Technical Update Feb 12

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Audit | Tax | Advisory

Financial Accounting Update

28 February 2012

Matthew Stallabrass

Update on recent developments

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Crowe Clark Whitehill

Introduction

► The future of UKGAAP

► Background to the proposals

► Impact

► Timetable

► Key areas of difference

► Audit exemption proposals

► Recent developments in IFRS

► Revenue recognition

► First time adoption


The future of UKGAAP - background

► The future of UKGAAP has been under discussion and consultation since 2004

► View that it is difficult to maintain two different accounting frameworks (UKGAAP and IFRS)

► Exposure draft issued in October 2010 based on IFRS for SMEs with almost 300 comments received

► Current exposure draft issued in January 2012 with comments sought by 30 April 2012

► Final standards are expected to be issued by the end of 2012

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The future of UKGAAP - impact

► Small companies – retain the use of the FRSSE

► Minimal immediate impact

► FRSSE will be revised and simplified further if current EU proposals come into affect

► Listed groups – remain required to use EU-adopted IFRS

► No impact at a consolidated level

► Will impact subsidiary companies

► Everyone else will be required to use the new FRSs

► May elect to use EU-adopted IFRS


The future of UKGAAP - timetable

► Change will be mandatory for periods commencing on or after 1 January 2015

► Comparative balance sheet will need restating hence a transition date of 1 January 2014

► Early adopted will be permitted for most entities from as soon as the standard is published hence it might be possible to convert for a 31 December 2012 year end

► Issues to consider for early adoption:

► Impact of the conversion on reported profits and taxable profits

► Banking covenants

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Key areas of difference – financial instruments

► The lack of a financial instruments standard was seen as one of the main weaknesses of current UKGAAP

► A financial instrument is a contract that gives rise to a financial asset in one entity and a financial liability or equity instrument of another entity

► Two categories of financial instruments:

► Basic financial instruments

► Other financial instruments



► Basic financial instruments:

► Cash

► A debt instrument (such as accounts receivable and payable)

► Commitments to receive a loan that satisfy certain criteria

► Investments in non convertible preference shares and non puttable ordinary shares

► Basic financial instruments are valued at amortised cost or cost less impairment

► Except for investments in non convertible preference shares and non puttableordinary shares which are publically trading or whose value can be measured reliably in which case measured at fair value through profit and loss

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► Other financial instruments are financial instruments not classed as basic, common examples are:

► Interest rate swaps

► Forward or futures contracts (such as for foreign currency)

► Commitments to make a loan

► Other financial instruments are valued at fair value through profit and loss and could impact taxable profit

► Fair value assessed using a hierarchy:

1. Quoted price for an identical asset in an active market

2. Recent transaction for an identical asset

3. Valuation technique



► 1 January enter into a commitment to buy an item of equipment for $1m on 30 September and enter into a forward currency contact to fix the exchange rate

► At 31 March (year end):

► Under existing UKGAAP disclose the capital commitment and the forward currency contract

► Under current proposals the forward currency contract is an other financial instrument held at fair value through profit and loss

► At 30 September:

► Under UKGAAP the base cost of the asset is calculated using the fixed rate

► Under current proposals the base cost of the asset is calculated using a 30 September exchange rate with movement to the profit and loss

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► Unless hedge accounting is applied:

► Entity documents the hedge identifying the hedged item, the hedging instrument and the risk

► The risk is one of the risks specified

► The hedging instrument is one of the ones specified

► The hedge is estimated to be highly effective

► In which case the gain or loss on the hedged item and the hedging instrument should be recognised through the profit and loss account at the same time

► Rules are very specific and not all commercial hedging arrangements will be classed as accounting hedges


Key areas of difference – deferred tax

► Use of timing difference plus approach to deferred tax

► Likely to result in greater deferred tax liabilities

► New areas which will give rise to deferred tax:

► Revaluations including investment property

► Fair values on business combinations

► Unremitted earnings on overseas subsidiaries or associates

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Key areas of difference – intangible assets

► Definition of intangible asset is similar to the IFRS definition and hence will give rise to more identifiable intangible assets upon a business combination

► Treatment of negative goodwill is the same as the current UKGAAP treatment

► Intangible assets (including goodwill) are to be amortised and have a presumed life of five years unless an entity can make a reliable estimate of the life of the asset

► This will impact entities currently amortising intangible assets over a useful life of more than five years where this will need to be re-assessed

► An accounting policy choice remains on the capitalisation of development expenditure


Key areas of difference – pension schemes

► Change in what is charged to profit and loss and what is charged to the STRGL

► Currently expected return on plan assets is credited to profit and loss

► Proposed that this is replaced by interest income based on opening assets

► Likely to result in a lower P&L credit with the difference being put through the STRGL

► Group defined benefit schemes

► Currently often treated as a defined contribution scheme in the subsidiary accounts

► Will now appear on the balance sheet of at least one subsidiary (the main sponsoring employer)

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Key areas of difference – reduced disclosure

► Reduced disclosure framework available for the individual accounts of parents and subsidiaries included in group accounts prepared under EU-adopted IFRS or UKGAAP

► Exemptions from specified disclosures made on a group basis including:

► Share based payments (IFRS 2)

► Financial instruments (IFRS 7)

► Acquisitions (IFRS 3)

► Impairment (IAS 36)

► Must notify shareholders in writing about the use of disclosure exemptions


Key areas of difference – other

► Revaluation gains and losses on investment properties are taken to profit and loss instead of the STRGL

► Related party disclosures are likely to change due to current EU proposals

► Could see the removal of the exemption from disclosure for 100% subsidiaries

► Further consultation on biological assets and a project to be undertaken on grants

► Current SORPs to be updated

► Leasing and Banking Segments SORPs withdrawn

► Consultation on the Accounting for Insurance Business SORP

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The future of UKGAAP – conclusion

► Changes could have a significant impact on the reported results for certain companies

► Need to understand the impact of the change and ensure that it will not have an adverse impact on banking covenants

► Early identification of areas of difference will allow information to be collated and a transition planned in a cost effective manner

► Companies should consider whether there is a case for early adoption


Audit exemption proposals

► Proposal to align the audit exemption requirements with the small companies limits

► A company would need to breach two out of three criteria to trigger the requirement to have a statutory audit

► Proposal to exempt subsidiary companies from audit if certain criteria were met:

► Owned by an EU parent and included within consolidated accounts

► Parent company guarantees the debts of the subsidiary

► All shareholders have declared their agreement (must be done annually)

► Currently proposed to effect years ended on or after 1 October 2012

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Recent developments in IFRS

► Second exposure of plans on revenue recognition with implementation date no earlier than periods commencing 1 January 2015

► Five step approach to recognising revenue

► Step 1 – identify the contract with a customer

► Step 2 – identify separate performance obligations

► Step 3 – determine the transaction price

► Step 4 – allocate the transaction price to performance obligations

► Step 5 – recognise revenue when performance obligations are satisfied

► Significantly enhanced disclosure requirements

► Specific impact on the construction industry and companies who currently recognise revenue over time


IFRS first time implementation

► Periods commencing on or after 1 July 2010

► IFRIC 19 – guidance on debt for equity swaps

► Periods commencing on or after 1 January 2011

► IAS 24 (revised) – amended definition of related party

► Periods commencing on or after 1 July 2011

► Amendment to IFRS 7 – disclosure on transfers of financial assets

Documents

Technical Update Feb 12