U.S. companies will have to start producing financials for all their British subsidiaries under a new financial reporting rulebook next year.
The need to switch follows the completion last month of a U.K. project to abolish the country's national accounting standards—U.K. Generally Accepted Accounting Principles. The change affects operations in the Republic of Ireland, too, since it also uses the U.K.'s accounting rulebook.
Companies that don't want to transition to full International Financial Reporting Standards will have to adopt one of two new U.K. standards, both of which are derived from IFRS: either the Financial Reporting Standard 101, which is similar to IFRS but with less disclosures, or the new Financial Reporting Standard 102, a simplified version of IFRS for small- and medium-sized companies.
Even though Britain's existing accounting rules are broadly aligned with the principles of IFRS, the switch will force companies to make some big reporting changes. Whichever of the new standards they choose, companies will have to change to fair-value treatment of financial assets and liabilities, says Richard Martin, head of corporate reporting at the Association of Chartered Certified Accountants.
They'll also have to review their policies in a host of other areas, such as stock valuation, holiday pay accrual, and goodwill. Each change might be small on its own, but the number of changes could trip companies up, accountants say. “We have quite a complex matrix of different requirements. And it's here, down in the detail, that companies will feel the pain of transition,” says Nigel Sleigh-Johnson, head of the financial reporting faculty at the Institute of Chartered Accountants in England and Wales.
The accounting changes could have a significant business impact, too, since they will change a subsidiary's reported profits, which in the United Kingdom is the starting point for its tax bill, says Martin. They will also affect distributable reserves, which under U.K. law determine whether a subsidiary can pass profits up to its parent as a dividend.
IFRS has been mandatory for U.K. public companies since 2005, but most private companies and subsidiaries have taken the option to stay with Britain's national GAAP code, which is simpler and requires fewer disclosures. That option is going away in 2015, with a transition period that begins next year. All but the smallest U.K. companies will then have to move to IFRS or apply one of two new standards.
The first of the standards, FRS 102, is based on the International Accounting Standards Board's simplified version of IFRS for small- and medium-sized companies. Those that move from U.K. GAAP to FRS 102 will have fewer rules to comply with and will be able to make fewer disclosures, says Sleigh-Johnson.
Most U.K. companies that aren't part of a group that already uses IFRS will move to FRS 102, he predicts. But the choice is less straightforward for the roughly 13,000 U.K. companies that have a U.S. parent. The other new standard—FRS 101—might be their default choice for U.K.-based U.S. subsidiaries, says Jake Green, director of financial reporting at Grant Thornton.
“We have quite a complex matrix of different requirements. And it's here, down in the detail, that companies will feel the pain of transition.”
—Nigel Sleigh-Johnson,
Head of Financial Reporting Faculty,
ICAEW
This standard is the same as full IFRS but with about half the disclosures, he says. It's designed for companies that are part of a group that reports under IFRS already, but could prove a good match for those that use U.S. GAAP, which is becoming more closely aligned with IFRS.
“The numbers my U.S. subsidiary clients would be producing under FRS 101 would be broadly the same as under U.S. GAAP because the recognition and measurement principles are very similar,” he says. “So they could bring those numbers into their consolidation a lot easier.”
Andrew Davies, lead partner on U.K. financial reporting at Ernst & Young, expects most of his U.S. clients to reach the same conclusion. “They'd most likely have to make fewer reconciliations under FRS 101, and fewer reconciliations means a reduction in the risk of error,” he says.
Still, Sleigh-Johnson thinks companies with U.S. parents will be more likely to adopt FRS 102, not 101, because it's nearer to what they do currently. “There might be a case for them to switch to 101, because of the aligned principles. But I'm not convinced that is a route many would want to take,” he says.
One thing's clear: There are important differences between U.K. GAAP, FRS 101, FRS 102, and even full IFRS that companies need to understand before deciding which standard to move to. “You can't just go with your gut reaction,” says Davies.
The treatment of goodwill is one example. Under FRS 102 a company has to write off goodwill over five years if it can't estimate its useful economic life, with those deductions allowable for tax. But under FRS 101, goodwill stays on the balance sheet and isn't amortized.
FEWER DISCLOSURES
The following excerpt from FRS 102 explains why there will be reduced disclosures for subsidiaries (and ultimate parents).
A qualifying entity (for the purposes of this FRS) which is not a financial institution may take advantage in its individual financial statements of the disclosure exemptions set out in paragraph 1.12. In relation to paragraph 1.12(c) for financial liabilities that are held at fair value that are either part of a trading portfolio or are
derivatives, the qualifying entity can take advantage of those exemptions. Where the qualifying entity
has financial instruments held at fair value subject to the requirements of paragraph 36(4) of Schedule 1 to the
Regulations, it must apply the disclosure requirements of Section 11 Basic Financial Instruments
to those financial instruments held at fair value.
1.9 A qualifying entity (for the purposes of this FRS) which is a financial institution may take
advantage in its individual financial statements of the disclosure exemptions set out in
paragraph 1.12, except for the disclosure exemptions from Section 11 and Section 12
Other Financial Instruments Issues.
1.10 A qualifying entity (for the purposes of this FRS) which is required to prepare
consolidated financial statements (for example, if the entity is required by section 399 of
the Act to prepare consolidated financial statements, and is not entitled to any of the
exemptions in sections 400 to 402 of the Act), or which voluntarily chooses to do so,
may not take advantage of the disclosure exemptions set out in paragraph 1.12 in its
consolidated financial statements.
1.11 A qualifying entity (for the purposes of this FRS) may take advantage of the disclosure
exemptions in paragraph 1.12, in accordance with paragraphs 1.8 to 1.10, provided
that:
(a) Its shareholders have been notified in writing about, and do not object to, the use
of the disclosure exemptions. Objections to the use of the disclosure exemptions
may be served on the qualifying entity, in accordance with reasonable specified
timeframes and format requirements, by a shareholder that is the immediate
parent of the entity, or by a shareholder or shareholders holding in aggregate
5 percent or more of the total allotted shares in the entity or more than half of the
allotted shares in the entity that are not held by the immediate parent.
(b) It otherwise applies the recognition, measurement and disclosure requirements of this FRS.
(c) It discloses in the notes to its financial statements:
(i) a brief narrative summary of the disclosure exemptions adopted; and
(ii) the name of the parent of the group in whose consolidated financial statements its financial statements are consolidated, and from where those financial statements may be obtained.
1.12 A qualifying entity (for the purposes of this FRS) may take advantage of the following
disclosure exemptions:
(a) The requirements of Section 4 Statement of Financial Position paragraph 4.12(a)(iv).
(b) The requirements of Section 7 Statement of Cash Flows and Section 3 Financial
Statement Presentation paragraph 3.17(d).
(c) The requirements of Section 11 paragraphs 11.39 to 11.48A and Section 12
paragraphs 12.26 to 12.29 providing the equivalent disclosures required by this
FRS are included in the consolidated financial statements of the group in which
the entity is consolidated.
(d) The requirements of Section 26 Share-based Payment paragraphs 26.18(b),
26.19 to 26.21 and 26.23, provided that for a qualifying entity that is:
(i) a subsidiary, the share-based payment arrangement concerns equity instruments of another group entity;
(ii) an ultimate parent, the share-based payment arrangement concerns its own equity instruments and its
separate financial statements are presented alongside the consolidated financial statements of the group;
and, in both cases, provided that the equivalent disclosures required by this FRS are included in the consolidated financial statements of the group in which the entity is consolidated.
(e) The requirement of Section 33 Related Party Disclosures paragraph 33.7.
1.13 Reference shall be made to the Application Guidance to FRS 100 in deciding whether
the consolidated financial statements of the parent provide disclosures which are
equivalent to the requirements of this FRS (ie the full requirements of this FRS when
not applying the disclosure exemptions) from which relief is provided in paragraph 1.12.
Source: ICAEW.
Some of the differences are more complex. IFRS requires companies to capitalize development expenditures, for example, if it meets certain criteria. The International Accounting Standards Board's IFRS for Small and Medium-sized Entities (IFRS for SMEs) doesn't allow it—expenditure has to be written off to profit or loss. But FRS 102, which is based on IFRS for SMEs, does.
“Companies will have to do a lot of work to look at each standard and decide whether the differences are significant for them or not. It's not a straight switch over,” says Sleigh-Johnson.
Accounting treatments aside, companies will also need to make sure they comply with the disclosure requirements of the new standards. “Both standards are simpler and shorter than U.K. GAAP, but that doesn't necessarily apply to the disclosures,” says Martin. “In some areas there are fewer disclosures, but in others, such as lease accounting, they are extended. People will have to be careful and work their way through them.”
Even though the disclosures for FRS 101 are reduced compared to full IFRS, they are much greater than under current U.K. GAAP, says Green. “So companies taking that option will need to spend a lot of time redrafting their accounts,” he says. “It's a very boring point, but a very practical one when it comes to thinking about the audit and completion timetable and whether you can gather all the evidence you need to produce the accounts.”
As they work out which standard to use, and how their choice might affect their accounting, companies with a U.S. parent could have a steeper mountain to climb. “U.S. groups know less about IFRS, because they've been mainly focused on U.S. GAAP reporting,” says Davies. “Generally speaking, I'm seeing that with U.S. companies there's a little bit more learning that needs to take place before they can make the decision about which standard to use.”
Clock Is Ticking
While the required transition doesn't start until 2014, accounting advisers are suggesting U.S. companies with British subsidiaries get started on the move. “Really, they should be begging to understand the implications now,” says Davies. Companies will have to use whichever new standard they choose for accounting periods starting on or after Jan. 1, 2015. But they'll need to be using the standard from at least 2014, so they have comparative data and opening balances.
“Really, you need to have decided what road you will go down before the end of this year,” says Davies. “Otherwise, you'll miss the opportunity to move early or lose the chance to mitigate any downside.”
Another wrinkle: Companies that want to use FRS 101 need to get approval from shareholders, which will take time. And it would be wise to discuss some tax elections with HM Revenue & Customs, Britain's tax collection service, says Davies.
“Companies that leave it until 2015 will be firefighting,” he adds. “They won't be able to do much planning and will just have to take the implications, with little opportunity to soften the risks or find benefits.”
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