The Regulatory Framework of Accounting

The The Regulatory Regulatory Framework of Framework of AccountingAccounting

Copyright, 2002 © M C Pratt

M C PrattM C Pratt

St Martin’s CollegeSt Martin’s College

LancasterLancaster

Introduction Introduction 11

Unincorporated UK businesses can prepare Unincorporated UK businesses can prepare their financial statements in any form they their financial statements in any form they choosechoose

Companies must comply with the Companies must comply with the provisions of:provisions of: the Companies Act 1985 the Companies Act 1985

SSAPsSSAPs Accounting standardsAccounting standards

FRSsFRSs

Introduction 2Introduction 2

Accounting standards apply to all Accounting standards apply to all financial statements whose purpose financial statements whose purpose is to give a ‘true and fair’ viewis to give a ‘true and fair’ view

therefore, they apply to therefore, they apply to every every UK UK company’s financial statements company’s financial statements


Introduction 3Introduction 3

Therefore, regulatory framework based on:Therefore, regulatory framework based on:

company lawcompany law

accounting standardsaccounting standards

International accounting standards International accounting standards and and

other national standard setting bodies’ influenceother national standard setting bodies’ influence

Stock Exchange Stock Exchange requirementsrequirements


Company law 1

Companies Act 1985 consolidated most Companies Act 1985 consolidated most previous UK company legislation and previous UK company legislation and subsequently amended by Companies subsequently amended by Companies Act 1989 Act 1989

EU: UK obliged to comply with EU EU: UK obliged to comply with EU legislation by enacting UK laws to legislation by enacting UK laws to implement EU directives. Companies implement EU directives. Companies Act 1989 in part enacted to implement Act 1989 in part enacted to implement provisions of EU’s 7provisions of EU’s 7thth and 8 and 8thth Directives Directives

Company law Company law 11

Company law Company law 22

Some accounting Some accounting principles principles are are embodied in law. embodied in law.

Others are regulated by Others are regulated by accounting standardsaccounting standards

Accounting Accounting standards 1standards 1

rules or sets of rules prescribing the method(s) by which accounts (financial statements) should be prepared and presented.

These are ‘working regulations’ and are issued by a national or international body of the accountancy profession.

Accounting standards 2Accounting 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 2Accounting standards 2

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


Stock Exchange insists on member Stock Exchange insists on member organizations (listed companies) organizations (listed companies) following following accounting standardsaccounting standards

failure to comply with accounting failure to comply with accounting standards will lead to standards will lead to auditorsauditors “qualifying” their report “qualifying” their report

– – which companies will wish to avoid!which companies will wish to avoid!


Dearing Committee Report 1988 led Dearing Committee Report 1988 led to ASC being disbandedto ASC being disbanded

Replaced by following:Replaced by following:

F R CF R C guides the standards setting body guides the standards setting body

(ASB) on policy and (ASB) on policy and sees that its work is properly sees that its work is properly

financed financed

UK standards setting UK standards setting process (1)process (1)

A S BA S B devises the accounting standards devises the accounting standards issues standards on its own authorityissues standards on its own authority full-time chair and technical directorfull-time chair and technical director two-thirds majority required to two-thirds majority required to

approve (and issue) new accounting approve (and issue) new accounting standardstandard

legal backing to accounting legal backing to accounting standardsstandards


U I T FU I T F Offshoot of ASBOffshoot of ASB FunctionFunction:: ‘‘to tackle urgent matters not to tackle urgent matters not

covered by accounting standards covered by accounting standards and for which, given the urgency, and for which, given the urgency, the normal standards-setting the normal standards-setting process would not be practicable.’ process would not be practicable.’

(Sir Ron Dearing) (Sir Ron Dearing)


U I T F cont’dU I T F cont’d pronouncements called ‘abstracts’pronouncements called ‘abstracts’ and intended to become effective and intended to become effective

quicklyquickly tend to become effective within approx. tend to become effective within approx.

1 month of pub. date 1 month of pub. date abstracts then superseded by FRSs and abstracts then superseded by FRSs and

FREDsFREDs abstracts close loopholes, thus halting abstracts close loopholes, thus halting

abuses when they become widespreadabuses when they become widespread


Review PanelReview Panel 11 chaired by barristerchaired by barrister concerned with examining and concerned with examining and

questioning departures from accounting questioning departures from accounting standards by large companiesstandards by large companies

Companies Act 1985’s provisions - Companies Act 1985’s provisions - financial statements must give reasons financial statements must give reasons for any departures - ‘triggers’ cases for for any departures - ‘triggers’ cases for investigation by Review Panelinvestigation by Review Panel


Review PanelReview Panel 22 revised accounts have to be revised accounts have to be

circulated to all persons likely to rely circulated to all persons likely to rely on the previous accounts on the previous accounts

companies are becoming more companies are becoming more cautious in their attempts to break or cautious in their attempts to break or bend the rulesbend the rules

most ‘disciplined’ companies have most ‘disciplined’ companies have obeyed Panel decisions without any obeyed Panel decisions without any real argumentreal argument


Review PanelReview Panel 33 discussion with company should discussion with company should

resolve most referrals, but resolve most referrals, but Panel has power to apply to courts for Panel has power to apply to courts for

revisions of company’s accounts revisions of company’s accounts court costs potentially payable by court costs potentially payable by

directorsdirectors auditors can also be disciplined if audit auditors can also be disciplined if audit

report was report was notnot qualified due to qualified due to departure from accounting standards departure from accounting standards


Produced by IASCProduced by IASC

I A S C I A S C 11 set up in 1973set up in 1973

works for improvement and works for improvement and harmonisation of financial reportingharmonisation of financial reporting

develops IASdevelops IAS s through an s through an international process, involving:international process, involving:

International Accounting International Accounting standards (IASs)standards (IASs)

IASC IASC 22 involving:involving:

world-wide accounting profession,world-wide accounting profession,

preparers and users of financial preparers and users of financial statements statements

national standard setting bodiesnational standard setting bodies


IASC IASC 33 ObjectivesObjectives::

formulate and publish accounting standards (in formulate and publish accounting standards (in public interest) for companies to observe in public interest) for companies to observe in presenting financial statements, and presenting financial statements, and

promote world-wide acceptance and promote world-wide acceptance and observanceobservance

works generally for improvement and works generally for improvement and harmonisation of regulations, accounting harmonisation of regulations, accounting standards and procedures relating to financial standards and procedures relating to financial statements presentationstatements presentation


IASC IASC 44 impact on ASB:impact on ASB:

IASC’s IASC’s Framework for preparation Framework for preparation and presentation of financial and presentation of financial statementsstatements was introduced to: was introduced to: ‘‘set out the concepts that underlie set out the concepts that underlie

the preparation and presentation the preparation and presentation of financial statements for external of financial statements for external users’users’


IASC IASC 55 ASB has adopted same conceptualASB has adopted same conceptual

approach to financial reporting as theapproach to financial reporting as the

IASC, because:IASC, because:

ASB has based own ASB has based own Statement of Statement of PrinciplesPrinciples on the IASC’s on the IASC’s FrameworkFramework

ASB states in its FRSASB states in its FRS s that they s that they complycomplywith IASwith IAS s or IAS exposure draftss or IAS exposure drafts


The Stock Exchange 1The Stock Exchange 1

In UK, two different securities markets: Stock Exchange

Alternative Investment Market

shares quoted on Stock Exchange are said to be ‘listed’

to obtain listing, company must conform with Stock Exchange rules in ‘Yellow Book’ issued by Stock Exchange’s Council

The Stock Exchange 2The Stock Exchange 2

firms commit themselves to obey certain procedures and standards, including rules on accounting information disclosure

rules are more stringent than Companies Acts

Yellow Book requirements not backed by law,

Stock Exchange can withdraw company’s securities from its market/listing, so company’s shares would not be traded on Stock Exchange

GG AA AA PP (1)(1)

Means all rules from whatever source Means all rules from whatever source which govern accounting.which govern accounting.

In UK, combination of:In UK, combination of:

Company law, mainly Companies Act Company law, mainly Companies Act 19851985

Accounting standards Accounting standards

Stock Exchange requirementsStock Exchange requirements

GG AA AA PP (2)(2)

Also includes:Also includes:

International Accounting standards International Accounting standards

Laws in other countries, particularly in Laws in other countries, particularly in USAUSA

Not backed by law in UK. Not backed by law in UK.

No UK legal definitionNo UK legal definition

Has US legal definition/authorityHas US legal definition/authority

GG AA AA PP (3)(3)

dynamic – changes with circumstances: dynamic – changes with circumstances: legal, accounting standards and practice legal, accounting standards and practice changeschanges

this recognised in ASB’s this recognised in ASB’s Statement of Statement of AimsAims: ‘changes’:: ‘changes’:

‘‘evolving business practices, new evolving business practices, new economic developments and deficiencies economic developments and deficiencies identified in current practice…’identified in current practice…’

GG AA AA PP (4)(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, laws, 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

GAAP and Conceptual GAAP and Conceptual Framework of AccountingFramework of Accounting (1)(1)

FASB (USA) has defined Conceptual FASB (USA) has defined Conceptual Framework.Framework.

Conceptual FrameworkConceptual Framework:: (1)(1)

‘‘a constitution, a coherent system of a constitution, a coherent system of interrelated objectives and fundamentals interrelated objectives and fundamentals that can lead to consistent (accounting) that can lead to consistent (accounting) standards and that prescribes the nature, standards and that prescribes the nature, function and limits of financial accounting function and limits of financial accounting and financial statements.’and financial statements.’


avoids ‘fire fighting’ – in SSAP approachavoids ‘fire fighting’ – in SSAP approach

aim to develop underlying philosophy as basis aim to develop underlying philosophy as basis for consistent accounting principles so each for consistent accounting principles so each SSAP/FRS structured into whole frameworkSSAP/FRS structured into whole framework

lot of work on conceptual framework carried lot of work on conceptual framework carried outout

by IASC’s by IASC’s Framework for preparation and Framework for preparation and presentation of financial statementspresentation of financial statements, , published 1989published 1989


Professor David Solomons’ 1989 Professor David Solomons’ 1989 discussion paper addressed to:discussion paper addressed to:

ASC’sASC’s Guidelines for Financial Reporting Guidelines for Financial Reporting StandardsStandards

paper known as Solomons Reportpaper known as Solomons Report


IASC’s IASC’s FrameworkFramework not mandatory. Deals with: not mandatory. Deals with:

Objectives of financial statements Objectives of financial statements

Qualitative characteristics that decide Qualitative characteristics that decide usefulness of information in financial statements usefulness of information in financial statements

Definition, recognition and measurement of Definition, recognition and measurement of elements from which financial statements builtelements from which financial statements built

Concepts of ‘capital’ and ‘capital maintenance’Concepts of ‘capital’ and ‘capital maintenance’


IASC believe international harmonisation of IASC believe international harmonisation of accounting methods possible by focussing on accounting methods possible by focussing on aboveabove

Solomons Report is similar and deals with: Solomons Report is similar and deals with: purpose of financial reportingpurpose of financial reporting

financial statements and their elementsfinancial statements and their elements

qualitative characteristics of accounting qualitative characteristics of accounting informationinformation

recognition and measurementrecognition and measurement

choice of a general purpose accounting model.choice of a general purpose accounting model.


Solomons Report: Solomons Report:

Recognises unsatisfactory nature of then Recognises unsatisfactory nature of then current ‘fire fighting’ approach current ‘fire fighting’ approach

to UK standard setting andto UK standard setting and

Produced his own set of guidelines he felt Produced his own set of guidelines he felt could provide an explicit statement of could provide an explicit statement of

agreed financial accounting conceptsagreed financial accounting concepts


Advantages : (1) SSAPs were on ‘patchwork’ basis

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


Advantages : (2)– Some SSAPs concentrated on Income

Statement.

– Others concentrated on Balance Sheet.

– An unambiguous definition of ‘income’ and ‘value’ would ensure that all financial statements have equal usefulness to different user groups.


Disadvantages : (1)

Counter argument might be:

Financial statements intended for variety of users and may not be possible to devise single conceptual framework suiting all users.

May need variety of accounting standards, each produced for different purpose (and with different concepts as basis)

Accounting Standards Accounting Standards Board (ASB)Board (ASB) (1)(1)

ASCASC set up in 1970 set up in 1970

joint committee of 6 major UK accountancy joint committee of 6 major UK accountancy bodies, members of CCAB bodies, members of CCAB

Produced SSAPs after consultationProduced SSAPs after consultation

Not all consultation was satisfactory and some Not all consultation was satisfactory and some SSAPs criticised for being ‘unrealistic’ and SSAPs criticised for being ‘unrealistic’ and ‘unfair’.‘unfair’.

SSAPs applied to all financial statements intended SSAPs applied to all financial statements intended to give a ‘true and fair’ view, including overseas to give a ‘true and fair’ view, including overseas companies incorporated in UK company accounts companies incorporated in UK company accounts


Some SSAPs only applied to listed companies Some SSAPs only applied to listed companies

Some areas of SSAPs overlap with company Some areas of SSAPs overlap with company law but intention is to cover areas where law is law but intention is to cover areas where law is silentsilent

UK accountancy bodies prefer self-regulation, UK accountancy bodies prefer self-regulation, not lawsnot laws

Departure from Companies Act 1985 allowable Departure from Companies Act 1985 allowable if consistent with giving ‘true and fair’ view, so if consistent with giving ‘true and fair’ view, so

SSAPs may recommend departure from SSAPs may recommend departure from the lawthe law


SSAPs and FRSs generally apply to UK private SSAPs and FRSs generally apply to UK private companies companies

accounting standard will choose accounting standard will choose oneone particular treatment deemed to be best particular treatment deemed to be best practicepractice

But is it?But is it?

SSAPs have been developed haphazardlySSAPs have been developed haphazardly


• FRSFRS ss

Draft for Discussion (DD)Draft for Discussion (DD) is first produced is first produced

Then converted into Then converted into FF RR EE DD ss

Other ASB published documents known as Other ASB published documents known as Exposure DraftsExposure Drafts


• Statement of AimsStatement of Aims

‘‘To establish and improve (accounting) To establish and improve (accounting) standards of financial accounting and standards of financial accounting and reporting by’ :reporting by’ :

developing principles developing principles

issuing new accounting standards issuing new accounting standards

addressing urgent issues promptlyaddressing urgent issues promptly

Urgent Issues Task Force (UITF)Urgent Issues Task Force (UITF)

offshoot of Accounting Standards Boardoffshoot of Accounting Standards Board

‘‘urgent matters not covered by existing urgent matters not covered by existing standards, and for which, given... urgency,… standards, and for which, given... urgency,… normal standard setting normal standard setting process ...not ...practicable’ (Dearing)process ...not ...practicable’ (Dearing)

‘‘abstracts’ intended to come into force quicklyabstracts’ intended to come into force quickly

at least 22 ‘abstracts’ so far; some ‘turned into’ at least 22 ‘abstracts’ so far; some ‘turned into’ FRSs or FREDsFRSs or FREDs

has closed many loopholeshas closed many loopholes

Most UK companies small, generally owned and Most UK companies small, generally owned and managed by one person or familymanaged by one person or family

No outside shareholdersNo outside shareholders

Large companies with outside shareholders Large companies with outside shareholders needing protection so larger companies need needing protection so larger companies need tougher rulestougher rules

Could have Could have 22 types of company accounts: types of company accounts:

Simple ones with fewer rules and requirementsSimple ones with fewer rules and requirements

Complicated ones for large companies with Complicated ones for large companies with stringent rules and requirementsstringent rules and requirements

Big GAAP/Little GAAP (1)Big GAAP/Little GAAP (1)


Therefore, been that suggested small Therefore, been that suggested small companies should be exempt from companies should be exempt from allall accounting standards, except certain (5) accounting standards, except certain (5) corecore onesones

This seen as too radical at first, This seen as too radical at first,

now idea is being more acceptednow idea is being more accepted

an FRS for small companies/entities (an FRS for small companies/entities (FRSSEFRSSE) ) has been developed has been developed


FRSSEFRSSE (1)(1)

retains all basic principles of accounting retains all basic principles of accounting standards but discards detailed explanatory standards but discards detailed explanatory notesnotes

applicable to all companies meeting definition applicable to all companies meeting definition of ‘small company’of ‘small company’

company complying with FRSSE then exempt company complying with FRSSE then exempt from all other accounting standards from all other accounting standards

FRSSE contains, in simplified form, FRSSE contains, in simplified form, requirements from existing accounting requirements from existing accounting standards relevant to most small entitiesstandards relevant to most small entities


FRSSEFRSSE (2)(2)

large companies must prepare large companies must prepare cash flow cash flow statementstatement

small companies do not need to, small companies do not need to,

but but recommended torecommended to produce simplified produce simplified version by FRSSEversion by FRSSE

‘‘a commendable summary of UK GAAP… a commendable summary of UK GAAP… succint and to the point.’ succint and to the point.’

(Barry Johnson, (Barry Johnson, Certified AccountantCertified Accountant, Feb. , Feb. 1996)1996)


FRSSEFRSSE (3)(3)

However:However:

FRSSE not likely to make preparing financial FRSSE not likely to make preparing financial statements easier or cheaperstatements easier or cheaper

exemptionexemption from from disclosuredisclosure, not measurement, not measurement

Not everybody convinced of case for relaxing Not everybody convinced of case for relaxing measurement for smaller companiesmeasurement for smaller companies

Some say it should say, in each FRS or SSAP, Some say it should say, in each FRS or SSAP, what not applicable to smaller companieswhat not applicable to smaller companies


FRSSEFRSSE (4)(4)

questionable whether accounts produced questionable whether accounts produced under FRSSE will give ‘true and fair’ view under FRSSE will give ‘true and fair’ view (which applies (which applies to to allall companies) companies) under the under the Companies ActsCompanies Acts

users users would still have to refer to ‘mainstream’ would still have to refer to ‘mainstream’ accounting standards in order to give a ‘true accounting standards in order to give a ‘true and fair’ viewand fair’ view

balance between those favouring balance between those favouring no no accounting standards for small companies and accounting standards for small companies and those wanting those wanting to retain present systemto retain present system


FRSSEFRSSE (5)(5)

FRSSE will be periodically updated and FRSSE will be periodically updated and revised to reflect future developments in revised to reflect future developments in financial reporting financial reporting

FRSSE will probably be carefully monitored FRSSE will probably be carefully monitored and reviewed after 2 years in operationand reviewed after 2 years in operation

Key (1)

• AIMAIM Alternative Investment Market Alternative Investment Market • ASBASB Accounting Standards BoardAccounting Standards Board• ASCASC Accounting Standards CommitteeAccounting Standards Committee• CA Companies Act(s) (eg CA 1985)• CCABCCAB Consultative Committee of Accounting BodiesConsultative Committee of Accounting Bodies• DDsDDs Drafts for Discussion/Discussion DraftsDrafts for Discussion/Discussion Drafts• DTIDTI Dept. of Trade and IndustryDept. of Trade and Industry• EDsEDs Exposure DraftsExposure Drafts• EUEU European UnionEuropean Union• FASBFASB The Financial Accounting Standards Board The Financial Accounting Standards Board

(USA)(USA)• FRCFRC Financial Reporting CouncilFinancial Reporting Council

Key (2)

• FREDsFREDs Financial Reporting Exposure DraftsFinancial Reporting Exposure Drafts• FRRPFRRP (Financial Reporting) Review Panel(Financial Reporting) Review Panel• FRSsFRSs Financial Reporting StandardsFinancial Reporting Standards• FRSSEFRSSE FRS for Small EntitiesFRS for Small Entities• GAAPGAAP Generally Accepted Accounting PracticeGenerally Accepted Accounting Practice• IASCIASC International Accounting Standards International Accounting Standards

CommitteeCommittee• IASsIASs International Accounting StandardsInternational Accounting Standards• SORPsSORPs Statements of Recommended PracticeStatements of Recommended Practice• SSAPsSSAPs Statements of Standard Accounting PracticeStatements of Standard Accounting Practice• UITFUITF Urgent Issues Task ForceUrgent Issues Task Force• UK United Kingdom

The Regulatory Framework of Accounting

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