Technical update

FASB

FASB has issued Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. The Statement improves the accounting for certain financial instruments that, under previous guidance, issuers could account for as equity. It requires that those instruments be classified as liabilities in statements of financial position. Statement 150 affects the issuer�s accounting for three types of freestanding financial instruments:

• mandatorily redeemable shares, which the issuing company is obligated to buy back in exchange for cash or other assets
• a second type (including put options and forward purchase contracts) which involves instruments that do or may require the issuer to buy back some of its shares in exchange for cash or other assets
• obligations that can be settled with shares, the monetary value of which is fixed, tied solely or predominantly to a variable such as a market index, or varies inversely with the value of the issuers� shares.

Statement 150 does not apply to features embedded in a financial instrument that is not a derivative in its entirety.

Most of the provisions of Statement 150 are consistent with the existing definition of liabilities in FASB Concepts Statement No. 6, Elements of Financial Statements. The remaining provisions of this Statement are consistent with the Board�s proposal to revise that definition to encompass certain obligations that a reporting entity can or must settle by issuing its own equity shares, depending on the nature of the relationship established between holder and issuer. That revision is expected as part of a second phase of the Board�s project on liabilities and equity that is planned to begin later in 2003. In that phase, the Board plans to address the accounting for convertible bonds, puttable stock, and other instruments with embedded features characteristic of both liability and equity that are not in the scope of Statement 150.

In addition to its requirements for the classification and measurement of financial instruments in its scope, Statement 150 also requires disclosures about alternative ways of settling the instruments and the capital structure of entities, all of whose shares are mandatorily redeemable. Most of the guidance in Statement 150 is effective for all financial instruments entered into or modified after 31 May 2003, and otherwise is effective at the beginning of the first interim period beginning after 15 June 2003. For private companies, mandatorily redeemable financial instruments are subject to the provisions of this Statement for the fiscal period beginning after 15 December 2003.

The full text of Statement 150 is available on FASB�s website at www.fasb.org.

IASB

The IASB has published its first standard, IFRS 1, First Time Adoption of International Financial Reporting Standards, which explains how companies should make the transition to IFRSs from another basis of accounting. The standard will be relevant to the consolidated accounts of listed companies, which are required by an EU regulation to comply with international accounting standards for accounting periods starting after 1 January 2005.

The standard is based on the proposals published in an exposure draft in July last year, and contains a number of changes that the IASB made in response to comment letters it received.

According to IFRS 1, companies should comply with every IASB standard in force in the first year of adopting IFRSs. There are, however, some limited exemptions for first-time adopters where the cost of complying with these new requirements exceeds the benefits to users of the financial statements. Companies must also explain how the transition to IASB standards affects their reported financial position, financial performance and cash flows.

Commenting on the standard, Sir David Tweedie, IASB chairman, said: �IFRS 1 is very timely, because demand is growing for high quality international standards set by the IASB. Thousands of companies throughout the world will be required to adopt IFRSs in the coming years, and the requirements in IFRS 1 are designed to ease the transition for all concerned and to ensure that users of accounts are given high quality information.�

More IASB standards are expected in the next year.

In its public meeting in May, the IASB continued its discussions on Improvements to IAS 39, Financial Instruments: Recognition and Measurement. The Board considered the conditions that must be met before a transfer of a financial asset qualifies for derecognition under IAS 39. It tentatively agreed not to proceed with the approach proposed in the exposure draft of proposed improvements to IAS 39, but to revert to the concepts in the original IAS 39 (e.g. control and substantially all the risks of ownership). The Board tentatively agreed to clarify how and in what order those concepts should be applied, as follows:

• An entity should first evaluate what asset has been transferred.
• The entity should then evaluate its exposure to the likely variation in all the cash flows from the transferred asset before and after the transfer (i.e. a risks and rewards test). The exposure would be evaluated on a present value basis using market interest rates. If the entity has retained substantially all the exposure, the asset would continue to be recognised in its entirety. If the entity has transferred substantially all the exposure, the asset would be derecognised in its entirety and any remaining components recognised.
• If the entity has neither retained nor transferred substantially all of the exposure, the entity should evaluate whether it has retained control of the transferred asset. Control would be evaluated based on whether the transferee has the practical ability to sell the asset. If the transferor has retained control, the asset would continue to be recognised to the extent the transferor may reacquire its previous contractual rights. If the transferor has lost control, the transferred asset would be derecognised.

Amongst other issues, the Board also discussed whether IAS 39 should be amended so as to permit an entity to use fair value hedge accounting for a macro hedge of interest rate risk. In particular, the Board considered in outline an approach that being developed in meetings between representatives of the IASB and representatives of the Fédération Bancaire de l�Union Européenne (FBE). The Board was not asked to make a decision on the approach, given that some important details had not yet been finalised. However, the Board expressed support for continuing to develop the framework.

The IASB is holding a series of roadshows throughout the summer and autumn to highlight issues related to the transition to International Financial Reporting Standards (IFRSs) for EU publicly-listed companies in 2005. Starting with Rome in June, presentations will be given in Warsaw and Prague in July, Amsterdam and Luxembourg in September, Berlin in October and Madrid in November. The date for Paris was yet to be finalised at the time of going to press. Further information is available on the IASB�s website (www.iasb.org.uk).

IFAC

IFAC�s International Auditing and Assurance Standards Board (IAASB) has issued an exposure draft containing a proposed International Standard on Quality Control (ISQC) 1, Quality Control for Audit, Assurance and Related Services Practices, and a proposed revised International Standard on Auditing (ISA) 220, Quality Control for Audit Engagements.

The proposed ISQC 1 requires a firm to establish a system of quality control designed to provide it with reasonable assurance that the firm and its personnel comply with professional standards and applicable regulatory and legal requirements. It contains new proposed basic principles and procedures regarding leadership and responsibilities within the firm, including a requirement that the chief executive officer (or equivalent) of the firm has ultimate responsibility for the firm�s system of quality control. Other areas addressed in the ED include ethics, partner rotation, acceptance and continuance of client relationships, engagement quality control review, and monitoring.

ISQC 1 represents the first in a series of International Quality Control Standards. The ultimate goal of the project is to establish quality control standards for all engagements falling within the scope of IAASB engagement standards.

The proposed revised ISA 220 establishes basic principles and essential procedures, and provides guidance on quality control procedures for audit engagements. These include requirements for an engagement quality control reviewer to perform an objective evaluation of the compliance with applicable professional standards. Guidance is specifically provided on leadership responsibilities, ethics, engagement performance, engagement quality control review, and monitoring.

It is proposed that the new guidance becomes effective on 1 January 2005. The ED may be downloaded from the IFAC website (www.ifac.org/eds). IAASB welcomes comments on any aspect of the ED by 31 August 2003. Comments may be sent to edcomments@ifac.org, mailed to the technical director, IAASB, 545 Fifth Ave, NY, NY 10017, US, or faxed to the technical director on +1 212 286 9570.

FEE

The European Federation of Accountants (FEE) has called for urgent progression of the European Commission�s recent communications on Reinforcing the Statutory Audit in the European Union and on Modernising Company Law and Enhancing Corporate Governance in the European Union.

FEE welcomed the Commission�s intention to continue the Audit Advisory Committee as a discussion forum between regulators and the audit profession. FEE also supported the proposal to require the use of International Standards on Auditing (ISA) by 2005.

FEE agreed with the Commission that there is a need to strengthen European corporate governance arrangements for listed companies so that they are equally effective in supporting the provision of financial information of the highest quality to the capital markets. FEE also supported the Commission in believing that EU-wide consistency needs to be achieved on such issues as confirming the collective responsibility of directors for financial reporting and the function of audit committees in providing high quality financial information for investors. The proposed European Corporate Governance Forum could support convergence of best practice and FEE would be pleased to participate in it.

Regarding company law, FEE welcomed the initiatives to enhance consultation, including the creation of a structure to provide the Commission with expert advice. FEE noted that, given its experience, the accountancy profession has a profound contribution to make to such a structure. On the topic of auditor liability, FEE has called for the issue to be studied as a priority. It believes auditor liability should reflect the different responsibilities for financial reporting of management and auditors, and that audit liability reasonably relates to the consequences of unsatisfactory audit performance.

Further information on the EC�s communications is available on-line ( europa.eu.int/comm/internal_market/ en/index.htm) via the �Financial Reporting & Company Law� link.

FEE has published an Issues Paper entitled Principles of Assurance: Fundamental Theoretical Issues with Respect to Assurance in Assurance Engagements. The primary conclusions of the paper are as follows:

• Standard setters should reject the distinction between high and moderate level assurance. International Standards on Auditing (ISAs) are already based on the concept of �reasonable assurance� and this concept should be the basis for all assurance standards. Where auditors or assurance providers limit the assurance they obtain, the nature of the relevant limitations should be clearly understood.
• Fundamental analysis can help provide potential solutions to practical auditing and assurance issues; there is a need to develop and agree a principle-based conceptual framework for assurance engagements that will serve as a foundation for future standard setting and guidance in this area. The FEE Issues Paper, while not presenting a complete conceptual framework, does indicate what such a framework might look like.

The FEE paper can be downloaded from FEE�s website (www.fee.be) or ordered from Sylvie Romancide (e-mail Sylvie_Romancide@fee.be).

EFRAG

EFRAG has released a draft comment letter to be sent to the IASB�s International Financial Reporting Interpretations Committee on the topic of Draft Interpretations 1 (D1), Emission Rights. The draft letter says that, while EFRAG believes the proposed interpretation is consistent with existing IFRS, EFRAG is concerned that, when an entity values its emission rights at historical cost (benchmark treatment), the outcome of the required accounting under D1 becomes inappropriate. EFRAG�s draft letter notes that Paragraph 8 of D1 requires that, as emissions are made, a liability is recognised for the obligation to deliver rights equal to emissions that have been made. The liability is to be measured as the best estimate of the expenditure required to settle the present obligation at the balance sheet date. This will normally be the present market price of the number of allowances required to cover emissions made up to the balance sheet date. When an entity applies the benchmark treatment under IAS 38, Intangible Assets, the draft interpretation requires that emission rights would be carried at historical cost less any accumulated impairment losses. However, EFRAG says where an entity�s emissions equal the rights obtained, but the market price has increased by the end of the financial year, the draft interpretation implies that the entity needs to recognise a loss. Subsequently, assuming that the obligation is settled shortly after year-end, a gain would be recognised for the same amount at settlement date. EFRAG believes the outcome of such accounting is inappropriate and should be avoided, suggesting two alternative methods for doing so. Further information is available via EFRAG�s website (www.efrag.org).

Australia

Corporate governance
The Group of 100, an association of Australia�s senior finance executives from the top companies, has published a Guide to Review of Operations and Financial Condition to help companies comply with the listing rules of the Australian Stock Exchange and, in particular, listing rule 4.10.17. This requires listed entities to include a review of operations and activities in the annual report and the guide provides appropriate instruction on the form and content of such a review. The Group of 100 believes application of the guide�s provisions �...is an integral part of good corporate governance and high quality financial reporting�.

The Australian Stock Exchange (ASX)
The ASX Corporate Governance Council has released a 75-page document, Principles of Good Corporate Governance and Best Practice Recommendations. The aim of the Council was �...to develop and deliver an industry wide, supportable framework for corporate governance which could provide a practical guide for listed companies, their investors, the wider market and the Australian community�.
The 10 essential corporate governance principles are:

• lay solid foundations for management and oversight
• structure the board to add value
• promote ethical and responsible decision-making
• safeguard integrity in financial reporting
• make timely and balanced disclosure
• respect the rights of shareholders
• recognise and manage risk
• encourage enhanced performance
• remunerate fairly and responsibly
• recognise the legitimate interest of stakeholders.

The Australian Securities and Investments Commission (ASIC)
The ASIC has released the results of its stage two accounting surveillance project which began in July 2002.
The project reviewed the audited full-year financial reports of over 1,000 listed companies with balance sheet dates between 30 June and 31 July. Attention was focused on capitalised and deferred expenses, revenue recognition and recognition of controlled entities and assets. Of the 31 companies needing follow-up, no action was taken on 13 other than requiring 10 of these to improve their disclosures. The others are still under discussion. Major shortcomings noted were:

• revenue. Where a company acts as agent it should only recognise its commission as revenue rather than the gross receipts. This applies in particular to travel agencies
• use of book values rather than fair values in some asset transfer transactions
• assets recorded at greater than recoverable amount
• non-amortisation of goodwill, later classified as exploration expenditure (required to be written off)
• investment companies marking to market all investments whereas non-current investments should be treated according to AASB 1041.

The ASIC has proposed a Financial Reporting Panel to comprise two or four accountants and one lawyer to be constituted under the FRC to resolve accounting issues such as those noted under the surveillance program without having to go to court.

The ASIC has announced that it will scrutinise prospectuses and product disclosure statements (PDS) containing long-range financial forecasts. This is as a result of concerns over the use of highly speculative long-range forecasts to entice investors where there are no reasonable grounds to do so. ASIC Policy Statement 170 makes it clear that there must be reasonable grounds for a forecast; if not the ASIC will take corrective action.

The Auditing & Assurance Standards Board (AuASB)
The AuASB has released AGS 106, Audit Implications of Prudential Reporting Requirements for General Insurers. This has been issued in response to the new prudential supervisory regime introduced in 2002 by the Australian Prudential Regulation Authority (APRA) for general insurers following the HIH collapse. A responsibility is imposed on auditors to report on general insurers� compliance with prudential standards and statistical reporting obligations to APRA, and this statement will assist auditors in meeting that responsibility.

UK

Financial reporting

Mary Keegan, chairman of the ASB, has welcomed the publication of the IASB�s first standard, IFRS 1, First Time Adoption of International Financial Reporting Standards. The new standard applies to companies that are required by an EU regulation to comply with international accounting standards. Mary Keegan described the requirements of the standard as �mainly sensible and pragmatic�, adding that it was helpful for companies making the transition to IFRS in 2005.

Employment law

Monitoring at work
After a considerable delay (and numerous drafts), Part 3 of the Data Protection Code on Employment Practice has been published by the information commissioner. It deals with workplace monitoring and the Code, coupled with supplementary guidance, totals over 100 pages. The key principles that can be distilled are as follows:

• employers can monitor workers where the benefit to the organisation outweighs the intrusion into the privacy of the workers
• employers should usually conduct an �impact assessment� before monitoring and the assessment should evaluate whether the advantage to the organisation outweighs the intrusion
• workers should be informed if they are being monitored
• information discovered by reason of monitoring should usually only be used for the purpose for which the monitoring was carried out
• that information should be kept secure
• employers should take special care when monitoring personal communications which are clearly personal
• employers should not undertake covert monitoring except in extreme circumstances where it is for the prevention or detection of crime, has been authorised at the highest level, and there is a risk that notifying workers of the monitoring would frustrate the purpose of the monitoring.

Permanent health insurance
Permanent health insurance is an attractive benefit for employees which is utilised in many organisations. However, a series of cases has shown that the operation of such schemes can lead to complications in the field of employment law. In Jowitt v Pioneer Technology Ltd, the Court of Appeal ruled that an employee�s contractual entitlement to long-term disability benefit was governed by an express provision of his contract of employment - and not by the terms of the policy between the employer and the insurers (which contained different conditions for continued payment of benefit). The lesson for employers is to ensure that there is no mis-match between the relevant wording in the employment contract and in the insurance policy. Another question in the Jowitt case concerned the circumstances where benefit was payable under the scheme. The Court of Appeal said that an employee was "unable to work" for the purposes of the scheme if there was no continuous remunerative full-time work which she could realistically be expected to do. The scheme was designed to cushion the earnings of employees who became so disabled that they could neither be found other work within the organisation nor realistically be expected to find work elsewhere.

Compensation
The case of Bentwood Bros (Manchester) Ltd v Shepherd illustrates the potential cost of discriminating against an employee. A worker who was made redundant whilst pregnant was awarded compensation of over £190,000. The question which came before the Court of Appeal concerned the discount that should be applied to the compensation to take account of the fact of accelerated payment (given that the compensation was to cover two-and-a-half years� future earnings and 10 years� pension payments). The Court of Appeal said that a tribunal should not ignore the fact that an employee receiving compensation has the benefit of receiving immediately what he or she would otherwise have had to wait to receive in instalments over the period of loss. The employment tribunal had also been wrong to award interest on gross compensation, rather than on the net sum after deductions for income tax and national insurance. There is no logic in awarding interest on sums which the employee would never have received. But the tribunal was not wrong to award loss of pension rights for 10 years, even though its finding that the 35-year-old applicant would never again find pensionable employment was �surprising�.

Holiday pay
In MPD Structure Ltd v Munroe, the Court of Session held that a term in an employee�s contract which provided for holiday pay to be �rolled up� so as to form part of ordinary wages paid throughout the working year failed to meet the employee�s entitlement under the Working Regulations 1998.

Equal pay
The Employment Appeal Tribunal�s ruling in Barton v Investec Henderson Crosthwaite Securities Ltd has attracted a good deal of publicity. A highly paid research director was awarded a bonus of £300,000 whereas a male research director was awarded a bonus of £1m. An employment tribunal noted that the bonus policy was �non-transparent� but took into account that �it is a vital component of the City bonus culture that bonuses are discretionary, scheme rules are unwritten and individual�s bonuses are not revealed�. The Employment Appeal Tribunal made it clear that no tribunal should condone a bonus culture involving secrecy and/or lack of transparency, because of the potentially large amounts involved, as a reason for avoiding obligations under equal pay law.

Taxation

Employers Share Schemes
An extra statutory concession is to be published which will allow reservists who were called up for active service in Iraq to continue to participate in their civilian employers share scheme.

Stamp Duty SP1/03
A Statement of Practice has been issued on the subject of exemption from Stamp Duty in disadvantaged areas.
The relief is provided for in s92 and Schedule 30 FA 2001, and originally only applied to transfers for a consideration up to £150,000.
From 10 April 2003, the restriction applies only to residential property and the Statement of Practice provides guidance on the meaning of residential for this purpose, and the Inland Revenue practice in relation to:

• mixed use properties
• gardens and grounds
• construction or adaption for use as a dwelling
• six or more dwellings transferred by a single contract
• property only partly within disadvantaged areas, etc.

Inland Revenue Publications etc
New leaflets have been published as follows:

• WTC 2, Child Tax Credits and Working Tax Credits - A Guide
• WTC 6, Child Tax Credits and Working Tax Credits - Other Types of Help You May Be Able to Get
• COP 14, Corporation Tax - Self Assessment Enquiries
• WTC 5, Child Tax Credit and Working Tax Credit
• Edition 1 of New Tax Credits - Questions and Answers Published
• IR 14/15 (CIS), Construction Industry Scheme Issued
• IR 59, Collection of Student Loans and CA02, National Insurance Contributions for Self Employed People with Small Earnings 2003-2004 Revised
• IR 61, Tax Relief for Employees� Business Travel is now Obsolete - Alternative Guidance is Contained in IR 124, IR 136 and IR 172
• R85LP, Savings: Application by Savers who Usually Live in the UK to Receive Interest Without Tax Taken Off Updated, and
• CA13, National Insurance Contributions for Women with Reduced Elections and CA72, National Insurance Contributions - Deferring Payments Updated.

European business law

The EU Commission�s proposal for an IP enforcement directive
The UK Patent Office has issued a notice about the EU Commission�s proposal for a directive on the enforcement of intellectual property rights and invited comments on it. This follows the 30 January 2003 Commission announcement of its proposed directive on the enforcement of intellectual property rights (see europa.eu.int/comm/internal_market/en/indprop/piracy/index.htm). It is part of a broad-based approach by the Commission to tackle counterfeiting and piracy.
The proposal covers infringement of all intellectual property rights (IPR) (both copyright and industrial property, such as trademarks, patents and designs) deriving from Community and European law. It concentrates on infringements carried out for commercial purposes or which cause significant harm to rights holders. It aims to build on member states� international obligations such as the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS).
Patent Office contact: Jeff Watson, The Patent Office, Concept House, Cardiff Road, Newport, NP10 8QQ. Tel: +44 (0)1633 813650, fax: +44 (0)1633 814922. E-mail: jeff.watson@patent.gov.uk.