Memorandum submitted by the Accounting
THE REGULATION OF ANNUAL FINANCIAL REPORTING
1.1 This paper responds to a request dated
22 March 2002 from the Treasury Committee, for the Accounting
Standards Board to submit written evidence in connection with
the inquiry into the financial regulation of public limited companies.
1.2 It provides information on:
the structure and organisation of
the independent bodies concerned with the regulation of annual
financing reporting, including the role of the Financial Reporting
Review Panel in enforcing UK accounting standards [sections 2
current UK accounting standards [section
the current strategy and agenda of
the Accounting Standards Board [sections 6 and 7].
2.1 The Financial Reporting Council (FRC)
and its two operational bodies, the Accounting Standards Board
(ASB) and the Financial Reporting Review Panel (FRRP), were set
up in 1990.
2.2 The regime was established in line with
the recommendations of a committee under the chairmanship of Sir
Ron (now Lord) Dearing, set up in the wake of several spectacular
corporate failures and other financial scandals involving poor
There was widespread acceptance in business, government and the
profession of the need for improved accounting standards and a
stricter enforcement system. There was also widespread support
for the recommendation that the regulatory bodies should be independent
of sectional interest and also of government. Until that time,
accounting standards had been set solely by the accountancy profession.
2.3 Annex A provides an organigram of the
current independent regulatory structure concerned with annual
2.4 The FRC, the over-arching body, plays
a central role in the success of the system. It is funded by contributionone-third
eachfrom government, from the accountancy profession and
from business, the latter largely through a levy now administered
by the Financial Services Authority (FSA).
The Chairman and Directors of the FRC are appointed by the Secretary
of State for Trade and Industry and the Governor of the Bank of
2.5 Members of the FRC
are drawn from the business, financial, professional and other
communities at senior levels. It provides broad guidance to the
operational bodies and administers their funding. Its Appointments
Committee, which includes the Chairman and Directors, makes appointments
to the ASB and FRRP.
3.1 The ASB makes, amends and withdraws
accounting standards, the ultimate authority for which derives
from the recognition of the ASB by the Secretary of State for
Trade and Industry under section 256 of the Companies Act 1985.
The ASB has up to 10 Board members,
of whom two (the Chairman and the Technical Director) are full-time,
and the remainder, with a variety of backgrounds, are part-time.
Three observers also attend ASB meetingsfrom the Department
of Trade and Industry, from HM Treasury and, since 1 April 2001,
from the International Accounting Standards Board (IASB).
3.2 The ASB's predecessor body issued "Statements
of Standard Accounting Practice" (SSAPs). Early in its life
the ASB adopted these standards and began developing its own,
contained in "Financial Reporting Standards" (FRSs).
Both SSAPs and FRSs fall within the legal definition of accounting
standards. Many of the SSAPs have been superseded by FRSs but
some remain in force.
3.3 Accounting standards apply to the annual
financial statements of all companies, and of other kinds of entities
that prepare accounts that are intended to provide "a true
and fair view". They also apply to other accounting information
published by companies (and for example the preliminary announcements
and interim financial statements of listed companies) insofar
as relevant regulators require this.
3.4 The Foreword to Accounting Standards
explains the authority, scope and application of accounting standards.
The principles that guide the ASB in establishing accounting standards
are contained in the ASB's Statement of Principles for Financial
3.5 The ASB's policy is to consult widely
on all its proposals. Generally the development of a new accounting
standard involves at least two formal consultation documents,
a Discussion Paper and a Financial Reporting Exposure Draft (FRED).
Responses to such consultations are made publicly available. Published
Financial Reporting Standards provide commentary on the development
of the standards, including how the main aspects of responses
to consultation have been dealt with.
3.6 As indicated in Annex A, the ASB has
a number of sub-committees, principal amongst which is the Urgent
Issue Task Force (UITF). The work of these sub-committees is described
in paragraphs 5.5 to 5.9 below.
3.7 Throughout its history, the ASB has
collaborated with accounting standard-setters from other countries
and the International Accounting Standards Committee (IASC), the
predecessor body of the current International Accounting Standards
Board (IASB), in order to ensure that its own standards are developed
with due regard to international developments. The ASB now has
a particularly close working relationship with the IASB, which
is described in more detail in section six below.
3.8 The Chairman of the ASB makes an annual
report to the FRC on its activities, published in the FRC's own
Annual Review. In addition, the ASB publicises its activities
through press releases, its website
and its quarterly newsletter "Inside Track" which provides
a broad, non-technical report on the ASB's activities. The Chairman,
Technical Director and staff also meet regularly with groups from
business and the accountancy profession to discuss the ASB's work;
these meetings are important in shaping the Board's thinking.
4.1 The Dearing Committee, in setting up
the present regulatory regime, concluded that improved standards
alone would not secure better financial reporting. Indeed, as
standards became more rigorous they believed that pressures on
auditors would increase and securing compliance would become more
difficult. The committee thus recommended the creation of a separate
bodythe Financial Reporting Review Panel (FRRP)to
oversee this compliance. It was set up as a second operational
body under the FRC.
4.2 At the same time, the arrangement recognised
that primary responsibility for high quality financial reporting
must continue to rest with the company's board of directors. It
recognised too that the auditor remains the first line of defence
against the pressures of defective financial reporting.
4.3 The FRRP was given authority by the
Secretary of State to enquire into the annual accounts of public
companies and large private companies where they do not appear
to comply with the requirements of the Companies Act 1985, including
applicable accounting standards. The FRRP's power is confined
to the statutory accounts. It cannot consider other financial
material such as the auditor's report or chairman's statement;
nor can it consider preliminary announcements; interim reports
or financial material included in prospectuses.
4.4 It relies on matters being brought to
its attention either directly by complainants or by press comment.
However, the FRRP has also considered and reported to the FRC
on the case for, and the questions raised by, introducing an element
of proactivity into its procedures. It is continuing to review
4.5 When there is clearly a case to answer,
it is heard by a Group (normally of five Panel members) including
the Chairman, who selects the Group, and the Deputy Chairman.
If, having questioned the accounts and heard the company's explanations,
the Panel Group is still not satisfied, it seeks to persuade the
company voluntarily to adopt a more appropriate accounting treatment.
The directors may then voluntarily correct the accounts, taking
the remedial action agreed with the FRRP. Should the FRRP fail
to effect a voluntary correction, it can exercise its powers to
secure revision of the original accounts through a court order.
The FRRP maintains a legal cost fund of £2 million for this
4.6 So far, the FRRP has succeeded in resolving
all cases brought to its attention without having to apply for
a court order. Since 1 January 1997 the FRRP has required corrective
action to be taken in 28 cases. Its pronouncements on such cases
provide a useful additional analysis of contentious issues. More
important than the statistics however is the support the Panel
provides to preparers of accounts and to auditors in reinforcing
commitment to good financial reporting. The deterrent effect of
the FRRP should not be underestimated although there are no statistics
to show the instances where its findingsor indeed its existencehave
discouraged an unhelpful accounting treatment.
4.7 A further strength of the FRRP is the
fact that its member
are held in high regard and command a wide range of professional
financial and business expertise.
4.8 The focus of the Panel is the quality
of company accounts on the public record. However, it does liaise
with other regulators, specifically with the professional bodies
of auditors and directors involved in Panel cases, as well as
other regulators who may have an interest in the material drawn
to its attention.
CURRENT UK ACCOUNTING
5.1 A list of the ASB's extant standards
and related documents is set out on page 79 of the 2001 Annual
Review of the Financial Reporting Council. A number of these standards,
developed against the background of the corporate scandals of
the 1980s, are targeted at practices previously considered to
represent abuses. Principal amongst these are:
FRS 4 "Capital Instruments",
to prevent companies' debt being characterised as equity;
FRS 5 "Reporting the Substance
of Transactions", focused on ensuring that operational assets
and related finance are shown on the balance sheet and on curbing
early revenue recognition;
FRS 7 "Fair Values in Acquisition
Accounting" and FRS 12 "Provisions, Contingent Liabilities
and Contingent Assets" which have curtailed the shifting
of profits from one accounting period to another; and
FRS 8 "Related Party Disclosures".
5.2 Of more recent standards, FRS 17 "Retirement
Benefits" highlights the pension funding obligations that
companies have entered into, and the resources available to meet
those obligations. FRS 18 "Accounting Policies", which
replaced SSAP 2 "Disclosure of Accounting Policies",
includes the requirement that a company adopt accounting policies
"most appropriate to its particular circumstances for the
purpose of giving a true and fair view".
5.3 Each of the above-named standards has
requirements that are, in their different ways, more stringent
than the present equivalent standards of the IASC/IASB.
5.4 UK standards are written in a style
which emphasises principles of financial reporting and which calls
for the exercise of judgement. By comparison with US Financial
Accounting Standards and the related rulings of the US Securities
and Exchange Commission, the absence of "bright line"
rules in the UK regime does not easily allow loopholes to be exploited.
It also permits auditors to challenge company directors as to
whether their proposed accounting treatments reflect a "true
and fair view" within the context of the standards.
5.5 If issues of concern begin to emerge
within this regime, the ASB's Urgent Issues Task Force (UITF)
has shown itself robust in issuing Abstracts to combat discreditable
interpretations of the UK standards. Abstracts are issued in draft
for public consultation and, once agreed in their final form by
the UITF, are reviewed by the ASB prior to publication.
They are regarded as definitive statements on the interpretation
5.6 Accounting standards and UITF Abstracts
normally address issues that affect the generality of companies.
Statements of Recommended Practice (SORPs) are the acknowledged
vehicles for guidance on application of accounting standards in
particular industries or sectors.
5.7 The ASB itself does not issue SORPs;
that is the responsibility of the SORP-making bodies. The ASB's
statement "SORPs: Policy and Code of Practice"
sets out the requirements which recognised SORP-making bodies
are expected to follow. The code of practice aims to maintain
the quality of SORPs and to ensure due process in their development,
whilst at the same time giving SORP-making bodies freedom to develop
their guidance in the most useful way for their industry or sector.
5.8 The ASB appends a statement, where appropriate,
that the SORP does not appear to contain any fundamental points
of principle that are unacceptable in the context of current accounting
practice or to conflict with an accounting standard or the ASB's
plans for future standards. Two sub-committees of the ASBthe
Financial Services and Other Special Industries Committee (FSOSIC)
and the Public Sector and Not-for-profit Committee (PSNC)provide
advice to the Board in its review of SORPs.
5.9 One further sub-committee, the Committee
on Accounting for Smaller Entities (CASE), advises the ASB: on
its policies with regard for accounting standards for non-public
companies which meet the requirements for treatment as small companies
under the Companies Act 1985.
CURRENT ASB STRATEGY
6.1 Two events in 2001 had a significant
bearing on the current strategy of the ASB.
the reconstitution of the IASC to
set up the IASB; and
the publication of a draft Regulation
to implement an earlier decision of the Council of Ministers that
the group financial statements of listed companies in the EU should
comply with international rather than with national accounting
6.2 These two events are fully discussed
on pages 22 to 28 of the 2001 Annual Review of the FRC. Of particular
note is the mission of the reorganised IASB to achieve a single,
internally consistent, high-quality set of accounting standards
for use across the globe. To achieve this, it works in partnership
with major national standard-setters, drawing on the expertise
and resource of those bodies; the national standard-setters also
take particular responsibility for ensuring that the views of
their domestic constituents are heard in the international debate.
6.3 The ASB is one of the eight standard-setters
named as "partners" in the current work of the IASBtogether
with the standard-setters of Australia/New Zealand, Canada, France,
Germany, Japan and the USA. Individual projects on the IASB's
agenda are being developed by staff either at one of the national
standard-setters or at the IASB or, in many cases, on a co-operative
basis. The ASB currently has a substantial share of the international
6.4 EU Ministers have proposed that from
1 January 2005, all listed companies in the EU should prepare
their consolidated financial statements in accordance with adopted
international accounting standards. A draft Regulation to this
effect is at a late stage of negotiation and EU Ministers are
expected to approve it in early May. The intention is that the
IASB's standards will form the basis of those adopted international
accounting standards. It is therefore now virtually certain that
the IAS-based regime for the group financial statements of listed
companies will begin in 2005.
6.5 Present International standards are
acknowledged as less robust in many respects than their UK equivalents.
The IASB accepts that improvements are necessary for many of its
existing standards and has an extensive on-going programme of
This seems likely to result in manyif
not mostof the IASB's standards being revised before 2005.
6.6 Against this background, the ASB's current
strategy is focused on:
working with the IASB and with "partner"
standard-setters around the world to improve and extend the existing
International standards; and
seeking to adopt International standardsonce
they are agreedwithin the UK regime, in order to effect
a smooth transition towards 2005 and a congruence of the standards
applied by listed and unlisted companies. In this connection,
the ASB intends shortly to issue six UK FREDs proposing the adoption
of International standards that have recently been reconsidered
by the IASB (together with related material), in place of their
current UK equivalents.
7.1 The Committee's terms of reference make
specific reference to the Enron collapse; there are as yet insufficient
facts available to reach conclusions on how the activities of
that group would have been accounted for under UK accounting standards.
The ASB has, however, already resolved that, as the facts do emerge,
it should consider whether any existing UK standards might need
7.2 In addition, the ASB's current workload
already includes a number of projects which appear to be relevant
to problems encountered at Enron and in other recent "profile"
cases. These are summarised below.
Accounting for financial instruments
7.3 The IASB will shortly publish a revision
of its existing (and complex) standard on the valuation of financial
instruments (IAS 39). The UK currently has no standard requiring
financial instruments (and including derivatives) to be accounted
for other than at historical cost, although FRS 13 "Derivatives
and other Financial Instruments: Disclosures" does require
substantial information on fair values to be provided in the footnotes
to the financial statements. The new IASB text will be published
as a FRED in the UK, together with a commentary from the ASB,
with a view to the ensuing International standard being adopted
in the UK. However, adoption will not be possible without changes
in the EU Company Law Directives and the UK Companies Act, which
it is understood may take until 2004 to complete.
7.4 Given increasing complexity in business'
terms of trade, there is a need for a revenue recognition standard
in the UK, to supplement material in FRS 5 "Reporting the
Substance of Transactions" and a related UITF Abstract. The
current International standard on revenue recognition is relatively
simplistic and out-moded; there is no general US standard (although
the US SEC and various US committees have issued a substantial
volume of rules). An ASB Discussion Paper was issued in July 2001;
work is in hand to develop a draft standard, which the ASB intends
to discuss with the IASB this year.
Consolidation Policy and Practice
7.5 The current international standard (IAS
27) and interpretation (SIC 12) on consolidation methodology provide
rather less guidance than equivalent UK standards. There is, in
addition, some debate internationally as to whether the global
standard should be based on "control" (used in the UK)
or "ownership" (used in the USA) and, indeed, how an
international standard should be written (ie whether it should,
as in the current US model, include "bright line" ownership
criteria as a basis for deciding whether or not to consolidate
a dependent entity). The ASB is running a project for IASB, working
with the other national "partner" standard-setters to
try to resolve the current debate, which is particularly relevant
to special purpose entities [SPEs]. A first paper will be presented
to the IASB in May.
Recognition and De-recognition
7.6 The IASB has no standard dealing comprehensively
with recognition and de-recognition issues (for example, when
an asset has been sold or merely offered as security for loan
finance). The UK standard, FRS 5 "Reporting the Substance
of Transactions", has proved successful in curbing "off
balance sheet finance". The ASB has been asked by the IASB
to develop an overall framework approach to recognition and de-recognition
issues, for consideration for international use.
7.7 Concerns have been expressed with regard
to the current model for accounting for leases, which makes an
artificial distinction between finance leases (where obligations
are recorded on the balance sheet) and operating leases (where
they are not). An equivalent distinction is made in UK, US and
International standards. In 1999, the ASB published an international
discussion paper proposing a single model for lease accounting;
it is now developing the ideas in that paper to prepare a draft
standard. The IASB is monitoring this project, with a view to
taking it onto its agenda in due course.
Operating and Financial Review
7.8 Encouraging boards of directors to set
out their explanation of factors significant to prospects for
the business is paramount in assisting investors to understand
the financial statements. In 1993, the ASB issued its statement
"Operating and Financial Review" (OFR) to encourage
high quality explanations. It is now working on a revision to
that statement and is currently discussing proposals with the
FSA and others. The ASB intends to issue a consultation paper
on its revision in the next two months.
7.9 It should be noted that the current
OFR statement has persuasive rather than mandatory effect; the
ASB does not currently have the authority to make standards in
this area. It is understood, however, that the government may
bring forward for adoption in law, the recommendation of the recent
Company Law Review Steering Group that the OFR statement should
be made mandatory for public limited and other large companies.
7.10 One area of financial reporting remains
a particular challenge. Insurance accounting has developed under
the twin pressures of financial reporting and regulatory control;
this latter aspect means that the accounting practices adopted
are quite different from one country to another, and generally
regarded as unsatisfactory. The ASB has been contributing to an
international project on insurance accounting since 1996 and continues
to participate in what has now become an urgent priority for the
7.11 Further detail of the above projects,
and of the other items on the ASB's and IASB's agendas. Is given
in the report from the Chairman of the ASB included in the enclosed
2001 Annual Review of the FRC.
FRCFinancial Reporting Council.
ASBAccounting Standards Board.
FRRPFinancial Reporting Review Panel.
CASECommittee on Accounting for Smaller
FSOSICFinancial Sector and Other Special
PSNCPublic Sector and Not-for-Profit
UITFUrgent Issues Task Force.
LIST OF DOCUMENTS SUBMITTED WITH THIS PAPER
"The Making of Accounting Standards",
a report published in 1988 by a committee chaired by Sir Ron Dearing.
2001 Annual Review of the Financial Reporting
The Foreword to Accounting Standards (published
The Statement of Principles for Financial Reporting
SORPs: Policy and Code of Practice (published
15 April 2002
1 The report of the Dearing Committee-"The Making
of Accounting Standards"-was published in 1988 and is annexed
in evidence (not printed). Back
Summary financial information, for the year ended 31 March 2001,
is provided on page 76 of the annexed 2001 Annual Review of the
FRC (not printed). Back
The members of the FRC at 31 December 2001 are set out on page
66 of its 2001 Annual Review. Back
The membership of the ASB is set out on page 69 of the 2001 Annual
Review of the FRC. Back
Annexed in evidence. Back
The membership of the FRRP is set out on page 74 of the 2001
Annual Review of the FRC. Back
The membership of the UITF is set out on page 70 of the 2001
Annual Review of the FRC. Back
UITF Abstracts extant at 31 December 2001 are listed on page
80 of the 2001 Annual Review of the FRC. Abstract 33 "Obligations
in Capital Instruments" has since been issued, and two further
draft Abstracts, already issued for consultation, are awaiting
final review by the ASB. Back
Annexed in evidence. Back
For membership of FSOSIC, see page 71 of the 2001 Annual Review
of the FRC. Back
For membership of PSNC, see page 72 of the 2001 Annual Review
of the FRC. Back
Not reproduced. Back