will in future be responsible for appointing the external auditor, reviewing the quality of the auditor’s work and determining both the level and scope of any non-audit services that can be provided by the auditor. Whether the UK and US approaches can be reconciled, and whether the SEC will deem the UK’s revised approach sufficiently robust, remain to be seen. (Spectrum – Policy and Technical Perspectives for CIPFA members, March 2003 Issue number 1. Also see submitted articles.)
Conclusion
It may be that the IAS will reduce the level of international accounting diversity. Given the recent support of the IOSCO, this may indeed be feasible in the longer term. In the meantime, international accounting harmonisation remains a desirable but often elusive goal.
Appendix 1 (cont.)
Appendix 2
Appendix 2 (cont.)
Appendix 3
HANSON PLC AND SUBSIDIARIES
Reconciliation to US GAAP
The following is a summary of the estimated material adjustments to profit and ordinary shareholders’ equity which would be required if US GAAP had been applied.
Appendix 4
Bibliography
Text Books
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International Accounting (4th Ed) by Frederick D.S. Choi, Carol Ann Frost, Gary K. Meek.
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International Financial Reporting and Analysis (2nd Ed) by Haskins, Ferris, selling.
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Comparative International Accounting (7th Ed) by Christopher Nobes & Robert Parker.
- Harmonisation of Accounting Standards (1986) by OECD.
- International Accounting and Comparative Financial Reporting (1999) by Christopher W. Nobes.
Journal Articles
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International accounting harmonisation and global equity markets by Mary E. Barth, Graduate School of Business, Stanford University, Stanford, CA 94305-5015, USA; Greg Clinch, Australian Graduate School of Management, University of New South Wales, Sydney, NSW 2052, Australia; Toshi Shibano, Graduate School of Business, University of Chicago, Chicago, IL 60637-1561, USA. (Selected submitted journal article)
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Spectrum – Policy and Technical Perspectives for CIPFA members, March 2003 Issue number 1. (Selected submitted journal article)
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US and UK GAAP: Important Differences for Financial Statement Preparers and Users by Alan Reinstein, CPA, D.B.A., George R. Husband Professor of Accounting, School of Business Administration, Wayne State University, Detroit, Michigan 48202 and Thomas R. Weirich, CPA, Ph.D., Professor of Accounting, College of Business Administration, Central Michigan University, Mt. Pleasant, Michigan 48859. (Selected submitted journal article)
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The Future of the IASC and the Implications for UK Companies by David Cairns. (Selected submitted journal article)
- The regulatory framework for financial reporting and auditing in the United Kingdom: the present position and impending changes by Stella Fearnley, Tony Hines; Department of Accounting and Management Science, Portsmouth Business School, Locksway Road, Milton, Southsea, Hants PO4 8JF, UK.
- Accounting Harmonisation (revised October 2000) by David Cairns.
- International Accounting Harmonisation – Developing a single world standard by F. Robert Buchanan, Doctoral Student in Management, University of Texas at Arlington.
- International Accounting Harmonisation and the Major Developed Stock Market Countries: An Empirical Study by Emmanuel N. Emenyonu and Sidney J. Gray Sacred Heart University and the University of Warwick.
