Global Assurance 9557 Global accounting UK, IAS and US compared Global accounting UK, IAS and US compared KPMG is the professional advisory firm whose aim is to turn knowledge into value for the benefit of its clients, its people and its communities. With more than 100,000 people collaborating world-wide, the firm provides assurance, tax and legal and financial advisory services from more than 800 locations in 160 countries. For further information about our services please speak to your usual contact or call any of our offices. http://www.kpmg.com e UK, IAS and US compared Global accounting Contents 1. Executive summary 2. Introduction 3. Regulatory background 3.1 Generally accepted accounting principles 3.2 Legal and listing requirements 4. Financial statement requirements 4.1 Form of the financial statements 4.2 Comparatives 4.3 Audit reports 4.4 Accompanying financial and other information 5. General issues 5.1 Classification and presentation within the financial statements 5.2 Prior period adjustments and other accounting changes 5.3 Statement of cash flows 5.4 Basis of accounting 5.5 Reporting the substance of transactions 5.6 Consolidation 5.7 Business combinations 5.8 Foreign currency translation 5.9 Hedging 5.10 Interim financial reporting 6. Specific balance sheet items 6.1 Intangible assets 6.2 Fixed tangible assets 6.3 Capitalisation of interest 6.4 Impairment of fixed assets other than investments 6.5 Investments in associates and joint ventures 6.6 Other investments and financial instruments 6.7 Stock 6.8 Debt instruments 6.9 Leases 6.10 Product financing arrangements 6.11 Tax provisions 6.12 Other provisions 6.13 Contingencies 6.14 Capital & reserves, or shareholders’ funds 7. Specific profit and loss account items 7.1 Revenue 7.2 Advertising costs 7.3 Non-monetary transactions 7.4 Holiday pay 7.5 Pensions and other post-retirement benefits 7.6 Other post-employment benefits 7.7 Other long-term employee benefits 7.8 Employee share purchase and option schemes 7.9 Exceptional items 7.10 Sale or termination of an operation & discontinued operations 7.11 Sales of property 7.12 Imputation of an interest cost 1 8 10 10 11 14 14 15 15 16 18 18 22 24 27 29 33 36 46 51 58 60 60 66 69 71 76 80 87 88 93 96 97 103 108 111 116 116 118 119 120 121 126 128 129 134 136 139 141 This book has been prepared to assist clients and others in understanding the differences of principle between accounting standards and the accounting requirements of company law in the United Kingdom, generally accepted accounting principles in the United States and accounting standards and other pronouncements of the International Accounting Standards Committee. Whilst care has been taken in its preparation, reference to the standards, statutes and other authoritative material should be made, and specific advice sought, in respect of any particular transaction. No responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication can be accepted by any member of KPMG International. ISBN 1 85061 2560 © 2000 KPMG International, a Swiss association. All rights reserved. Printed in the Netherlands. KPMG and the KPMG logo are trademarks of KPMG International. No part of this publication may be reproduced, stored in any retrieval system or transmitted in any form by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of the publisher. Designed and produced by Mattmo concept & design, Amsterdam. Printed by Drukkerij Dombosch, Raamsdonklsveer 1. Executive summary Introduction Despite having a great deal of common purpose and common concepts, the accounting principles in the UK and the US and under International Accounting Standards (IASs) can lead to markedly different financial statements. This is not merely of academic interest. In the global market for capital, the differences need to be understood and, eventually, eliminated. This book examines, but not exhaustively, those areas of UK, IAS and US requirements most frequently encountered where principles, or their application, differ. Regulatory background The overriding requirements for a UK company’s financial statements is that they give a ‘true and fair’ view. Accounting standards are an authoritative source as to what is and is not a true and fair view, but do not define it unequivocally. Ad hoc adaptations to specific circumstances may be required. Moreover, if, rarely, following the requirements of standards would fail to give a true and fair view, those requirements must be departed from to the extent necessary to give a true and fair view. Under IAS the situation is very similar. In the US however, financial statements are more closely tied into the rule-book by the requirement that they be prepared in accordance with GAAP. General issues Substance The ‘true and fair’ approach is typified by the UK standard that requires transactions to be accounted for in accordance with their substance. Whilst the real targets of this requirement were the (now defunct) off balance sheet finance schemes, it is significant that the way in which this has been achieved is by a highly conceptual standard. Assets and liabilities are defined and attention is directed toward analysing probable changes in benefits, risks and obligations in order to determine the substance - the so called risk-and-rewards approach. In contrast, the US deals with similar issues by detailed prescription for each type of transaction, eg leasing, product financing, sale of properties or transfers of financial assets and those prescriptions do not necessarily follow a risks-and-rewards approach, for example transfers of financial assets are on the so-called financial components basis (see below). As a general principle IASs follow the risk-and-rewards approach but have rather less guidance as to how this might be carried out; and in the case of transfers of financial assets they follow the American components approach. Revaluation Having established that an asset exists, the IAS and British bases of measurement can be fundamentally different from that of America. In Britain and under IASs certain classes of assets, principally but not solely property, may be revalued provided that this is done consistently and the valuations are kept up to date. In America the historical basis must be retained (aside from certain financial instruments). Business combinations Business combinations are often a source of accounting issues. A few, important differences remain between the three GAAPs. Both IAS and the UK include a size test in their uniting/ pooling-of-interests (merger) criteria; the US does not. As a result, pooling-of-interests accounting is comparatively common in the US but not in the UK or under IAS. When 1. Executive summary 1 7.13 Extraordinary items 7.14 Dividends 7.15 Earnings per share (EPS) 8. Specific major disclosure items 8.1 Segmental reporting 8.2 Disclosures about financial instruments 8.3 Related party transactions Appendices I Common differences in accounting terminology II Common accounting abbreviations 142 143 144 148 148 151 158 160 164 Specific balance sheet items Intangibles For many years perhaps the most significant differences between the three approaches lay in the area of intangibles. In the US, the long standing treatment of (positive) goodwill is the same as for any other acquired intangible. Such assets must be capitalised and subsequently amortised over their expected useful lives which may not exceed 40 years (although there are some proposals to modify this). Before 1998 in the UK and before 1995 under IASs, (positive) goodwill could be written off directly to shareholders’ funds and usually was. This has now changed and (positive) goodwill must be capitalised in both regimes. However, it should not be overlooked that both sets of transitional rules permit the old goodwill to remain in shareholders’ funds. A new set of differences now arises in respect of amortisation of (positive) goodwill and intangibles. Under IASs the life is usually limited to 20 years but this may be rebutted and a longer, but finite period may be used. In such a case annual impairment testing of the (positive) goodwill or intangible is required. The UK approach is very similar save that it is permitted for the life even to be indefinite. In addition, the US rules prohibit the carrying of development costs as an asset. In the UK they may, at the company’s option, be carried as an asset if certain conditions are satisfied. Under IASs they must be carried as an asset, again if certain conditions are met. Fixed tangible assets (property, plant and equipment) As mentioned above, this is the principal category of assets subject to optional revaluation in Britain and under IASs. However, in Britain one category of asset - investment properties - must be revalued. Moreover, these investment properties must not be depreciated because of their special purpose. IASs take a different approach to investment properties. From 2001 they need not be depreciated, in which case they must instead be stated at market value with changes therein flowing through the profit and loss account. In the US all property other than land must be depreciated but not be revalued. The US also requires interest to be capitalised during the period of an asset’s being made ready for use. Under IASs and in the UK this is optional. Impairment The existence of an impairment is judged differently by the US on the one hand and the UK and IASs on the other. The US considers that an asset is impaired only if its book value exceeds the undiscounted cash flows expected to be obtained from its use. If that is the case then it is written down to its fair value, which may be the present value of those cash flows (if fair value cannot be determined in other ways). Under both IAS and UK principles recognition and measurement are consistent: an impairment occurs when and to the extent that the book value exceeds the higher of the net realisable value and the present value of the cash flows expected to arise from the continued use of the asset. The US does not permit any subsequent reversal of the impairment. Both IASs and the UK do permit reversal but in respect of goodwill (IAS) and goodwill and intangibles (UK). There are some restrictions on this. Associates and joint ventures Under US GAAP there is no accounting distinction between associates and joint ventures: both are equity accounted. Under IASs certain types of joint venture may, optionally, be proportionately consolidated. In the UK joint ventures may not be proportionately consolidated, 1. Executive summary 3 acquisition accounting applies the UK requires any restructuring of the acquired entity to be charged in the post-acquisition profit and loss account. Under IAS and US requirements some such restructurings may increase the goodwill. In addition, where the fair value of the acquired assets and liabilities is greater than the price paid - negative goodwill - the US rules require the non-current asset fair values to be reduced to eliminate the difference and thereafter a deferred credit arises for any remaining difference and is amortised over up to 40 years. The UK records negative goodwill as a separately disclosed deduction from positive goodwill and amortises it in line with depreciation and sale of the acquired non-monetary assets. Any remainder is taken to the profit and loss account in the periods expected to benefit. The IAS approach involves a similar presentation but the release to the profit and loss account is as follows: first, to match any costs that it has been identified with; then to match and to the extent of the depreciation of acquired non-monetary assets; and any balance thereafter is taken immediately to income. Foreign currency translation The translation of foreign currency financial statements of foreign operations throw up some important differences. All use the closing rate/ net investment method but in the UK the profit and loss account may be translated at either the average or the closing rate. Some companies do choose the latter. Under IASs and in the US the actual, or an average rate, must be used. Moreover, under IASs it is a matter of choice as to whether to include capitalised goodwill and fair value adjustments as part of the retranslated net investment, whereas in the UK and US they are always included. Lastly, under IASs and US GAAP the cumulative translation adjustment on a net investment is recycled through the profit and loss account on disposal of the net investment. In the UK there is no recycling. Hedging Both IASs and US GAAP have comprehensive standards on hedging; the UK does not. Some of the differences in approach here are typified by the case of a hedge of a future transaction, which can be either a contracted future transaction or a forecast one. In the UK the hedge would usually be held off balance sheet until the transaction occurs, the transaction then being stated on the hedged basis. Under IASs the cash flow hedging model is applied to this hedge: the hedge is stated at fair value with the resulting adjustment, so far as it is an effective hedge, taken directly to equity; it is held there until the transaction occurs when it is then recycled out to adjust the transaction (either affecting the profit and loss account immediately or adjusting the cost of the purchased asset as appropriate). The US uses the cash flow hedging model for hedges of forecast transactions; however, the gains and losses initially taken to equity are not recycled into the cost of the hedged purchased asset (if that is the case) but are instead recycled into the profit and loss account to match the cost of the asset as it flows through, eg as it is depreciated. Where the future transaction is a contracted one the US uses the fair value model: the hedge is stated at fair value with the resulting adjustment flowing through the profit and loss account; the hedged item, in this case the contract, is stated at fair value to the extent hedged with the resulting adjustment flowing through the profit and loss account. (IASs also use the fair value model for some hedges.) Cash flow The statement of cash flows of a British company is markedly different. It is based on pure cash - cash deposits and overdrafts both of which are repayable on demand. Both the IAS and US GAAP statements are based not only on cash but also on cash equivalents, ie short-term highly liquid investments. In addition, the US excludes overdrafts and IASs may in some cases include them. 1. Executive summary 2 gain or loss is required to be treated as an extraordinary item. The IAS guidance is somewhat more brief, and the UK guidance very much so, but for all practical purposes neither permits classification as extraordinary. Deferred tax Under UK principles deferred tax is provided in respect of timing differences - differences between the timing of inclusion of items in accounting and in taxable profit. The IAS and US provisions are in respect of the rather different, wider concept of temporary differences. These are the differences between the balance sheet carrying amounts of assets and liabilities and those carried in the tax computation. The purpose is to provide for the tax arising on the recovery of each asset (or settlement of each liability) at book value whether that recovery is through use, realisation or whatever. Furthermore, in the US and under IAS, provision is made in full for all liabilities (and for assets but subject to a recoverability test). In the UK the provision is only for that element of the full potential liability that will probably crystallise. In determining this ‘partial provision’, account is taken of the effect of future transactions (eg, capital expenditure) on the deferral, perhaps indefinitely, of crystallisation of the tax relating to past timing differences. However, the UK’s partial provision approach looks set to change towards full provision. Other provisions The UK and IASC standards on provisions are virtually identical, as IASC based its standard on the UK one. They provide comprehensive frameworks for provisions, whereas the US does not. One of the main UK and IASC principles is that all restructuring costs are provided on the basis only of a commitment resulting from some form of external action; the same applies in the US as regards redundancy costs, but other costs are still provided on a decision-basis. On the other hand, the US prohibits provision for voluntary redundancies until an employee has accepted the invitation. Under UK and IAS standards provision is made for the expected take up once the terms have been announced. Decommissioning costs are another specific area of difference. In the UK and under IAS the cost of necessary decommissioning of a plant or facility is made, on a discounted basis, when the plant is constructed and is charged as part of its cost (and then depreciated). In practice in the US such costs are usually spread over the plant’s life on an undiscounted basis. A further specific area is repairs and maintenance. The UK and IAS prohibit provision for the maintenance of own assets, but the US does not. Purchase of own shares It is a permitted, and not uncommon practice, for US companies to hold their own shares as treasury stock. Such shares are shown as a deduction from stockholders’ equity (shareholders’ funds); IASs require the same treatment. Under UK law a company cannot formally hold its own shares without cancelling them. Nevertheless companies may hold such shares in substance in connection with employee share option schemes. Such shares are shown as an asset in the balance sheet (usually a fixed asset). Specific profit and loss account items Defined benefit pensions and similar The current UK standard is quite different from those of the US and IAS. The UK approach could be termed actuarial: it uses valuation assumptions, for both assets and liabilities, that look to the long-term outcome. The US and IASs use current market rates for high quality corporate bonds to discount the obligation and use market values for the assets (although in the US certain 1. Executive summary 5 although the equity accounting is expanded somewhat to give a similar effect in the profit and loss account. It is also worth noting that the US and IASs presume a 20% investee to be an associate whereas the UK has no such presumption but more closely defines ‘significant influence’. In addition, IASs distinguish between types of joint venture on the basis of legal form, whereas the UK uses substance. Financial instruments Comprehensive standards in this area are a recent innovation. IASs and US GAAP have them; the UK does not. The IAS and US standards are very similar. They have three different treatments for financial instruments (other than hedges, for which see above). One is amortised cost. This is reserved firstly for a very restricted class of assets for which there is the positive intention and ability to hold it to maturity. It also applies under IAS to any loan or receivable originated by the company, or in the US to any non-marketable equity securities and any debts that are not securities. Next, any financial instrument (IAS) or security (US) held for trading purposes, and all derivatives other than those held as certain hedges, are stated at fair value with the resulting adjustments taken to the profit and loss account. Lastly, any asset (US – a security) not fitting in the other categories is known as ‘available-for-sale’. These are stated at fair value also. In the US the fair value adjustments are taken to shareholders’ funds (through other comprehensive income) and are recycled into the profit and loss account when the item is sold. Under IASs a company may choose to use the US treatment for the fair value adjustments or to take them immediately to the profit and loss account. In the UK market-makers, for example, mark their financial instruments to market through the profit and loss account but otherwise investments are usually held at amortised cost. Investments may be revalued but the resulting adjustment goes directly to shareholders’ funds and is not recycled. The UK does, however, have a standard dealing with transfers of financial assets. An asset is derecognised on a substance basis, ie only if all significant risks and rewards of the assets are transferred. If credit risk is retained then the asset remains on the balance sheet. Under the US and IAS financial components approach, however, a credit risk component would be retained to portray the credit risk but the rest of the asset would be taken off the balance sheet. Stock (inventory) In Britain the LIFO method of establishing the cost of stock would rarely be appropriate; in America and under IASs it is acceptable. Debt Where a company’s own shares contain an obligation, as for example some preference shares do, IASs classify them as debt. In the UK they would be classed as shareholders’ funds, albeit the ‘non-equity’ element thereof. Under US GAAP there is ‘mezzanine’ level shown separately from both debt and shareholders’ funds; preference shares whose redemption is not controlled by the company are reported at this level. Where an instrument contains both debt and equity-share characteristics, for example convertible debt, IASs split the two elements and report them as debt and shareholders’ funds respectively. In the UK and US this is only done if the equity element is actually separable. There are also differing treatments for the maturity classification of debt. Under IASs and US GAAP a short-term debt can be reclassified as long-term on the basis of a post-balance sheet long-term refinancing. This is not possible in the UK. The US rules provide copious guidance on the extinguishment of debt and in many cases any 1. Executive summary 4 amounts reported internally irrespective of whether they are on the same basis as the external financial statements. (A reconciliation must, of course, be included.) Under IASs, broadly speaking, the management approach is used to identify the segments but the UK approach is used to report figures for them. In addition, under IAS the amounts disclosed include gross assets and liabilities, depreciation and cash flow information; none of these is given in the UK; in the US gross assets are required and other items may be required depending upon the internal reporting. Financial instruments All three GAAPs have plentiful disclosure requirements for financial instruments. However, there are a number of differences between them. First of all, the UK has a wide requirement to make qualitative disclosure of the objectives, policies and strategies for holding or issuing financial instruments. The SEC requirement in the US is very similar. Under IASs the equivalent disclosure is in relation only to instruments held for risk management. IASs require disclosure for all financial instruments of the terms and conditions, which may include notional principals, maturities, amount and timing of future cash payments etc. In the UK there are no general terms and conditions disclosures at all. In the US this sort of disclosure is similar to the ‘tabular’options for dealing with market risk (the other two options are sensitivity analysis and value- at-risk). Further, the US requires separate disclosure about four components of market risk: interest, currency, commodity and other market risk, such as equity price risk. The UK has requirements for interest and currency but only encourages other market price risk disclosures. IAS has specific requirements only for interest risk and otherwise other market risks are dealt with only by the general terms and conditions disclosures (which would have some similarities with the US tabular option). The UK does not require any disclosure of credit risk. On the other hand US GAAP calls for disclosure of concentrations of credit risk. IASs go further and require all credit risk, as well as all concentrations thereof, to be disclosed. Lastly on financial instruments, the UK requires disclosures about unrecognised or deferred gains and losses on all hedges other than of net investments in foreign entities. Under US GAAP and IASs the equivalent requirements apply only to cash flow hedges, which are used, for example, for hedges of future transactions whether contracted or uncontracted in the case of IAS and, for example, for hedges of forecast (eg, future uncontracted) transactions in the US. Future developments In all three GAAPs a number of areas of accounting practice are under review, although having emerged from a period of intense standard setting there is perhaps less just over the horizon than is usual. Those that are under review are quite major areas. In some instances the UK proposals would, if carried through to future standards, narrow but not eliminate some areas of difference with the US and IASs. First, it is proposed that deferred tax will remain on the timing differences basis but will move towards full provision. Second, after drawn out debate it looks as though the measurement principles for pensions will be aligned with IASs; however there will be no spreading at all - the whole change in value will go onto the balance sheet immediately but with the other entry split between the profit and loss account and the statement of total recognised gains and losses (other comprehensive income). In the US also, some of the proposals would also narrow the differences. At present it is fairly common for US business combinations to use pooling/ uniting-of-interests (merger) accounting, whereas it is comparatively rare under UK and IAS principles. The FASB proposes to prohibit the method entirely. The IASC is monitoring US developments and may re-examine this area. The FASB has also proposed that the maximum life of goodwill should be reduced to 20 years. However, other intangibles might in some cases have longer lives, even indefinite lives if there is an observable market price for the intangible. 1. Executive summary 7 de minimis fluctuations may be ignored and some averaging of asset market values is permitted). Moreover, the US and IAS rules prescribe particular actuarial methods and assumptions. The UK standard does not. The differences may sound trivial but in the field of pensions a small change in an assumption can be magnified to a large monetary amount. In the UK all variations from the regular costs are spread over the remaining working lives of the employees. In the US there is an option not to account for any variation if it falls within certain limits known as the ‘corridor’. Under IASs any vested past service costs are booked immediately; all other variations are either spread forward if they fall outside a similar corridor, or instead any faster, systematic recognition method may be used. The cost of employee share schemes Where an employee is awarded a share option the cost to the company is based, in the UK, on the intrinsic value (the difference between the option exercise price and the share’s market price) at the grant date. In the US the cost may be based either on intrinsic value at a measurement date that may be later than the grant date, or on the fair value of the option itself. (It should be noted that in both countries, if certain conditions are met, no intrinsic value-based cost at all is accrued.) IASs have no rules on share-based remuneration. Sale or termination of an operation and discontinued operations The US definition of a discontinued operation is more narrowly drawn than that of the UK; that of IASs is between the two. In addition, a major difference arises in the presentation of discontinued operations. In the US the post-tax results are presented as a single line item positioned immediately before extraordinary items. Furthermore, the assets and liabilities of the operation are presented as a single net amount in the balance sheet. In the UK the revenues, expenses, assets and liabilities remain in their normal locations in the accounts. The results of the discontinued operation are separately identified but only by analysis, on the face of the profit and loss account, of the turnover and operating profit of the whole group into continuing and discontinued elements. The assets and liabilities are not identified. The IAS requirements are similar to those of the US insofar as they require all profit and loss account items down to profit after tax, and assets and liabilities, to be attributed to discontinued operations. However, it is not clear whether the US single line item presentation is possible under IAS; and, in contrast to the UK, amounts so attributed may be given in the notes rather than on the face. So far as provisions for sales or terminations of operations are concerned the US rules require provision for a discontinued operation to be made on a decision-basis. IAS and the UK require a commitment basis, whether the sold or terminated operation is a discontinued one or not. When provision is made the UK and US approaches include certain operating losses in that provision, but under IAS they may not be included. Dividends In the UK a dividend declared after the year end, but in respect of the year just ended, is accounted for in that previous year. In the US and under IAS such a dividend would be dealt with in the year of declaration. Specific major disclosure items Segmental reporting Rather different approaches are taken by the three for segmental reporting. In the UK segments are distinguished from one another by their differing risks and returns and the amounts reported therefor are analyses of the relevant figures as stated in the financial statements. By contrast, the US uses the management approach whereby the company is split into segments in line with the internal reporting structure, whatever that may be. Moreover, the amounts reported are the 1. Executive summary 6 constitutional arrangements for setting IASs have been put in place in order to improve both that process and the relationship with national standard setters and others. Where these reviews and new arrangements will in practice leave the balance between IASs and national standards, such as those of the UK and US, is difficult to predict. If US endorsement is slow in coming then IASs may be marginalised. But there might then develop a powerful IAS-bloc, perhaps centred on the European Union, including the UK, to rival the other standard setters’ power- bases. The European Commission is already proposing, again with some qualification, that IASs become mandatory for listed European companies. On the other hand, the IAS table might become the place where national standard setters thrash out agreed treatments to be put into their own national standards and into IASs. Or IASs might even become the single global super- code replacing national standards altogether – indeed, this is the only rational long-term objective. Notwithstanding this hurly-burly, none of UK, IAS or US standards will disappear overnight. Important differences between them, and the need to cope with them, will remain for some years to come. This book describes the significant differences between accounting principles followed in the UK, under IASs and in the US. It is not a complete listing; rather it is a summary of those areas most frequently encountered where the principles differ or where there is a difference in emphasis between the three. Furthermore, it does not address accounting in specialised industries, for example banking and insurance. It looks first at the regulatory background and at general requirements and issues before turning to specific matters affecting the balance sheet, the profit and loss account and finally major disclosure matters. The comparison is effected by examining the UK principles in the left-hand column, those of IASs in the middle and those of the US on the right. As far as possible then, the requirements of the three frameworks dealing with the same circumstances are set out side-by-side. The narratives use the terminology of the UK, IASs or the US as appropriate. A table of common differences in terminology is provided in Appendix I. In addition, the narratives usually refer to the reporting entity, for the sake of convenience, as being a company. However, the terms ‘entity’, ‘enterprise’ or ‘undertaking’ are used where the context requires it (eg, where an ‘entity’ is a quasi-subsidiary). References to the sources of the accounting requirements or practices are included in the headings or sub- headings as appropriate. The key to these and other abbreviations is set out in Appendix II. US references which comprise a letter followed by a number (eg, B50 for business combinations) are to the section of the Current text (a condensed version of the requirements of the standards ordered by subject and issued by the FASB) with that same reference. The last standards which were taken into consideration in writing this book were FRS 16 (Current taxation) in the UK, IAS 40 (Investment property) and the US’s SFAS 138 (Accounting for certain derivative instruments and certain hedging activities - an amendment of FASB Statement No 133); the text reflects the latest standards even though some of them are not yet mandatory. The matters referred to in this book are complex. Legislation, accounting standards and other authoritative material are, of course, subject to change. Accordingly, professional advice should be sought before acting on, or refraining from acting on, any material in this book. 2. Introduction 9 2. Introduction As this book rolls off the presses, the course of international accounting harmonisation has reached a defining but as yet unclosed chapter in its history. There will soon crystallise into reality the international relationship between different standards, and their standard setters, for many years to come. Before looking forward to that, the progress to date should not be overlooked. The force that drove it, and continues to do so, can be stated in three words: global capital markets. Both Britain and America have long histories of exchange traded equity investment by the public and their accounting has developed to report companies’ activities from this perspective. As the capital markets become increasingly global other countries that have hitherto used, say, the perspective of the tax authorities or lenders as their accounting model, have found that to participate in the market they need to adopt its perspective. At the same time globalisation demands that the various versions of that perspective come closer together, if not become replaced by a single version. Here International Accounting Standards, IASs, join the story. IASs are another version of that Anglo-Saxon model. But with the world as their constituency they have the potential to achieve more widespread acceptability than other versions. In so saying, one cannot but recognise that these three are indeed different versions of the same basic model. The apparently common language of the capital markets has marked differences when put into effect by these three proponents. Why should this be so? There are probably many factors at work. On the cultural side, the US puts the emphasis on consistency between companies and, combined with a traditionally litigious environment, this tends toward the formulation of accounting rules for almost all conceivable circumstances. In the UK and under IASs the drive has been towards a few principles (although the detailed rule approach has made a modest showing of late) and a more pragmatic approach. Moreover, the British and IAS standard setting processes started only in the 1970s - America had something like a 30 year head start. The result is that in the US there is very little scope for alternative treatments, whilst a range of detailed adaptations of the principles to specific cases is often possible in the UK. On the academic side there are the intractable accounting problems, such as deferred tax - is it really a liability and if so how much should be recognised? There are various solutions to the intractables but no one solution is without its drawbacks. The result is that different nations opt for different drawbacks just as much as they opt for different solutions. IASs are perhaps mid-Atlantic. In some areas the UK approach is favoured, for example the true and fair view and, usually, substance; in others the US approach is adopted, for example the components approach to financial asset transactions. However, the gap between the GAAPs has narrowed of late. IASs have undergone a period of overhaul, eliminating many of the optional treatments; the UK has changed to deal with some of the intractables, for example goodwill, by accepting largely the same drawbacks as others do; and in the US there has even been recognition that its standards are not the most rigorous when it comes to the availability of pooling (merger) accounting. Moreover, the standard setters in different countries have co-operated on issues such as the overhaul of earnings-per-share standards. So there is cause to hope that there might be less divergence in the use of the common concepts. Looking forward, whilst IASs have received endorsement, albeit somewhat qualified, from the International Organisation of Securities Commissions (IOSCO), significantly they await the results of a review by the US Securities and Exchange Commission that may bring about a good degree of endorsement for their use in the US by non-US registrants. And lately, new 2. Introduction 8 3. Regulatory background 10 UK USIAS 3. Regulatory background 3.1 Generally accepted accounting principles The term ‘generally accepted accounting principles’ has no formal meaning in the UK. The term ‘generally accepted accounting practices’ (GAAP) is used informally in the UK to denote the corpus of practices forming the basis for determining what constitutes a true and fair view: that is, broadly, accounting standards and, where relevant, the accounting requirements of company law and The Listing Rules of the Financial Services Authority. Accounting standards are applicable to the accounts of a reporting entity that are intended to give a true and fair view (see 3.2 below) of its state of affairs at the balance sheet date and of its profit or loss for the financial period ending on that date. The development of such standards is overseen by the Financial Reporting Council (FRC), a body representing a wide constituency of interests. Its function is primarily to guide the Accounting Standards Board (ASB), its subsidiary body, on its work programmes and issues of public concern. The ASB does the work of developing, issuing and withdrawing accounting standards. Such standards developed and issued by the ASB are known as Financial Reporting Standards (FRSs); the standards issued by the ASB’s predecessor body, and which 3.1 Generally accepted accounting principles (IAS 1, SIC 18) Under IASs there is no formal term ‘generally accepted accounting principles’ (or ‘practices’), although ‘GAAP’ may occasionally be used to signify the whole body of IASC authoritative literature. The sources of such accounting requirements are the International Accounting Standards (IASs) themselves and interpretations thereof made by the IASC’s Standing Interpretations Committee (such pronouncements being known as ‘SICs’). When these sources do not cover a particular issue then the IASC’s conceptual framework, Framework for the preparation and presentation of financial statements (the Framework), should be consulted. If that does not provide guidance then it is permitted to look to the pronouncements of other standard setting bodies (eg, the UK’s ASB and the US’s FASB) and to accepted industry practice, provided that conflicts with neither IASs, SICs nor the Framework. IASs sometimes include optional treatments. One is designated the Benchmark Treatment and the other is designated the Allowed Alternative Treatment. For each such choice a company should 3.1 Generally accepted accounting principles The principal sources of generally accepted accounting principles (GAAP) are Statements of Financial Accounting Standards (SFASs) issued by the Financial Accounting Standards Board (FASB) together with Accounting Research Bulletins (ARBs) and Accounting Principles Board Opinions (APBs) which were issued by predecessor bodies of the FASB. The FASB is the designated organisation in the private sector for establishing financial accounting and reporting standards. Its board is composed entirely of full time members. It also issues Interpretations (to clarify, explain, or elaborate on existing SFASs, ARBs or APBs) and Technical Bulletins (to address issues not directly covered by existing standards). US pronouncements are issued sequentially. They are not withdrawn but may be revised or superseded by subsequent pronouncements. The FASB publishes each year the updated Original pronouncements and the Current text. The former contains the original text of all FASB pronouncements, Interpretations and Technical Bulletins presented in sequential order. The latter is a reorganised version of the Original pronouncements categorised by subject. As [...]... or purchase accounting While both purchase and pooling-of-interests accounting are used in the US, they are not alternatives Pooling must be used if certain criteria are met These criteria relate to the attributes of the combining entities before the combination, the manner of combining the entities, and the absence of certain planned transactions but do not include a size test In outline, they are as... determine whether a business combination meets the conceptual definition of a merger as one that results in the creation of a new reporting entity formed from the combining parties, in which the shareholders of the Applicability of uniting-of-interests or purchase accounting Uniting-of-interests accounting must be used for a business combination where, rarely, no acquirer can be identified; purchase accounting. .. IAS or in any case where the change will result in a more appropriate presentation of events or transactions in the A change in accounting principle must be explained and justified as preferable The term accounting principle also includes the methods of applying principles In most instances prior periods are not They do not include normal recurring adjustments or corrections of estimates made in prior... capital items If the indirect method is used, amounts of interest paid (net of amounts capitalised) and income taxes paid during the period are disclosed Under both the direct and the indirect method, cash inflows and outflows from investing and from financing activities should be reported on a gross basis Other matters Information about all investing and financing activities of a company during a period... limited, there was a disagreement over an accounting treatment or information could not be obtained In some situations it will be appropriate to include an emphasis of matter referring to an uncertainty; such emphasis is not a qualification 4.4 Accompanying financial and other information (IAS 1) In the UK and US the accompanying information arises out of legal and listing requirements Since IASs do... computing depreciation to another (for example, from the sumof -the- years’-digits to the straight-line method) is a change in accounting principle and should be accounted for accordingly A change in estimated useful life or residual value, however, is a change in an accounting estimate and should be accounted for prospectively 23 UK I AS US I AS US Changes in accounting estimate (FRS 3) Changes in accounting. .. flows from operating activities may be presented either by the direct method (gross receipts from customers etc) or the indirect method (net profit and loss for the period with adjustments to arrive at the total net cash flow from operating activities) Although the standard encourages the use of the direct method, in practice the indirect method is usually used All financing and investing cash flows... of computing depreciation/ amortisation to another is not treated as a change in accounting policy; the unamortised cost should be written off over the remaining useful life beginning in the period in which the change is made A change in estimated useful life or residual value should also be treated in this way financial statements In either case if the company chooses the current period adjustment... of the change should be shown in the income statement, after extraordinary items and before net income, in the year in which the change occurs Income before extraordinary items and net income should be shown on a pro forma basis on the face of the income statement for all periods presented as if the newly adopted accounting principle had been applied during all periods presented The effect of adopting... other regulatory requirements (for example UK I AS US 11 The overriding requirement is for the financial statements to give a ‘true and fair view’ I AS US A ‘true and fair view’ is not defined but for a combination of reasons, including the authorisation of the ASB to issue accounting standards under the Act, it is generally accepted as requiring compliance with applicable accounting standards - indeed . clients and others in understanding the differences of principle between accounting standards and the accounting requirements of company law in the United Kingdom, generally accepted accounting principles. Executive summary Introduction Despite having a great deal of common purpose and common concepts, the accounting principles in the UK and the US and under International Accounting Standards (IASs) can. accepted accounting principles The principal sources of generally accepted accounting principles (GAAP) are Statements of Financial Accounting Standards (SFASs) issued by the Financial Accounting Standards