GAAP 2000

The purpose of this manual is to suggest best practice in respect of: (a)the form and content of financial statements;(b)best practice and acceptable alternatives in respect of accounting policies and disclosures adopted for the presentation of financial information; and(c)the form and content of auditors’ and accountants’ reports.

The sources and status of accounting principles and disclosures required of UK companies may be described under two headings: mandatory and advisory.

One of the recommendations of the Dearing report on the setting of accounting standards (the report that gave rise to the new financial reporting regime at the end of the 1980s) was that the successor body to the Accounting Standards Committee (ASC) should develop a statement on the principles that underlie accounting and financial reporting. The ASB separately published a number of draft chapters which, after amendment, were combined in a single exposure draft, issued in November 1995, of the ASB’s ‘Statement of Principles. In a progress paper issued in July 1996, Statement of Principles for Financial Reporting — The Way Ahead: Progress Paper on the Exposure Draft, the ASB announced that the next step would be to issue for comment a revised draft of the Statement of Principles addressing the substantive points raised on the 1995 document. This further draft was issued in March 1999.

Every UK company registered under the Companies Acts is required to prepare a balance sheet and profit and loss account for each financial year (individual accounts) which give a true and fair view (see 21.140 as regards a parent company’s individual profit and loss account). [s226] If the company is a parent company, consolidated accounts must also be prepared (group accounts). [s227] An exemption from the requirement to prepare group accounts is given to groups which qualify as small or medium-sized groups (see 31.23 below).

The directors of every company registered under a UK Companies Act are required to prepare financial statements in respect of each accounting reference period and these financial statements should include a balance sheet, profit and loss account and additional information provided by way of notes. [ss226 and 227] These statements should comply with the requirements of the Act as to their form and content. (See chapter 4 for further requirements in respect of the preparation, filing and publishing of financial statements.)

All financial statements are required by the Act to be accompanied by a directors’ report. The information to be included is specified in the Act; there are, in addition, a number of mandatory ‘miscellaneous’ disclosures for listed companies which are normally included in the directors’ report. The Stock Exchange also requires listed companies to provide disclosures relating to directors’ emoluments and corporate governance. This information is usually included in a separate statement.

Save for certain exemptions (see 7.9 below), companies listed on the London Stock Exchange with accounting periods ending on or after 31 December 1998 are subject to a new Listing Rule and Combined Code which reflect the recommendations of the Committee on Corporate Governance (‘the Hampel Committee’).

The requirements to make disclosures on directors’ remuneration in the financial statements are contained in the Act and the Stock Exchange Listing Rules. The requirements contained in the Listing Rules and the Combined Code, which are based on the recommendations of the Greenbury Committee and the Hampel Committee (see chapter 7), go further than the requirements of the Act. The requirements of the Act were revised in 1997 (effective for accounting periods ending on or after 31 March 1997); one of the DTI’s objectives in revising the legislation was to align the Act’s rules with those in the Listing Rules, although not to replicate them. A further objective of the DTI was to reduce the disclosure requirements for unlisted companies (i.e., companies with securities neither listed on the London Stock Exchange nor traded on AIM). The requirements of the Act are dealt with in 8.3 to 8.59 below. The requirements contained in the Listing Rules are covered in 8.60 to 8.98 below.

The Act provides that every profit and loss account shall give a true and fair view of the profit or loss for the financial year and shall comply with Sch 4 as to its form and content. [s226] The Act allows certain exemptions from its requirements for companies that qualify as small or medium-sized. These exemptions are dealt with in chapter 31.

FRS 14 Earnings per share was issued on 1 October 1998, replacing SSAP 3, which was also entitled Earnings per share, and amending UITF Abstract 13 Accounting for ESOP trusts. The FRS was developed not through any dissatisfaction with SSAP 3, but exploiting an opportunity to align the UK with international developments.

Not all components of an entity’s financial performance will flow through the profit and loss account. Therefore, FRS 3 requires financial statements to include, as a primary statement, a ‘statement of total recognised gains and losses’ to highlight the gains and losses that are recognised in a period. [FRS 3(27)] The statement deals with gains or losses recognised, not necessarily realised, in a period. Therefore, certain gains, such as revaluation surpluses, may be recognised in one period and realised in a subsequent period.

The Act provides that every balance sheet shall give a true and fair view of the state of the company’s affairs at the end of its financial year and shall comply with Sch 4 as to its form and content. [s226]

Although there has been no change in Companies Act requirements recently, the accounting treatment of intangible assets has changed radically as a result of the introduction of FRS 10 Goodwill and intangible assets. This standard became mandatory for accounting periods ending on or after 23 December 1998, superseding SSAP 22. For accounting periods ending before 23 December 1998, companies have the option either of continuing to apply SSAP 22 or of adopting FRS 10 early. It is important to note that, if early adoption is chosen, it is necessary to adopt FRS 10 in all respects. Note that FRS 10 does not affect the treatment of research and development costs (which are covered by SSAP 13) or oil and gas exploration and development costs (covered by the relevant SORP). FRS 10 also does not affect entities applying the original FRSSE, unless they are preparing consolidated financial statements. (FRSSE (effective March 1999) includes requirements for dealing with goodwill in entity accounts which are modifications of FRS 10’s requirements — see 31.63 below.)

Stocks is a main heading which should appear on the face of the balance sheet. The subheadings required, which may be shown either on the face of the balance sheet or in the notes to the accounts, are: (a)Raw materials and consumables;(b)Work in progress;(c)Finished goods and goods for resale;(d)Paymentson account.

The requirements on presentation and disclosure of liabilities, provisions and contingencies come from four sources: the Act, FRS 4 Capital instruments, FRS 12 Provisions, contingent liabilities and contingent assets and the Stock Exchange Listing Rules.

The Act lays down, in the Sch 4 balance sheet formats, the headings which should be shown on the face of the balance sheet under share capital and reserves. Schedule 4 also sets out a number of disclosure requirements.

There is no statutory requirement for companies to produce a cash flow statement. However, FRS 1 (revised) Cash flow statements requires financial statements intended to give a true and fair view of the reporting entity’s financial position and profit or loss to include such a statement and related notes, unless the entity is specifically exempted from producing a cash flow statement by the standard. [FRS 1(4)] Such exemptions are dealt with in 17.9 below.

The requirements to provide segmental information come from two sources: the Act and SSAP 25 Segmental reporting.

The Act prescribes certain fundamental accounting principles to be followed in the preparation of a company’s financial statements and these are discussed in 5.14 to 5.31 above. Within the framework of these fundamental principles, there is room for some measure of choice in regard to the specific accounting policies to be applied, though this choice is significantly reduced by the statutory valuation rules, accounting standards and UITF Abstracts. The effect of these rules and standards is discussed under the appropriate headings throughout this volume.

The Act requires that all liabilities and losses which have arisen or are likely to arise relating to a period prior to the balance sheet date should be taken into account, including those which only become apparent between the balance sheet date and the date on which it is signed on behalf of the board of directors. [Sch 4: 12] This requirement does no more than give statutory authority to part of the standard practice required under SSAP 17.

The Act requires that ‘if at the end of a financial year a company is a parent company the directors shall, as well as preparing individual accounts for the year, prepare group accounts’. [s227(1)] It follows from this that the assessment of whether group accounts are required depends on the situation at the balance sheet date; where a parent has held subsidiaries during a period, but at its balance sheet date no longer has any subsidiaries, then group accounts are not required. The Act also requires group accounts to be presented as consolidated accounts.

The following table sets out the types of investment that one entity may hold in another entity together with a summary of the appropriate accounting treatments.

A company may enter into foreign currency activities in two main ways: (a)it may enter directly into transactions denominated in a foreign currency; and(b)it may operate through an investment in a foreign enterprise which maintains its accounting records in a foreign currency.

The main features of company taxation in the UK (often referred to as the ‘imputation system’) are: (a)corporation tax is levied on the company’s taxable profit;(b)when a distribution is made to shareholders the company has to pay to the Inland Revenue an advance payment of corporation tax (ACT); a tax credit is imputed to the shareholder;(c)ACT is available to be set off against the company’s liability to corporation tax for the period in which the dividend is paid. Any unrelieved ACT can be carried back for six years or carried forward indefinitely. The set-off is restricted in certain circumstances. (The special rules relating to foreign income dividends are dealt with in 24.92 to 24.103 below);(d)the resultant net liability is known as ‘mainstream’ corporation tax.

In the absence of a finalised ASB Statement of Principles (currently issued as an exposure draft — see chapter 3), the key foundation statement within UK accounting is SSAP 2 Disclosure of accounting policies, issued in 1971. This lists four fundamental accounting concepts, i.e., going concern, accruals, consistency and prudence. However, as early as 1964, a fifth concept was evident in official UK literature. In that year, the ICAEW issued Recommendation on Accounting Principles 23, requiring hire purchase and other instalment credit transactions to be accounted for, not according to legal form, but according to substance. That same ‘substance over form’ concept was central to the development, in the early 1980s, of SSAP 21 Accounting for leases and hire purchase contracts. After many years of debate and development, the ASB issued FRS 5 Reporting the substance of transactions in April 1994, making the application of this accounting for substance concept a generalised requirement applicable in all circumstances where there is no more specific accounting rule.

The accounting treatment of leases, both by lessors and lessees, is dealt with in SSAP 21 Accounting for leases and hire purchase contracts. In some cases, the accounting requirements and disclosures are complex and, for this reason, the SSAP is supported by guidance notes, which give more detailed guidance on how the statement should be applied, including illustrations and discussion of problem areas. Although the guidance notes are not part of the SSAP, and therefore do not have mandatory status, they should be regarded for all practical purposes as if they were part of the SSAP.

Over the last few decades, occupational pension schemes which provide benefits for employees on their retirement have become almost universal for employers in the UK. This trend has been actively encouraged by the Government’s favourable tax regime. The usual pattern is for both employee and employer to pay regular amounts, based on a percentage of the employee’s salary.

The accounting treatment of government grants is dealt with in SSAP 4, which was first issued in 1974 and substantially revised in 1990, following changes in company law and an increase in the forms of assistance available.

Disclosure of transactions with related parties is required by: (a)statute;(b)the London Stock Exchange; and(c)FRS 8 (for periods beginning on or after 23 December 1995).

This chapter summarises the main aspects of the Act relating to: (a)the issue of share capital;(b)the repurchase, redemption or reduction of share capital;(c)the granting of financial assistance; and(d)distributions. The requirements relating to the disclosure of share capital and reserves in financial statements, together with the accounting for that purpose under FRS 4, are dealt with in chapter 16.

This chapter considers the exemptions available to small and medium-sized companies and groups in respect of the annual accounts that are sent to members. The Companies Act 1985 (Accounts of Small and Medium-sized Companies and Minor Accounting Amendments) Regulations 1997 (SI 1997 No 220), which were issued to clarify the requirements applicable to small companies, apply to annual accounts approved on or after 1 March 1997 and to auditors’ reports in respect of those accounts. However, transitional provisions allow the changes to be disregarded for periods ending on or before 24 March 1997; in which case, the previous requirements may be followed. The provisions of the FRSSE are briefly considered in 31.63 to 31.80 below. The statutory exemptions that permit abbreviated accounts to be filed with the Registrar of Companies are dealt with in chapter 32.

This chapter considers the exemptions available to small and medium-sized companies in respect of the accounts to be delivered to the Registrar of Companies. The exemptions available in respect of the annual accounts which are to be presented to members are considered in chapter 31. This chapter reflects SI 1997 No 220, the Companies Act 1985 (Accounts of Small and Medium-sized Companies and Minor Accounting Amendment) Regulations 1997, which were issued to clarify the requirements applicable to small companies. They apply to annual accounts approved on or after 1 March 1997 and to auditors’ reports in respect of those accounts. However, transitional provisions allow the changes to be disregarded for periods ending on or before 24 March 1997; in which case, the previous requirements may be followed.

The facility for listed companies to issue summary financial state-ments rather than the full financial statements was introduced by the Companies Act 1989 and the Companies (Summary Financial Statement) Regulations 1990 (SI 1990 no 515) and was initially restricted to the financial statements sent to members. This restriction was relaxed in 1992, so that a company fully listed on the London Stock Exchange may now send copies of a summary financial statement to shareholders, debenture holders and other persons entitled to receive notice of general meetings (‘entitled persons’) if it has obtained the entitled person’s consent and provided the company’s Articles or debenture trust deed or governing instrument do not require the full financial statements to be sent to entitled persons. The rules relating to summary financial statements were further revised in 1995 to make it easier for companies to ascertain the wishes of entitled persons. [s251 and SI 1995 No 2092]

There is no legal requirement for companies to issue a preliminary statement of annual results and dividends.

There is no legal requirement for companies to prepare an interim financial report.

In May 1993, the APB issued SAS 600 Auditors’ reports on financial statements. The auditing standards contained in SAS 600 are reproduced in the paragraphs below in bold type. They represent the basic principles and essential procedures with which auditors are required to comply. Apparent failures by auditors to comply with them are liable to be enquired into by the appropriate committee established under the authority of the relevant accountancy body and disciplinary or regulatory action may result. SAS 600 is accompanied by explanatory material which is designed to assist auditors in interpreting and applying auditing standards.

The guidance in this chapter is applicable to financial periods ending on or after 31 December 1998. This corresponds with the effective date of the Combined Code (see chapter 7) and APB Bulletin 1998/10 Corporate governance reporting and auditors’ responsibility statements. This chapter addresses reporting on the annual report, preliminary announcement or interim financial statement of a listed company. It does not deal with other reports that may be required by the London Stock Exchange.

Most financial statements are prepared on the basis that the entity will continue in operational existence for the foreseeable future (i.e. on the going concern basis). This means that there is no intention or necessity to liquidate or curtail significantly the scale of operation of the entity. The Act and SSAP 2 state that an entity is presumed to be carrying on business as a going concern unless the financial statements state otherwise.

Many of the examples of other audit reports given in this chapter are restricted to the wording of the opinion section. For appropriate wording required in the other sections of the audit report, reference should be made to the examples given in 36.86, 36.98 and 37.4 above, which illustrate the full wording of an unqualified audit report for a single company, an unlisted group and a listed group respectively.

The introduction to the reporting standards indicates that much of the guidance provided can be adapted to auditors’ reports on financial information other than financial statements. The APB (with assistance from the ICAEW) has issued Practice Note 8 Reports by auditors under company legislation in the United Kingdom, which gives guidance on the application of the principles of SAS 600 to reports by auditors under the Act. The examples in this chapter are, where appropriate, in line with the Practice Note.

Accountants are frequently asked to give reports to official or quasiofficial bodies and to contracting parties. Examples are reports on investment grants, insurance for consequential loss, circulation of periodicals, royalties, government contracts and borrowing powers under a trust deed. Quite often, the report is contained in a printed form. Occasionally, the form of the report has been agreed between the accounting institutes and the body concerned, in which case, it is likely to be acceptable to the accountants. In some other cases, however, the wording may not be acceptable and accountants must either amend the standard form or completely rewrite the report in a form in which they are prepared to give it.

In addition to acting as auditors, professional accountants are also frequently called on to act in different capacities in relation to financial information. Typically, they may be called on to compile (prepare) financial statements or to compare them with accounting records without carrying out an audit. Following the issue of the audit exemption regulations in July 1994, accountants are asked to carry out such work on those small companies that neither require an audit nor a report from a reporting accountant (see 31.48 to 31.62 above).

The last section of this chapter illustrates the report and financial statements of a hypothetical listed company, Delto PLC, which owns a group of manufacturing companies, showing the recommended style and layout. The purpose is to illustrate style and layout only. A single model cannot, of course, illustrate the disclosure requirements for all situations. A comprehensive check list of disclosures can be found in Appendices II and V.