The Regulatory Framework of Accounting

M C Pratt St Martin·s College Lancaster

Copyright, 2002 © M C Pratt

Introduction 1
y Unincorporated UK businesses can prepare their financial statements in any form they choose y Companies must comply with the provisions of: 
the Companies Act 1985  SSAPs  FRSs

Accounting standards

Introduction 2
y Accounting standards apply to all financial statements whose purpose is to give a true and fair view  therefore, they apply to every UK company s financial statements

Introduction 3
y Therefore, regulatory framework based on:  company law  accounting standards  International accounting standards and  other national standard setting bodies influence  Stock Exchange requirements

Company law 11 Company law 
Companies Act 1985 consolidated most previous UK company legislation and subsequently amended by Companies Act 1989  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 7th and 8th Directives

 Others are regulated by accounting standards .Company law 2  Some accounting principles are embodied in law.

.  These are working regulations and are issued by a national or international body of the accountancy profession.Accounting standards 1  rules or sets of rules prescribing the method(s) by which accounts (financial statements) should be prepared and presented.

Accounting standards 2  previously known as SSAP s  formulated by Accounting Standards Committee (ASC)  now known as FRS s  formulated by the Accounting Standards Board (ASB)  ASB is the successor to the ASC .

Accounting standards 2 3  SSAPs formulated by ASC. and not been replaced by an FRS. are still in force  accounting standards interact with company law:  final accounts (financial statements) must state whether accounting standards provisions have been followed or give reasons for any departures .

Accounting standards 4  Stock Exchange insists on member organizations (listed companies) following accounting standards  failure to comply with accounting standards will lead to auditors qualifying their report  which companies will wish to avoid! .

UK standards setting process (1)  Dearing Committee Report 1988 led to ASC being disbanded  Replaced by following: FRC  guides the standards setting body (ASB) on policy and  sees that its work is properly financed .

UK standards setting process (2) ASB  devises the accounting standards  issues standards on its own authority  full-time chair and technical director full two-thirds majority required to twoapprove (and issue) new accounting standard  legal backing to accounting standards .

(Sir Ron Dearing) .UK standards setting process (3) UITF  Offshoot of ASB  Function: Function:  to tackle urgent matters not covered by accounting standards and for which. given the urgency. the normal standardsstandards-setting process would not be practicable.

UK standards setting process (4)  U I T F cont d  pronouncements called abstracts  and intended to become effective quickly  tend to become effective within approx. thus halting abuses when they become widespread . date  abstracts then superseded by FRSs and FREDs  abstracts close loopholes. 1 month of pub.

financial statements must give reasons for any departures .triggers cases for investigation by Review Panel 1 .UK standards setting process (5)  Review Panel  chaired by barrister  concerned with examining and questioning departures from accounting standards by large companies  Companies Act 1985 s provisions .

UK standards setting process (6)  Review Panel 2  revised accounts have to be circulated to all persons likely to rely on the previous accounts  companies are becoming more cautious in their attempts to break or bend the rules  most disciplined companies have obeyed Panel decisions without any real argument .

UK standards setting process (7)  Review Panel 3  discussion with company should resolve most referrals. but  Panel has power to apply to courts for revisions of company s accounts  court costs potentially payable by directors  auditors can also be disciplined if audit report was not qualified due to departure from accounting standards .

involving: .International Accounting standards (IASs)  Produced by IASC  IASC 1  set up in 1973  works for improvement and harmonisation of financial reporting  develops IAS s through an international process.

International Accounting standards (IASs)  IASC  involving:  world-wide accounting profession. world preparers and users of financial statements  national standard setting bodies 2 .

and  promote world-wide acceptance and observance world works generally for improvement and harmonisation of regulations. accounting standards and procedures relating to financial statements presentation 3 .International Accounting standards (IASs)  IASC  Objectives: Objectives:  formulate and publish accounting standards (in public interest) for companies to observe in presenting financial statements.

International Accounting standards (IASs)  IASC 4  impact on ASB:  IASC s Framework for preparation and presentation of financial statements was introduced to:  set out the concepts that underlie the preparation and presentation of financial statements for external users .

because:  ASB has based own Statement of Principles on the IASC s Framework  ASB states in its FRS s that they comply with IAS s or IAS exposure drafts .International Accounting standards (IASs)  IASC 5  ASB has adopted same conceptual approach to financial reporting as the IASC.

two different securities markets:  Stock Exchange  Alternative Investment Market y shares quoted on Stock Exchange are said to be listed y to obtain listing.The Stock Exchange 1 y In UK. company must conform with Stock Exchange rules in Yellow Book issued by Stock Exchange s Council .

The Stock Exchange 2 y firms commit themselves to obey certain procedures and standards. so company s shares would not be traded on Stock Exchange . including rules on accounting information disclosure y rules are more stringent than Companies Acts y Yellow Book requirements not backed by law. y Stock Exchange can withdraw company s securities from its market/listing.

mainly Companies Act 1985  Accounting standards  Stock Exchange requirements .  In UK.GAAP (1)  Means all rules from whatever source which govern accounting. combination of:  Company law.

GAAP  Also includes: (2)  International Accounting standards  Laws in other countries.  No UK legal definition  Has US legal definition/authority . particularly in USA  Not backed by law in UK.

new economic developments and deficiencies identified in current practice . accounting standards and practice changes  this recognised in ASB s Statement of Aims: Aims: changes :  evolving business practices.GAAP (3)  dynamic changes with circumstances: legal.

GAAP (4)  emphasis has shifted from principles to practice in UK GAAP  Not easy to settle generally accepted so is:  whether practice addressed by UK accounting standards. international equivalents.  whether other companies have adopted practice.  Especially: is practice consistent with needs of users and objectives of financial reporting and  is it consistent with true and fair concept . laws.

 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.GAAP and Conceptual Framework of Accounting  Conceptual Framework: Framework: (1) (1)  FASB (USA) has defined Conceptual Framework.

1989 . published statements.GAAP and Conceptual Framework of Accounting  avoids fire fighting in SSAP approach (2)  aim to develop underlying philosophy as basis for consistent accounting principles so each SSAP/FRS structured into whole framework  lot of work on conceptual framework carried out  by IASC s Framework for preparation and presentation of financial statements.

GAAP and Conceptual Framework of Accounting (3)  Professor David Solomons 1989 discussion paper addressed to:  ASC s Guidelines for Financial Reporting Standards  paper known as Solomons Report .

GAAP and Conceptual Framework of Accounting  Objectives of financial statements (4)  IASC s Framework not mandatory. recognition and measurement of elements from which financial statements built  Concepts of capital and capital maintenance . Deals with:  Qualitative characteristics that decide usefulness of information in financial statements  Definition.

.GAAP and Conceptual Framework of Accounting (5)  IASC believe international harmonisation of accounting methods possible by focussing on above  Solomons Report is similar and deals with:  purpose of financial reporting  financial statements and their elements  qualitative characteristics of accounting information  recognition and measurement  choice of a general purpose accounting model.

GAAP and Conceptual Framework of Accounting  Solomons Report: (6)  Recognises unsatisfactory nature of then current fire fighting approach to UK standard setting and  Produced his own set of guidelines he felt could provide an explicit statement of agreed financial accounting concepts .

GAAP and Conceptual Framework of Accounting  Advantages : (1)  SSAPs were on patchwork basis (7)  Certain SSAPs were subject to considerable political interference from interested parties  Some external pressure was too strong for ASC to withstand  Policies derived from conceptual framework would be less open to criticism leading to strong external pressure .

. Others concentrated on Balance Sheet.GAAP and Conceptual Framework of Accounting  Advantages : (2) (8) Some SSAPs concentrated on Income Statement. An unambiguous definition of income and value would ensure that all financial statements have equal usefulness to different user groups.

May need variety of accounting standards.GAAP and Conceptual Framework of Accounting  Disadvantages : (1) (9)  Counter argument might be: Financial statements intended for variety of users and may not be possible to devise single conceptual framework suiting all users. each produced for different purpose (and with different concepts as basis) .

 SSAPs applied to all financial statements intended to give a true and fair view. including overseas companies incorporated in UK company accounts . members of CCAB  Produced SSAPs after consultation  Not all consultation was satisfactory and some SSAPs criticised for being unrealistic and unfair .Accounting Standards Board (ASB)  ASC set up in 1970 (1)  joint committee of 6 major UK accountancy bodies.

so SSAPs may recommend departure from the law . not selflaws  Departure from Companies Act 1985 allowable if consistent with giving true and fair view.Accounting Standards Board (ASB) (2)  Some SSAPs only applied to listed companies  Some areas of SSAPs overlap with company law but intention is to cover areas where law is silent  UK accountancy bodies prefer self-regulation.

Accounting Standards Board (ASB) (3)  SSAPs and FRSs generally apply to UK private companies  accounting standard will choose one particular treatment deemed to be best practice  But is it?  SSAPs have been developed haphazardly .

Accounting Standards Board (ASB) FRS s (4)  Draft for Discussion (DD) is first produced  Then converted into F R E D s  Other ASB published documents known as Exposure Drafts .

Accounting Standards Board (ASB) Statement of Aims (5)  To establish and improve (accounting) standards of financial accounting and reporting by :  developing principles  issuing new accounting standards  addressing urgent issues promptly .

.. given. some turned into FRSs or FREDs  has closed many loopholes ..practicable (Dearing)  abstracts intended to come into force quickly  at least 22 abstracts so far..Urgent Issues Task Force (UITF)  offshoot of Accounting Standards Board  urgent matters not covered by existing standards. and for which.not . normal standard setting process ... urgency.

Big GAAP/Little GAAP (1)  Most UK companies small. generally owned and managed by one person or family  No outside shareholders  Large companies with outside shareholders needing protection so larger companies need tougher rules  Could have 2 types of company accounts:  Simple ones with fewer rules and requirements  Complicated ones for large companies with stringent rules and requirements .

been that suggested small companies should be exempt from all accounting standards.Big GAAP/Little GAAP (2)  Therefore.  now idea is being more accepted  an FRS for small companies/entities (FRSSE) has (FRSSE) been developed . except certain (5) core ones  This seen as too radical at first.

Big GAAP/Little GAAP (3)  FRSSE (1)  retains all basic principles of accounting standards but discards detailed explanatory notes  applicable to all companies meeting definition of small company  company complying with FRSSE then exempt from all other accounting standards  FRSSE contains. requirements from existing accounting standards relevant to most small entities . in simplified form.

Feb. 1996) Accountant.  but recommended to produce simplified version by FRSSE  a commendable summary of UK GAAP to the point.Big GAAP/Little GAAP (4)  FRSSE (2)  large companies must prepare cash flow statement  small companies do not need to. Certified Accountant. succint and (Barry Johnson. .

in each FRS or SSAP.Big GAAP/Little GAAP (4)  FRSSE  However:  FRSSE not likely to make preparing financial statements easier or cheaper  exemption from disclosure. not measurement disclosure.  Not everybody convinced of case for relaxing measurement for smaller companies  Some say it should say. what not applicable to smaller companies (3) .

Big GAAP/Little GAAP (4)  FRSSE (4)  questionable whether accounts produced under FRSSE will give true and fair view (which applies to all companies) under the Companies Acts  users would still have to refer to mainstream accounting standards in order to give a true and fair view  balance between those favouring no accounting standards for small companies and those wanting to retain present system .

Big GAAP/Little GAAP (4)  FRSSE (5)  FRSSE will be periodically updated and revised to reflect future developments in financial reporting  FRSSE will probably be carefully monitored and reviewed after 2 years in operation .

of Trade and Industry Exposure Drafts European Union The Financial Accounting Standards Board (USA) Financial Reporting Council .Key AIM ASB ASC CA CCAB DDs DTI EDs EU FASB FRC (1) Alternative Investment Market Accounting Standards Board Accounting Standards Committee Companies Act(s) (eg CA 1985) Consultative Committee of Accounting Bodies Drafts for Discussion/Discussion Drafts Dept.

Key FREDs FRRP FRSs FRSSE GAAP IASC IASs SORPs SSAPs UITF UK (2) Financial Reporting Exposure Drafts (Financial Reporting) Review Panel Financial Reporting Standards FRS for Small Entities Generally Accepted Accounting Practice International Accounting Standards Committee International Accounting Standards Statements of Recommended Practice Statements of Standard Accounting Practice Urgent Issues Task Force United Kingdom .

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