Technical update

international

At the end of July the International Accounting Standards Board (IASB) issued an exposure draft setting out substantial amendments to IFRS 3, Business Combinations. The exposure draft represents the culmination of phase II of the IASB’s project in this area, which has been conducted jointly with the US Financial Accounting Standards Board (FASB). FASB has also issued the exposure draft for comment in the US.
Whilst the fundamental requirement of the previous version of IFRS 3 that acquisition accounting must be used for all business combinations is retained, there are a number of significant changes including:
- the acquirer should measure the business acquired at its total fair value and, therefore, goodwill attributable to any minority interests (now called non-controlling interests) will also be recognised. Currently, business combinations are recognised by reference to the accumulated cost of acquisition
- direct costs, such as legal and accountants fees, would be expensed rather than included as part of the cost of the acquisition
- there are few exceptions to the principle of measuring assets and liabilities acquired at fair value. The only exceptions will be goodwill, non-current assets classified as held for sale, deferred tax assets and liabilities, and assets and liabilities associated with any employee benefit plans
- currently, intangible assets are required to be recognised separately where they meet the definition in IAS 38, Intangible Assets. In future, it is proposed that intangibles will be recognised separately from goodwill if they meet the definition in IAS 38 and are identifiable (i.e. they arise from contractual rights or are separable)
- a bargain purchase (i.e. one where the cost of acquisition is less than the fair value of the assets and liabilities) should be accounted for by reducing the carrying value of goodwill to zero and then taking the remaining surplus to profit and loss account
- acquisitions of additional non-controlling interests will no longer be accounted for using acquisition accounting; instead they will be treated as transactions with equity owners.

As part of the convergence project with US GAAP, the IASB also issued an exposure draft of amendments to IAS 37, Provisions, Contingent Liabilities and Contingent Assets, which it is proposed will be renamed “Non-financial liabilities”. The terms “contingent asset” and “contingent liability” will disappear as the proposed standard considers that many items previously disclosed as contingent assets or liabilities meet the definition of an asset or liability in the IASB Framework. In these cases, the contingency is not in respect of whether the asset or liability exists but to one or more future events that affect the measurement of the asset or liability.
IAS 38 will be amended such that items previously described as contingent assets that meet the definition of an asset will fall within its scope rather than IAS 37. A non-financial liability should be recognised unless it cannot be measured reliably - uncertainty as to the amount or timing of the related cash outflow should be built into the measurement of that liability.
Non-financial liabilities for costs associated with a restructuring should only be recognised when the definition of a liability is satisfied and specific guidance is being proposed in respect of certain costs. This includes the termination of employment which will also give rise to consequent amendments to IAS 19, Employee Benefits.
In order to deal with all aspects of the proposed changes, amendments are also being proposed to IAS 27, Consolidated and Separate Financial Statements. As discussed above, changes in a parent’s ownership that do not result in a loss of control would be accounted for as transactions with equity holders and no gain or loss would be recognised in the profit and loss account. Where there is a loss of control the gain or loss will be reflected in the profit and loss account and any remaining non-controlling interest would be re-measured to fair value.

Yvonne Lang, a director at Smith & Williamson, the accountancy and financial advisory group, and technical adviser to the audit committee of Nexia International, an international network of accounting and consulting firms. www.smith.williamson.co.uk

UK & Ireland

The Accounting Standards Board has published for comment an exposure draft - FRED 36, Business Combinations (IFRS 3) - based on proposals developed jointly by the IASB and FASB. In addition, the ASB has also issued three other EDs containing consequential amendments to UK accounting standards: FRED 37, Intangible Assets (IAS 38); FRED 38, Impairment of Assets (IAS 36); and FRED 39, Amendments to FRS 12, Provisions, Contingent Liabilities and Contingent Assets and Amendments to FRS 17, Retirement Benefits.
UK adoption of these standards would keep it in line with international developments, in accordance with the ASB’s convergence plan. However, the ASB itself notes that some of the proposals raise a number of issues that might not be an improvement in UK financial reporting. Some of the more controversial issues in the ASB’s eyes are the proposal that goodwill is to be recognised in full (even if less than 100% is acquired); the requirement that, after initial recognition, goodwill should be measured at cost less impairment losses (and amortisation not permitted); and that liabilities be recognised even where it is probable that no outflow will be required to settle the obligation.
Meanwhile, the ASB has issued a paper outlining its plans for making changes to the UK’s current standards on financial instruments, in order to continue UK and international accounting convergence. The ASB has said it expects to issue a new standard on disclosures based on the IASB’s related standard, IFRS 7, later this year. It also plans to make amendments to FRS 26, which addresses the measurement of financial instruments. These amendments would, amongst other things, extend the scope of FRS 26 to cover all entities other than those adopting the Financial Reporting Standard for Smaller Entities, and implement changes made by the IASB to its equivalent standard, IAS 39.

Sarah Perrin, accountant and writer.

Section 45 of the Companies (Auditing and Accounting) Act 2003 introduced a new requirement for the directors of Irish companies over a certain size. The directors are required to make a statement in their financial statements confirming that they have complied with all company and tax law and “any other enactments that provide a legal framework within which the company operates and that may materially affect the company’s financial statements”. The company’s auditor would be required to review the statement to determine if it was “fair and reasonable” and to include in their audit report, a report on, and the conclusions of, the review.
Although the Act was passed in 2003, the commencement of Section 45 was delayed to allow guidance to be developed for both directors and auditors. Draft guidance was prepared and is available here.
While this guidance was being prepared it became apparent that the requirements of Section 45 would be very expensive to comply with and would be a disincentive to doing business in Ireland. The Section was also going to apply to quite small entities and it was adding additional controls over an area that was already well policed via money laundering regulations, the Office of the Director of Corporate Enforcement and, for many Irish subsidiaries of US quoted companies, existing Sarbanes-Oxley requirements. Following intensive lobbying of the Government by business interests and the professional accounting bodies, including ACCA, the Government referred the legislation to the Company Law Review Group (CLRG) “to examine and report to the Minister for Trade and Commerce… its views on the proportionality, efficacy and appropriateness of the Director’s Compliance Statement”.
CLRG is a statutory body charged with monitoring, reviewing and advising the Government on all aspects of company law. CLRG completed its review of Section 45 on 3 August and reported its findings to the Minister for Trade and Commerce. Although the CLRG report isn’t publicly available until this month, it was widely expected that the Section would be substantially watered down or scrapped entirely.

Aidan Clifford, advisory services manager, ACCA Ireland.

Asia Pacific

Hong Kong & China

In June, 20 new Hong Kong Standards on Auditing and a new Hong Kong Standard on Review Engagements were released. These apply to all audits of financial statements for periods beginning on or after 15 December 2005, whilst the new Hong Kong Standard on Review of Engagements is effective upon issue.
These new standards adopt the latest international equivalents issued by the International Auditing and Assurance Standards Board, and include:
- HKAS 210, Terms of Audit Engagements
- HKAS 250, Considerations of Laws and Regulations in an Audit of Financial Statements
- HKAS 260, Communication of Audit Matters with Those Charged with Governance
- HKAS 320, Audit Materiality
- HKAS 402, Audit Considerations Relating to Entities Using Service Organisations
- HKAS 501, Audit Evidence - Additional Considerations for Specific Items
- HKAS 505, External Confirmations
- HKAS 510, Initial Engagements - Opening Balances
- HKAS 520, Analytical Procedures
- HKAS 530, Auditing Sampling and Other Means of Testing
- HKAS 540, Audit of Accounting Estimates
- HKAS 545, Auditing Fair Value Measurements and Disclosures
- HKAS 550, Related Parties
- HKAS 560, Subsequent Events
- HKAS 570, Going Concern
- HKAS 580, Management Representation
- HKAS 610, Considering the Work of Internal Audit
- HKAS 620, Using the Work of an Expert
- HKAS 710, Comparatives
- HKAS 720, Other Information in Documents Containing Audited Financial Statements.
To further converge China and international accounting practices, the Ministry of Finance PRC issued the exposure drafts of a number of accounting standards for consultation. These include impairment of assets, business combination, consolidated financial statements, biological assets, oil and gas extraction, donation and government grants, investment property, foreign exchange translation, and segmental reporting. These accounting standards were developed with reference to the International Accounting Standards and due consideration of China’s commercial and regulatory practices with an aim of enhancing its applicability.

Sonia Khao, head of technical services, ACCA Hong Kong.

Malaysia

The Malaysian Institute of Accountants (MIA) recently approved the following International Standards on Auditing (ISAs), which will be effective for periods beginning on or after 1 January 2006:
- AI 200, Objectives and General Principles Governing an Audit of Financial Statements replaces existing AI 200
- AI 220 (Revised), Quality Control for Audits of Historical Financial Statements replaces existing AI 220
- AI 240 (Revised), The Auditor’s Responsibility to Consider Fraud in an Audit of Financial Statements replaces existing AI 240
- AI 315, Understanding the Entity and Its Environment and Assessing the Risk of Material Misstatements replaces existing AI 310, AI 400 and AI 401
- AI 330, The Auditor’s Procedures in Response to Assessed Risks replaces existing AI 400 and AI 401
- AI 500, Audit Evidence replaces existing AI 500.
MIA also approved the International Standard on Quality Control (ISQC) 1, Quality Control for Firms that Perform Audits and Reviews of Historical Financial Information and other Assurance and Related Services Engagements. Systems of quality control in compliance with ISQC 1 are required to be established by 1 July 2005.
Together with the above standards, the Institute released the following proposed Malaysian Approved Standards on Auditing (MASA) for comments from interested parties:
- ED 545/2005, Auditing Fair Value Measurements and Disclosures
The standard will provide guidance on auditing fair value measurement and disclosures contained in the financial statements. In particular, the standard will address audit considerations relating to the measurement, presentation and disclosure of material assets, liabilities and specific components of equity presented or disclosed at fair value in the financial statements.
- ED 1012/2005, Auditing Derivative Financial Instruments
The standard will provide guidance in planning and performing auditing procedures for financial statement assertions related to derivative financial instruments. It will also state the responsibilities of management and those charged with governance with regards to recording and reporting derivatives in the financial statements.
These exposure drafts are drawn primarily from International Standards on Auditing and the International Auditing Practice Statement issued by the International Auditing and Assurance Standards Board. Deadline for comments is 15 October 2005. Copies of the standards and proposed standards are available at www.mia.org.my.

Jennifer Lopez, manager of technical services, ACCA Malaysia.

Singapore

The revised Corporate Governance Code was issued by the Government on 15 July 2005. While accepting most of its recommendations, the Government rejected key proposals by the Council on Corporate Disclosure and Governance (CCDG). These include the proposal to exclude directors who are, or are associated with, substantial shareholders from becoming independent (non-executive) directors and the proposal to require companies to disclose the exact remuneration of directors.
The revised Code presents the Council’s recommendations in the format of principles, guidelines and commentaries. The commentaries are new to the format of the Code - its purpose is to make the Code more user-friendly by providing enhanced guidance to listed companies on how to implement best practice. Companies are not required to disclose and explain deviations from the commentaries. For clarity, the existing “Guidance Notes” have been renamed as “Guidelines”.
The new Code and the detailed reasons for the Government’s rejection of the two proposals identified above can be accessed at www.ccdg.gov.sg/news/media_release_13.htm.

The Ministry of Finance (MOF) invited members of the public to give their comments on proposed amendments to the Goods and Services Tax Act (GSTA) and the Stamp Duties Act (SDA) in July. The purpose of this consultation exercise was to seek feedback on areas of the draft legislation that require greater clarity or where compliance can be facilitated. The comment period closed on 5 August. The MOF is also seeking views on Singapore’s Avoidance of Double Taxation Agreements (DTAs) in a month-long consultation exercise from 1 August to 29 August 2005. The consultation paper and accompanying documents can be found at www.feedback.gov.sg as well as at MOF’s website, www.mof.gov.sg.

The Institute of Certified Public Accountants of Singapore (ICPAS) issued the following exposure drafts in July: ED/SSA 701 on The Independent Auditor’s Report on other Historical Financial Information, and ED/SSA 800 on The Independent Auditor’s Report on Summary Audited Financial Statements. The drafts may be modified in the light of comments received before being issued in final form. Comments should be submitted by 30 September 2005.

Joseph Alfred, technical manager, ACCA Singapore.

Australia & New Zealand

After a deluge of breach notices from auditors of small self-managed superannuation funds (SMSFs), the Australian Taxation Office (ATO) has decided to soften its hardline stance on auditor reporting in these funds.
Since 1 July 2004, auditors of SMSFs have been required to report any breaches of the strict provisions contained within the Superannuation Industry (Supervision) Act to the ATO. SMSFs have grown rapidly within the Australian superannuation system to almost 300,000 and they hold around A$156bn in assets.
Their popularity among small business owners and individuals has seen some use of these structures for purposes other than the accumulation of retirement savings. With many SMSFs run by inexperienced trustees, there have been problems with the separation of assets between the fund and the small business, as well as accumulation of assets for personal use.
Under the Act, all instances of non-compliance identified by the auditor, whether material or not and whether part of the audit scope or not, must be reported to the trustee and the regulator where relevant. Unlike a financial statement audit, a transaction in an SMSF may be material due to the duration or frequency of its occurrence, not just because of its dollar value.
The ATO’s tough line on breach reporting was designed to help stamp out problems in these funds, but it has now been forced to soften this approach and allow auditors to use their professional judgement to determine if breaches should be reported, rather than requiring compulsory reporting.
The regulator now expects SMSF auditors to exercise their professional judgement in line with professional auditing standards. If an auditor decides not to report a contravention, the ATO expects the decision to be explained in the management letter or audit finalisation report for the trustees.
It is also recommending that audit working papers include supporting documentation and reasons for the decision, along with any action taken or proposed by the trustees to rectify the contravention.

Janine Mace, Australian freelance finance and business journalist.

Americas

US

FASB did its best to provide some summer holiday reading, issuing at the end of June proposals for revising the accounting for business combinations. The proposals, developed jointly with the IASB, include a draft standard that would replace FASB Statement No. 141, Business Combinations.
The new approach would retain the fundamental requirement of FAS 141 to account for business combinations using a single method, where one party is identified as acquiring the other. The principal changes include a requirement to measure the business acquired at fair value, and to recognise the goodwill attributable to any noncontrolling interests (minority interests) rather than just the portion attributable to the acquirer. The proposals would also result in payments to third parties for consulting, legal, audit and similar services associated with the acquisition being recognised generally as expenses when incurred, rather than capitalised as part of the business combination.
In July, FASB also published an exposure draft of a proposed Interpretation, Accounting for Uncertain Tax Positions, which aims to reduce the range of practice associated with the recognition and measurement of income tax. The ED requires that a tax position meet a “probable recognition threshold” in order for the benefit to be recognised in the financial statements. It also contains guidance on a number of issues, such as the measurement of the benefit recognised, and when that benefit should be derecognised.
Meanwhile, FASB’s project on liabilities and equity - part of its work to improve the accounting for financial instruments - continues. A so-called “milestone draft” summarising the decisions reached by FASB in relation to the classification of single-component instruments is now accessible on the Board’s website, www.fasb.org. Work towards the second milestone is underway, in which FASB is addressing the accounting for multiple-component instruments - defined as financial instruments that have two or more equity or non-equity components.

Sarah Perrin, accountant and writer.

Canada

The Accounting Standards Oversight Council recently discussed the role of accounting standards in Nortel Networks Ltd’s recent restatements of its financial statements. After an internal investigation of its accounting practices, the global communications company restated its results for 2001, 2002, and 2003. A university lecturer’s presentation to AcSOC indicated the problems at Nortel resulted from the company’s desire to maintain its earnings growth, rather than any failure of accounting standards. His recommendations included additional disclosures in the notes, including reconciliation for all major provisions, separate disclosure in the income statement for net adjustments to provisions, discouraging non-GAAP performance indicators, and stronger action by regulators.
In response to the Canadian Public Accountability Board’s October 2004 report on quality inspections of Canada’s four largest accounting firms, which recommended more complete documentation of work, the Auditing and Assurance Standards Board (AASB) issued an exposure draft, presenting revisions to Section 5145, Documentation. The intent is to harmonise with the International Standard on Auditing 230, Documentation (ISA 230). Also, to minimise differences with US GAAP, the AASB considered the US Public Accounting Oversight Board Standard No. 3, Audit Documentation, which the Securities and Exchange Commission approved in August 2004 to improve audit quality and regain public confidence in auditing. The comment deadline was 31 August 2005.
The Accounting Standards Board (AcSB) has issued an exposure draft of a new standard on business combinations that would replace Section 1581, Business Combinations. The existing Section 1581 was the first stage in updating standards for business combinations, carrying forward existing guidance on the application of the purchase method. The AcSB then agreed that the overall guidance was applicable to business combinations between two or more co-operative enterprises; however, some additional guidance on the type of combination was necessary. The AcSB has developed these proposals in parallel with the joint US FASB/IASB project on business combinations. The comment deadline is 28 October 2005; the AcSB plans to issue the final standard in early 2006.

Alison Arnot, freelance writer and editor, Ottawa.

South Africa

The South African Companies Amendment Bill was released in July for public comment. Two provisions in particular will prove to be onerous for directors and may deter some people from developing new businesses.

Audit committees
Under the proposals in the new Bill, there would be a basic legal requirement for companies to appoint audit committees which are comprised of at least three non-executive directors who each satisfy the test of independence set out elsewhere in the Bill.
ACCA has commented that this will create significant difficulties for smaller companies, which not only have to identify and appoint suitable individuals to become directors in the first place, but which are then able to take on the role of audit committee members. Given the extensive responsibilities of audit committee members, and the strict test of eligibility, it will not prove easy, even for the largest companies, to find suitable individuals to take on these roles. But for smaller companies in particular, the requirement as drafted is likely to prove onerous and even impractical.
The Bill would also require public interest companies - which will include organisations such as charities - to appoint audit committees. This means that companies which do not have the same level of complexity and the same heightened need for transparency as listed companies would be regulated by the same strict standards.
ACCA believes that the Government must think again about the heavy demands that its proposals would place on smaller companies. It should re-consider whether it would be proportionate and cost-effective regulatory practice to require smaller public interest companies to appoint audit committees on the proposed basis. The proposals on this matter go much further than the equivalent rules in the US or the UK.
ACCA would favour the requirement for audit committees to be restricted to listed companies, either by legislation or alternatively by a listing rule. If unlisted companies were to be subjected to the same requirements as listed companies in this respect, this could act as a disincentive to businesses incorporating as public interest companies.

New criminal penalties
The new penalties facing directors and auditors of companies, if they allow themselves to be party to the publication of false or misleading accounts, means that they face increased legal responsibilities and must demonstrate high levels of skill and care to stakeholders.
While ACCA welcomes this, these added responsibilities, and the increased risk which directors and auditors feel they may face for making honest mistakes, may deter some people from developing new businesses, which would benefit the economy and provide employment opportunities.
ACCA believes that a new law should allow directors the opportunity to defend themselves against a legal charge by proving that they registered their objection at the time and tried to persuade their colleagues to not approve a misleading or incorrect statement.
ACCA has also called for a review of the civil liability of auditors, noting that while auditors should bear their share of the blame, they should not be the sole scapegoats for misleading statements.
ACCA believes that if a company’s directors are to be made criminally liable for false and misleading statements, it must follow that, under the civil law, an auditor who has failed to identify those statements should not be wholly liable to shareholders for all the losses incurred by them. Where an auditor has been negligent and has failed to properly protect the interests of shareholders, then shareholders should have a right of redress against the auditor under the civil law. But where the auditor has not been the only party at fault, and the company’s directors have successfully withheld certain information from the auditor or misled him, then the financial liability for meeting shareholders’ claims should be shared between the directors and the auditor in proportion to their respective faults.

Irene Christopher, head of policy development, ACCA South Africa.