Aligning Accounting Standards: The Grail of One Global GAAP

Universal accounting standards are slowly becoming a reality as countries begin to align generally accepted accounting principles (GAAPs) with International Financial Reporting Standards (IFRS). This alignment is being promoted by the G20 – in September 2009, the leaders called on “international accounting bodies to redouble their efforts to achieve a single set of high quality, global accounting standards within the context of their independent standard setting process, and complete their convergence project by June 2011.”

IFRS-based standards have been adopted across the EU and in about 120 other countries, and are being introduced in Canada, Brazil and China. Japan is holding back its decision until 2012, but some Japanese companies that are more focused on overseas markets, such as Japan Tobacco, are making the leap early and have set specific timetables for reporting earnings under IFRS voluntarily.

Likewise, the US has yet to decide whether it will back IFRS over its own system, the US GAAP, and should make a final decision by the end of April this year. There are some positive signs that harmonisation will move forward – recently the International Accounting Standards Board (IASB) and the US-based Financial Accounting Standards Board (FASB) have proposed to establish a common approach to offsetting financial assets and financial liabilities on the statement of financial position (balance sheet).

In the UK, the Accounting Standards Board (ASB) is further along in the harmonisation process – it published its proposals on the future of UK GAAP in October 2010, aiming to “simplify UK standards into a concise, coherent and updated form”. The exposure drafts contain proposals for a three-tier reporting framework based on public accountability, which aims to balance the needs of preparers and users of accounts (see Figure 1). It proposes that the new framework would be effective from 1 July 2013.

Figure 1: The Proposed Reporting Framework

Source: ASB

The three tiers are defined as follows:

  1. Tier 1 EU-adopted IFRS for publicly accountable (PA) companies.
  2. Tier 2 Financial Reporting Standard for Medium-sized Entities (FRSME), which is a new standard based on the IASB’s IFRS for Small and Medium-sized Entities (IFRS for SMEs), as adapted for use in the UK and to comply with EU law. The draft standard runs to less than 400 pages.
  3. Tier 3 Financial Reporting Standard for Smaller Entities (FRSSE), which is for smaller entities – i.e. those with 50 or fewer staff, turnover of less than £6.5m and assets of less than £3.26m – without public accountability.

The ASB released a draft impact assessment explaining the need for a change to current UK financial reporting standards and why it considers its proposals to be the way forward. As well as the costs, which are estimated at £78.9m, the impact assessment sets out the expected benefits that will arise from a consistent accounting framework (see Figure 2). As part of the consultation process, the ASB has launched a series of outreach meetings to debate the way forward.

Figure 2: Impact Assessment

Source: ASB

Consultation – Feedback Wanted

On 24 January 2011, the ASB gathered users (20% of the audience), preparers (46%) and auditors (34%) in London in order to present its methodology, as well as some criticisms from within its own ranks, but mainly to gauge the industry’s response to its proposed changes to UK GAAP.

The audience focus was varied. In a straw poll of 100 participants, almost half (48%) chose more than one tier as their main area of interest; Tier 1 and subsidiaries (1S) was the main interest for 29%, while Tier 2 and Tier 3 were of interest to 14% and 10% of the audience respectively.

Roger Marshall, ASB interim chairman and a former partner at PricewaterhouseCoopers (PwC), led off the discussion by explaining why the ASB decided to reform UK GAAP, which many believe is no longer fit for purpose. “UK GAAP is probably not where we would like it to be – it is a fairly incoherent mixture of standards with some original UK GAAP and some IFRS standards,” he said.

In addition, continuing to run two frameworks with different terminology was not an option. “It is difficult for preparers and also audit firms that have to do their own training on UK GAAP and IFRS,” he explained. Therefore, the ASB decided to design a UK framework based on the IFRS with some amendments, for example retaining revaluation that was allowed under UK GAAP but is not included in IFRS for SMEs. But its overarching aim was for efficiency and simplicity, with minimal change.

Why the tiered approach? “Because we think that this structure will meet the needs of the preparers and the users,” said Marshall. “On the one hand, users for PA companies need more information; and on the other hand, preparers need a simple methodology that will address the needs of the users.”

A Contrary Opinion

Presenting an opposing opinion from inside the ASB, Edward Beale, chief executive officer (CEO) of City Group and an ASB member, began by defining the objective of accounts as one of providing users with useful information in a usable format. “Accounts are all about communicating information,” he said, “and the big challenge lies in identifying the relevant information to be communicated. In order to meet the objective of accounts, the ASB needs to know who uses GAAP accounts, yet it does not have that information to date.

“Without a clear vision, the ASB cannot identify the benefits arising from these proposals. This is why the ASB is struggling to put together a coherent impact assessment,” he asserted.

Although Beale agreed with the main building blocks, such as the tiered approach, he too grappled with the question of the cut-off points. “The different tiers should reflect three sets of different information that users need depending on the nature of the company. They must be significantly different to require three sets of rules,” he argued. “At present UK GAAP is subject to all, bar certain limitations, so question is why can’t Tier 2 be an option for all?”

He also questioned the assumption that the ASB is the best body to set cut-off points. “As Donald Rumsfeld says, it is a known unknown. But for the ASB to be comfortable with certain cut-off points, this needs to change to a known known. The ASB has not been able to differentiate between different sets of users. Although it has stated that the IFRS for SMEs is not suitable for PA entities, it has not presented any evidence to support this.”

Pushing the ASB to fulfil its remit as a world leader in standards, Beale suggested that the board should be looking for the best possible solution, not just improving on the status quo. “If we are going to replace UK GAAP with IFRS standards, then the ASB ought to have the ambition to review those IFRS standards critically and improve them where necessary,” he said. “I don’t accept the policy that the changes should be minimal for the sake of convergence.”

In a straw poll of the audience on whether the ASB should be looking to improve on IFRS for SMEs, two-thirds wanted more extensive change, i.e. allow revaluations, whereas 20% wanted limited changes, for example deferred tax, and 14% were in favour of minimal changes, such as legal modifications.

He concluded by asking users to say what information they needed, particularly those who currently use UK GAAP. “The FRC [Financial Reporting Council] document challenges standards setters to reduce complexity and ASB should rise to the challenge. This is a once in a generation opportunity and we should take advantage of it. We shouldn’t be forced into doing the wrong thing by self-imposed deadlines. I would like this project to finish sooner rather than later, but think we should take our time to get it right. We have the time to do it – the question is do we have the inclination?”

Input From the Industry

The open discussion took up the issue of the lack of input from users and preparers. One participant argued that it was mainly medium-sized companies that reported under UK GAAP, but there aren’t any users of those financial statements. “If there were, they would be telling us what to do,” he said. “Most accounts that are filed at Companies House are never looked at again. This reality supports a solution based on minimum requirements by company law.”

From the panel, Brian Shearer, national director of financial reporting, Grant Thornton, argued against the idea that this was just an exercise in compliance and said that other companies, for example trading partners, would be the primary users of these accounts. “What do users want and why don’t we hear from them? They are a difficult group to hear from largely because they are too busy doing what they do to spend a lot of time explaining their usage,” Shearer said.

The number of tiers was the main area of contention. When surveyed as to whether the tiers are set at the right level, almost half (45%) favoured only two tiers, with the lower tier based on IFRS for SMEs (i.e. FRSSE taken out), while 30% were happy with three tiers and the remaining 25% wanted two tiers, with the lower based on FRSEE.

A Tier 2 participant asked: “Whereas UK GAAP has traditionally allowed us a choice of accounting policy, why does ASB want to stop that and force us into straightjackets and dumb down accounting?”

Andy Simmonds, a Deloitte partner, an ASB member and chair of the Institute of Chartered Accountants in England and Wales (ICAEW) Financial Reporting Faculty, said that the FRSME objective was to be as short as possible and a key way to do that was to remove choice, such as revaluation and a large amount of disclosures. “One of the reasons why there are only 300 disclosures rather than the 3000 in full IFRS is because the choices are limited. But we recognise that there are things such as revaluation that many would like put back in,” he explained.

Simmonds posed an important question: “Is international comparability important? Do we need a standard that is the same as that in other countries or is it more important to get it right for the UK?” In response, many voiced despair over the potential number of different variations, urging the panel to hang on to the grail of one global GAAP.

One participant from a company that provides training for small accountants said that it was good to have options available for FRSME, but she challenged the panel to consider whether FRSSE was needed. “Is there going to be that much difference to justify three tiers? The smaller practitioner will have clients following the FRSSE and FRSME, so the differences in training and education, which were the pain points in running two GAAPs, are going to continue,” she explained.

Danielle Stewart, one of the original authors of the FRSSE and a member of the ICAEW Financial Reporting Committee, said: “I think we should operate the middle tier for a bit longer because the cost will be disproportionately large for the smaller companies, particularly for preparers that do it themselves and don’t use accountants. Plus, very small companies haven’t got the complexity, such as using complex derivatives, that larger companies face.”

In terms of the timeline for change, most of the participants (61%) were in favour of the ASB’s proposal of mid-2013, with early adoption permitted, while only 10% wanted implementation to be done sooner and 29% wanted a later date.

However, one user made the point that he didn’t want constant change, as he struggled to keep up with change and discontinuity between the different standards. “I don’t want to constantly relearn, so please make your minds up and stick to it. Let’s have some longevity in what comes out of this process,” he urged.

The consultation period is open for comment until 30 April 2011.

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