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  1. 1. The Regulatory Framework of Accounting Copyright, 2002 © M C Pratt M C Pratt St Martin’s College Lancaster
  2. 2. <ul><li>Unincorporated UK businesses can prepare their financial statements in any form they choose </li></ul><ul><li>Companies must comply with the provisions of: </li></ul><ul><ul><li>the Companies Act 1985 </li></ul></ul><ul><ul><li>SSAPs Accounting standards </li></ul></ul><ul><ul><li>FRSs </li></ul></ul>Introduction 1
  3. 3. Introduction 2 <ul><li>Accounting standards apply to all financial statements whose purpose is to give a ‘true and fair’ view </li></ul><ul><li>therefore, they apply to every UK company’s financial statements </li></ul>Introduction 2
  4. 4. Introduction 3 <ul><li>Therefore, regulatory framework based on: </li></ul><ul><li>company law </li></ul><ul><li>accounting standards </li></ul><ul><li>International accounting standards and </li></ul><ul><li>other national standard setting bodies’ influence </li></ul><ul><li>Stock Exchange requirements </li></ul>Introduction 3
  5. 5. Company law 1 <ul><li>Companies Act 1985 consolidated most previous UK company legislation and subsequently amended by Companies Act 1989 </li></ul><ul><li>EU: UK obliged to comply with EU legislation by enacting UK laws to implement EU directives. Companies Act 1989 in part enacted to implement provisions of EU’s 7 th and 8 th Directives </li></ul>Company law 1
  6. 6. Company law 2 <ul><li>Some accounting principles are embodied in law. </li></ul><ul><li>Others are regulated by accounting standards </li></ul>
  7. 7. Accounting standards 1 <ul><li>rules or sets of rules prescribing the method(s) by which accounts (financial statements) should be prepared and presented. </li></ul><ul><li>These are ‘working regulations’ and are issued by a national or international body of the accountancy profession. </li></ul>
  8. 8. Accounting standards 2 <ul><li>previously known as SSAP s </li></ul><ul><li>formulated by Accounting Standards Committee ( ASC ) </li></ul><ul><li>now known as FRS s </li></ul><ul><li>formulated by the Accounting Standards Board ( ASB ) </li></ul><ul><li>ASB is the successor to the ASC </li></ul>Accounting standards 2
  9. 9. Accounting standards 2 <ul><li>SSAPs formulated by ASC, and not been replaced by an FRS, are still in force </li></ul><ul><li>accounting standards interact with company law : </li></ul><ul><li>final accounts (financial statements) must state whether accounting standards provisions have been followed or give reasons for any departures </li></ul>Accounting standards 3
  10. 10. <ul><li>Stock Exchange insists on member organizations (listed companies) following accounting standards </li></ul><ul><li>failure to comply with accounting standards will lead to auditors “qualifying” their report </li></ul><ul><li>– which companies will wish to avoid! </li></ul>Accounting standards 4
  11. 11. <ul><li>Dearing Committee Report 1988 led to ASC being disbanded </li></ul><ul><li>Replaced by following: </li></ul><ul><ul><li>F R C </li></ul></ul><ul><ul><ul><li>guides the standards setting body (ASB) on policy and </li></ul></ul></ul><ul><ul><ul><li>sees that its work is properly financed </li></ul></ul></ul>UK standards setting process (1)
  12. 12. <ul><ul><li>A S B </li></ul></ul><ul><ul><ul><li>devises the accounting standards </li></ul></ul></ul><ul><ul><ul><li>issues standards on its own authority </li></ul></ul></ul><ul><ul><ul><li>full-time chair and technical director </li></ul></ul></ul><ul><ul><ul><li>two-thirds majority required to approve (and issue) new accounting standard </li></ul></ul></ul><ul><ul><ul><li>legal backing to accounting standards </li></ul></ul></ul>UK standards setting process (2)
  13. 13. <ul><ul><li>U I T F </li></ul></ul><ul><ul><ul><li>Offshoot of ASB </li></ul></ul></ul><ul><ul><ul><li>Function : </li></ul></ul></ul><ul><ul><ul><li>‘ to tackle urgent matters not covered by accounting standards and for which, given the urgency, the normal standards-setting process would not be practicable.’ </li></ul></ul></ul><ul><ul><ul><li>(Sir Ron Dearing) </li></ul></ul></ul>UK standards setting process (3)
  14. 14. <ul><ul><li>U I T F cont’d </li></ul></ul><ul><ul><ul><li>pronouncements called ‘abstracts’ </li></ul></ul></ul><ul><ul><ul><li>and intended to become effective quickly </li></ul></ul></ul><ul><ul><ul><li>tend to become effective within approx. 1 month of pub. date </li></ul></ul></ul><ul><ul><ul><li>abstracts then superseded by FRSs and FREDs </li></ul></ul></ul><ul><ul><ul><li>abstracts close loopholes, thus halting abuses when they become widespread </li></ul></ul></ul>UK standards setting process (4)
  15. 15. <ul><ul><ul><li>Review Panel 1 </li></ul></ul></ul><ul><ul><ul><li>chaired by barrister </li></ul></ul></ul><ul><ul><ul><li>concerned with examining and questioning departures from accounting standards by large companies </li></ul></ul></ul><ul><ul><ul><li>Companies Act 1985’s provisions - financial statements must give reasons for any departures - ‘triggers’ cases for investigation by Review Panel </li></ul></ul></ul>UK standards setting process (5)
  16. 16. <ul><ul><ul><li>Review Panel 2 </li></ul></ul></ul><ul><ul><ul><li>revised accounts have to be circulated to all persons likely to rely on the previous accounts </li></ul></ul></ul><ul><ul><ul><li>companies are becoming more cautious in their attempts to break or bend the rules </li></ul></ul></ul><ul><ul><ul><li>most ‘disciplined’ companies have obeyed Panel decisions without any real argument </li></ul></ul></ul>UK standards setting process (6)
  17. 17. <ul><ul><ul><li>Review Panel 3 </li></ul></ul></ul><ul><ul><ul><li>discussion with company should resolve most referrals, but </li></ul></ul></ul><ul><ul><ul><li>Panel has power to apply to courts for revisions of company’s accounts </li></ul></ul></ul><ul><ul><ul><li>court costs potentially payable by directors </li></ul></ul></ul><ul><ul><ul><li>auditors can also be disciplined if audit report was not qualified due to departure from accounting standards </li></ul></ul></ul>UK standards setting process (7)
  18. 18. <ul><li>Produced by IASC </li></ul><ul><li>I A S C 1 </li></ul><ul><ul><li>set up in 1973 </li></ul></ul><ul><ul><li>works for improvement and harmonisation of financial reporting </li></ul></ul><ul><ul><li>develops IAS s through an international process, involving: </li></ul></ul>International Accounting standards (IASs)
  19. 19. <ul><li>IASC 2 </li></ul><ul><ul><li>involving: </li></ul></ul><ul><ul><li>world-wide accounting profession, </li></ul></ul><ul><ul><li>preparers and users of financial statements </li></ul></ul><ul><ul><li>national standard setting bodies </li></ul></ul>International Accounting standards (IASs)
  20. 20. <ul><li>IASC 3 </li></ul><ul><ul><li>Objectives : </li></ul></ul><ul><ul><li>formulate and publish accounting standards (in public interest) for companies to observe in presenting financial statements, and </li></ul></ul><ul><ul><li>promote world-wide acceptance and observance </li></ul></ul><ul><ul><li>works generally for improvement and harmonisation of regulations, accounting standards and procedures relating to financial statements presentation </li></ul></ul>International Accounting standards (IASs)
  21. 21. <ul><li>IASC 4 </li></ul><ul><ul><li>impact on ASB: </li></ul></ul><ul><ul><ul><li>IASC’s Framework for preparation and presentation of financial statements was introduced to: </li></ul></ul></ul><ul><ul><ul><ul><li>‘ set out the concepts that underlie the preparation and presentation of financial statements for external users’ </li></ul></ul></ul></ul>International Accounting standards (IASs)
  22. 22. <ul><li>IASC 5 </li></ul><ul><ul><ul><li>ASB has adopted same conceptual </li></ul></ul></ul><ul><ul><ul><li>approach to financial reporting as the </li></ul></ul></ul><ul><ul><ul><li>IASC, because: </li></ul></ul></ul><ul><ul><ul><ul><li>ASB has based own Statement of </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Principles on the IASC’s Framework </li></ul></ul></ul></ul><ul><ul><ul><li>ASB states in its FRS s that they comply </li></ul></ul></ul><ul><ul><ul><li>with IAS s or IAS exposure drafts </li></ul></ul></ul>International Accounting standards (IASs)
  23. 23. The Stock Exchange 1 <ul><li>In UK, two different securities markets: </li></ul><ul><ul><li>Stock Exchange </li></ul></ul><ul><ul><li>Alternative Investment Market </li></ul></ul><ul><li>shares quoted on Stock Exchange are said to be ‘listed’ </li></ul><ul><li>to obtain listing, company must conform with Stock Exchange rules in ‘Yellow Book’ issued by Stock Exchange’s Council </li></ul>
  24. 24. The Stock Exchange 2 <ul><li>firms commit themselves to obey certain procedures and standards, including rules on accounting information disclosure </li></ul><ul><li>rules are more stringent than Companies Acts </li></ul><ul><li>Yellow Book requirements not backed by law, </li></ul><ul><li>Stock Exchange can withdraw company’s securities from its market/listing, so company’s shares would not be traded on Stock Exchange </li></ul>
  25. 25. G A A P (1) <ul><li>Means all rules from whatever source which govern accounting. </li></ul><ul><li>In UK, combination of: </li></ul><ul><li>Company law, mainly Companies Act 1985 </li></ul><ul><li>Accounting standards </li></ul><ul><li>Stock Exchange requirements </li></ul>
  26. 26. G A A P (2) <ul><li>Also includes: </li></ul><ul><li>International Accounting standards </li></ul><ul><li>Laws in other countries, particularly in USA </li></ul><ul><li>Not backed by law in UK. </li></ul><ul><li>No UK legal definition </li></ul><ul><li>Has US legal definition/authority </li></ul>
  27. 27. G A A P (3) <ul><li>dynamic – changes with circumstances: legal, accounting standards and practice changes </li></ul><ul><li>this recognised in ASB’s Statement of Aims : ‘changes’: </li></ul><ul><li>‘ evolving business practices, new economic developments and deficiencies identified in current practice…’ </li></ul>
  28. 28. G A A P (4) <ul><li>emphasis has shifted from ‘principles’ to ‘practice’ in UK GAAP </li></ul><ul><li>Not easy to settle ‘generally accepted’ so is: </li></ul><ul><ul><li>whether practice addressed by UK accounting standards, laws, international equivalents, </li></ul></ul><ul><ul><li>whether other companies have adopted practice. </li></ul></ul><ul><ul><li>Especially: is practice consistent with needs of users and objectives of financial reporting and </li></ul></ul><ul><ul><li>is it consistent with ‘true and fair’ concept </li></ul></ul>
  29. 29. GAAP and Conceptual Framework of Accounting (1) <ul><li>FASB (USA) has defined Conceptual Framework. </li></ul><ul><li>Conceptual Framework : (1) </li></ul><ul><li>‘ a constitution, a coherent system of interrelated objectives and fundamentals that can lead to consistent (accounting) standards and that prescribes the nature, function and limits of financial accounting and financial statements.’ </li></ul>
  30. 30. GAAP and Conceptual Framework of Accounting (2) <ul><li>avoids ‘fire fighting’ – in SSAP approach </li></ul><ul><li>aim to develop underlying philosophy as basis for consistent accounting principles so each SSAP/FRS structured into whole framework </li></ul><ul><li>lot of work on conceptual framework carried out </li></ul><ul><li>by IASC’s Framework for preparation and presentation of financial statements , published 1989 </li></ul>
  31. 31. GAAP and Conceptual Framework of Accounting (3) <ul><li>Professor David Solomons’ 1989 discussion paper addressed to: </li></ul><ul><li>ASC’s Guidelines for Financial Reporting Standards </li></ul><ul><li>paper known as Solomons Report </li></ul>
  32. 32. GAAP and Conceptual Framework of Accounting (4) <ul><li>IASC’s Framework not mandatory. Deals with: </li></ul><ul><li>Objectives of financial statements </li></ul><ul><li>Qualitative characteristics that decide usefulness of information in financial statements </li></ul><ul><li>Definition, recognition and measurement of elements from which financial statements built </li></ul><ul><li>Concepts of ‘capital’ and ‘capital maintenance’ </li></ul>
  33. 33. GAAP and Conceptual Framework of Accounting (5) <ul><li>IASC believe international harmonisation of accounting methods possible by focussing on above </li></ul><ul><li>Solomons Report is similar and deals with: </li></ul><ul><ul><li>purpose of financial reporting </li></ul></ul><ul><ul><li>financial statements and their elements </li></ul></ul><ul><ul><li>qualitative characteristics of accounting information </li></ul></ul><ul><ul><li>recognition and measurement </li></ul></ul><ul><ul><li>choice of a general purpose accounting model. </li></ul></ul>
  34. 34. GAAP and Conceptual Framework of Accounting (6) <ul><li>Solomons Report: </li></ul><ul><ul><li>Recognises unsatisfactory nature of then current ‘fire fighting’ approach to UK standard setting and </li></ul></ul><ul><ul><li>Produced his own set of guidelines he felt could provide an explicit statement of agreed financial accounting concepts </li></ul></ul>
  35. 35. GAAP and Conceptual Framework of Accounting (7) <ul><li>Advantages : (1) </li></ul><ul><ul><li>SSAPs were on ‘patchwork’ basis </li></ul></ul><ul><ul><li>Certain SSAPs were subject to considerable political interference from interested parties </li></ul></ul><ul><ul><li>Some external pressure was too strong for ASC to withstand </li></ul></ul><ul><ul><li>Policies derived from conceptual framework would be less open to criticism leading to strong external pressure </li></ul></ul>
  36. 36. GAAP and Conceptual Framework of Accounting (8) <ul><li>Advantages : (2) </li></ul><ul><ul><li>Some SSAPs concentrated on Income Statement. </li></ul></ul><ul><ul><li>Others concentrated on Balance Sheet. </li></ul></ul><ul><ul><li>An unambiguous definition of ‘income’ and ‘value’ would ensure that all financial statements have equal usefulness to different user groups. </li></ul></ul>
  37. 37. GAAP and Conceptual Framework of Accounting (9) <ul><li>Disadvantages : (1) </li></ul><ul><ul><li>Counter argument might be: </li></ul></ul><ul><ul><li>Financial statements intended for variety of users and may not be possible to devise single conceptual framework suiting all users. </li></ul></ul><ul><ul><li>May need variety of accounting standards, each produced for different purpose (and with different concepts as basis) </li></ul></ul>
  38. 38. Accounting Standards Board (ASB) (1) <ul><li>ASC set up in 1970 </li></ul><ul><li>joint committee of 6 major UK accountancy bodies, members of CCAB </li></ul><ul><li>Produced SSAPs after consultation </li></ul><ul><li>Not all consultation was satisfactory and some SSAPs criticised for being ‘unrealistic’ and ‘unfair’. </li></ul><ul><li>SSAPs applied to all financial statements intended to give a ‘true and fair’ view, including overseas companies incorporated in UK company accounts </li></ul>
  39. 39. Accounting Standards Board (ASB) (2) <ul><li>Some SSAPs only applied to listed companies </li></ul><ul><li>Some areas of SSAPs overlap with company law but intention is to cover areas where law is silent </li></ul><ul><li>UK accountancy bodies prefer self-regulation, not laws </li></ul><ul><li>Departure from Companies Act 1985 allowable if consistent with giving ‘true and fair’ view, so SSAPs may recommend departure from the law </li></ul>
  40. 40. Accounting Standards Board (ASB) (3) <ul><li>SSAPs and FRSs generally apply to UK private companies </li></ul><ul><li>accounting standard will choose one particular treatment deemed to be best practice </li></ul><ul><li>But is it? </li></ul><ul><li>SSAPs have been developed haphazardly </li></ul>
  41. 41. Accounting Standards Board (ASB) (4) <ul><li>FRS s </li></ul><ul><li>Draft for Discussion (DD) is first produced </li></ul><ul><li>Then converted into F R E D s </li></ul><ul><li>Other ASB published documents known as Exposure Drafts </li></ul>
  42. 42. Accounting Standards Board (ASB) (5) <ul><li>Statement of Aims </li></ul><ul><li>‘ To establish and improve (accounting) standards of financial accounting and reporting by’ : </li></ul><ul><ul><li>developing principles </li></ul></ul><ul><ul><li>issuing new accounting standards </li></ul></ul><ul><ul><li>addressing urgent issues promptly </li></ul></ul>
  43. 43. Urgent Issues Task Force (UITF) <ul><li>offshoot of Accounting Standards Board </li></ul><ul><li>‘ urgent matters not covered by existing standards, and for which, given... urgency,… normal standard setting process ...not ...practicable’ (Dearing) </li></ul><ul><li>‘ abstracts’ intended to come into force quickly </li></ul><ul><li>at least 22 ‘abstracts’ so far; some ‘turned into’ FRSs or FREDs </li></ul><ul><li>has closed many loopholes </li></ul>
  44. 44. <ul><li>Most UK companies small, generally owned and managed by one person or family </li></ul><ul><li>No outside shareholders </li></ul><ul><li>Large companies with outside shareholders needing protection so larger companies need tougher rules </li></ul><ul><li>Could have 2 types of company accounts: </li></ul><ul><li>Simple ones with fewer rules and requirements </li></ul><ul><li>Complicated ones for large companies with stringent rules and requirements </li></ul>Big GAAP/Little GAAP (1)
  45. 45. Big GAAP/Little GAAP (2) <ul><li>Therefore, been that suggested small companies should be exempt from all accounting standards, except certain (5) core ones </li></ul><ul><li>This seen as too radical at first, </li></ul><ul><li>now idea is being more accepted </li></ul><ul><li>an FRS for small companies/entities ( FRSSE ) has been developed </li></ul>
  46. 46. Big GAAP/Little GAAP (3) <ul><li>FRSSE (1) </li></ul><ul><ul><li>retains all basic principles of accounting standards but discards detailed explanatory notes </li></ul></ul><ul><ul><li>applicable to all companies meeting definition of ‘small company’ </li></ul></ul><ul><ul><li>company complying with FRSSE then exempt from all other accounting standards </li></ul></ul><ul><ul><li>FRSSE contains, in simplified form, requirements from existing accounting standards relevant to most small entities </li></ul></ul>
  47. 47. Big GAAP/Little GAAP (4) <ul><li>FRSSE (2) </li></ul><ul><ul><li>large companies must prepare cash flow statement </li></ul></ul><ul><ul><li>small companies do not need to, </li></ul></ul><ul><ul><li>but recommended to produce simplified version by FRSSE </li></ul></ul><ul><ul><li>‘ a commendable summary of UK GAAP… succint and to the point.’ </li></ul></ul><ul><ul><li>(Barry Johnson, Certified Accountant , Feb. 1996) </li></ul></ul>
  48. 48. Big GAAP/Little GAAP (4) <ul><li>FRSSE (3) </li></ul><ul><ul><li>However: </li></ul></ul><ul><ul><li>FRSSE not likely to make preparing financial statements easier or cheaper </li></ul></ul><ul><ul><li>exemption from disclosure , not measurement </li></ul></ul><ul><ul><li>Not everybody convinced of case for relaxing measurement for smaller companies </li></ul></ul><ul><ul><li>Some say it should say, in each FRS or SSAP, what not applicable to smaller companies </li></ul></ul>
  49. 49. Big GAAP/Little GAAP (4) <ul><li>FRSSE (4) </li></ul><ul><ul><li>questionable whether accounts produced under FRSSE will give ‘true and fair’ view (which applies to all companies) under the Companies Acts </li></ul></ul><ul><ul><li>users would still have to refer to ‘mainstream’ accounting standards in order to give a ‘true and fair’ view </li></ul></ul><ul><ul><li>balance between those favouring no accounting standards for small companies and those wanting to retain present system </li></ul></ul>
  50. 50. Big GAAP/Little GAAP (4) <ul><li>FRSSE (5) </li></ul><ul><ul><li>FRSSE will be periodically updated and revised to reflect future developments in financial reporting </li></ul></ul><ul><ul><li>FRSSE will probably be carefully monitored and reviewed after 2 years in operation </li></ul></ul>
  51. 51. Key (1) <ul><li>AIM Alternative Investment Market </li></ul><ul><li>ASB Accounting Standards Board </li></ul><ul><li>ASC Accounting Standards Committee </li></ul><ul><li>CA Companies Act(s) (eg CA 1985) </li></ul><ul><li>CCAB Consultative Committee of Accounting Bodies </li></ul><ul><li>DDs Drafts for Discussion/Discussion Drafts </li></ul><ul><li>DTI Dept. of Trade and Industry </li></ul><ul><li>EDs Exposure Drafts </li></ul><ul><li>EU European Union </li></ul><ul><li>FASB The Financial Accounting Standards Board (USA) </li></ul><ul><li>FRC Financial Reporting Council </li></ul>
  52. 52. Key (2) <ul><li>FREDs Financial Reporting Exposure Drafts </li></ul><ul><li>FRRP (Financial Reporting) Review Panel </li></ul><ul><li>FRSs Financial Reporting Standards </li></ul><ul><li>FRSSE FRS for Small Entities </li></ul><ul><li>GAAP Generally Accepted Accounting Practice </li></ul><ul><li>IASC International Accounting Standards Committee </li></ul><ul><li>IASs International Accounting Standards </li></ul><ul><li>SORPs Statements of Recommended Practice </li></ul><ul><li>SSAPs Statements of Standard Accounting Practice </li></ul><ul><li>UITF Urgent Issues Task Force </li></ul><ul><li>UK United Kingdom </li></ul>