FRED22 - Revision of FRS3
Comments from the Association of Chartered Certified
Accountants
April 2001
Further information on ACCA is available on ACCA's website, www.accaglobal.com.
Summary
The Association of Chartered Certified Accountants (ACCA) is pleased to have this opportunity to respond to the above exposure draft (FRED22) of a revision to FRS3 issued for comment by the Accounting Standards Board.
ACCA supports in principle the development of a single performance statement, as reducing the risks that important elements of performance would be overlooked and avoiding the need for users to have to restate results by pulling together elements of performance from different places in the accounts.
We have some concerns over whether these proposals should be implemented in the UK, while the position of UK standards and requirements to use International Accounting Standards (IAS) after 2005 remains unclear. There is a risk that some companies would have to change their reporting for FRED22 and then have to change again in 2005 to conform with IAS.
If FRED22 were to become a standard, it follows that:
- there should be greater clarity on the legal position of what constitutes the profit and loss account and what is profit or loss for the year
- there should be two main sections to the performance statement and not the three proposed in FRED22
-
revaluation gains and losses on investment properties should be reported as a distinct component of the operating section
and - the UK accounting for proposed dividends should be harmonised with international practice and the ASB's Statement of Principles.
ACCA's Principal Comments
1. We broadly support the proposals in FRED22 and would like to see them put into practice at an appropriate point.
TIMING
2. We have concerns, however, over when this should happen. It appears likely that, by 2005, UK listed companies will at the very least be preparing consolidated accounts in compliance with IAS, with potentially also their individual accounts, those of their subsidiaries and others. Implementing these proposals as a UK standard runs a risk for those companies that the reporting of their financial performance would change as a result, and then have to change again in 2005. It is also possible that IAS might themselves have been revised by then along the lines of FRED22. We are conscious, however, that the successful introduction of a single performance statement in the UK would no doubt help to achieve acceptance of the proposals internationally. Until the position of UK standards post-2005 and the agenda of the IASB are clearer, the relative merits of implementing FRED22 as against delay seem hard to judge.
LEGAL COMPLIANCE
3. If FRED22 were to be implemented we would like to see more explicit guidance from ASB on how the proposals should be handled to ensure compliance with the Companies Act. We note the conclusions in Appendix II that the proposals comply with the requirement of the law to provide a P&L account using one of the formats specified, because there will be two sections (operating and financing) which together will correspond to the statutory P&L. It is, however, not clear from the text or the examples in Appendix I, whether the ASB believes that companies must show that part of the performance statement which represents the statutory P&L and identify any key totals as profit for the year and profit before tax. The SORP Accounting and Reporting by Charities for example includes the requirement for a single performance statement (the Statement of Financial Activities), but recognises that charitable companies will have to provide a statutory income and expenditure account in some form or another, including an explicit amount with the label net income/expenditure for the year.
4. Within the FRS itself, rather than in Appendix II or in the footnote to paragraph 70, of the correspondence between the statutory totals (profit on ordinary activities before taxation, profit for the financial year) and the subtotal results shown in the Statement of Financial Performance (SFP) should be more clearly identified. This is needed because there are references to "profit and loss account", "profit or loss for the year" and related terms not only in statute, but also through many other documents (including Articles of Association, shareholder agreements, bonus arrangements and banking covenants). Certainty over what constitutes those terms under current practice will be important.
DIVIDENDS
5. Our further suggestion is
that ASB should take the opportunity of a new standard and a proposed
change in the law to clarify and harmonise UK and international practice
with regard to accounting for dividends. We note that dividends will not
be included in the SFP but shown as a memorandum item at the bottom of the
SFP. We accept that these are not items of financial performance and so
should not be included in the SFP. We suggest, however, that the
memorandum item could include both paid dividends and, in line with
current practice, proposed dividends relating to the performance of the
year, if they are clearly disclosed as such. In the balance sheet,
however, and in the reconciliation of ownership interests and the movement
on reserves note, dividends should be restricted to those paid or those
which at the year end can be recognised as liabilities (based on the
definition in the Statement of Principles). This would be a step to
harmonising UK and international standards.
Answers to ASB's specific questions
We set out our responses to the specific questions raised for comment in FRED22.
Q1. Do you agree with the proposals in the draft FRS (paragraphs 6 and 7) to introduce a single performance statement, in which would be reported all gains and losses recognised in a period that relate to that period? Do you agree that, as a consequence:
(a) transactions with owners as owners, such as dividends paid, should not be shown in the performance statement (paragraphs 8 and 9)?
>(b) recycling between
sections of the performance statement should not be permitted (paragraphs
10 and11)?
Broadly yes. We consider that a single performance statement containing all items relating to the performance of an entity which have been recognised in the period will be an improvement over the present position of a profit and loss account and another statement to collect other items. The difficulties of the present position are that either important elements of performance risk being overlooked by users, or users have to adjust reported results by combining the elements of performance reported in different places in the accounts.
We note that the position under the existing version of FRS3 is already more satisfactory in this regard than IAS, in that a Statement of Total Recognised Gains and Losses (STRGL) is provided.
We have noted above comments in relation to the legal position and in relation to dividends.
Q2. Do you agree with the proposed structure of the performance statement of three sections ((a) operating, (b) financing and treasury, and (c) other gains and losses) as laid out in paragraphs 14-17?
We consider that for the present there
should be only two main sections to the SFP - operating (including
financing) and other. Our reasons are as follows.
- We note no distinction in principle or definition is provided for financing items as opposed to other or operating items.
- For certain businesses, such as banks, the two sections will be combined.
- Tax is to be provided on the two sections combined.
- There are some items where the categorisation is questionable (see Q3) below.
Q3. Do you agree with the bases on which gains and losses are allocated to the different sections of the performance statement as described in paragraphs 18-29 of the draft FRS and explained in Appendix IV 'The development of the FRED' (paragraphs 23-41)?
We agree:
- that the operating section rather than the other section should be
the default category. This is reasonable and prudent given an
expectation that that users of accounts will pay more attention to the
operating/financing sections than the other section, when estimating
future earnings. It also mirrors the current restrictions on those items
that can be taken through the STRGL
and - with the limited reclassification between what is currently in the P&L and what will be in the operating/financing section of an SFP, principally that gains and losses on disposal of properties and of discontinuing operations will move from being "super exceptionals" under FRS3 to the other section of an SFP. Disposal gains/losses and revaluations are both most likely to be holding items.
We think that there remain items where the treatment could be clarified.
- Does income from investments (paragraph 22(c)) held as part of the treasury activities include gains and losses on disposals of all current asset investments?
- How should gains or losses on investments treated as fixed assets, associates or joint ventures be classified?
- Is there intended to be a "super-materiality" test applied to the gain/loss on the disposal of businesses under paragraph 26(d), in the reference to discontinued operations (a separate major line of business or geographical area)?
- It is not so clear why the gains on disposals in paragraph 26(b) should be restricted to those on properties (land and buildings, presumably) rather than tangible fixed assets generally. We note that gains and losses on disposal of intangible assets will be reported as a revaluation gain.
We find the categorisation of the unwinding of the discount on a provision as a financing loss problematic, as no finance as such has been provided. To then treat the discount on deferred tax as part of the tax charge is anomalous.
Q4. For complex organisations, the single performance statement would contain a great deal of information. The Board does not wish to overburden the face of the statement, nor does it wish to see critical information relegated to the notes to the statement. Companies legislation offers some flexibility on this issue and views are therefore sought on how much information should be shown on the face of the performance statement.
(a) Should the FRS specify the minimum disclosure of items within each or any of the sections of the performance statement?
(b) Should the FRS specify the minimum disclosure for the results of discontinuing and continuing operations, for example turnover and operating result?
(c) Should the FRS specify the maximum permitted
disclosure, thereby outlawing the provision of additional information or
even formatting (at least on the face of the statement) that is provided
at the discretion of management?
Yes to (a) and (b) and no to (c). There seems no good reason to change from the current position on these matters.
Q5. The Board has considered two different approaches to the allocation of gains and losses between the operating section and the financing and treasury section (paragraphs 21-24 and Appendix IV, paragraphs 28 and 29).
(a) Do you agree with the approach laid out in the FRED, under which gains and losses resulting from operating activities that are financial in nature are reported in the operating section, whereas gains and losses arising from the financing of all the entity's activities, whether financial or not, are reported in the financing and treasury section?
(b) Alternatively, do you prefer an approach under which all gains and losses arising on financial activities are reported in the financing and treasury section?
We have noted above that we think there should not be a separate financing section. Based on the definition in paragraph 2 however, we think that (a) is the better approach.
Q6. The FRED has moved from the notion in FRS 3 of 'discontinued' operations to the focus in the international standard on 'discontinuing' operations (paragraphs 39-59). Do you agree that the proposed FRS should adopt the international requirement in this respect?
Yes.
Q7. The FRED would amend FRS 15 'Tangible
Fixed Assets' so that disposal gains and losses arising on fixed assets
are reported in the same way as revaluation gains and losses and
impairment losses (see Appendix IV, paragraph 42). Do you agree that these
gains and losses should be reported in the same way, regardless of whether
they are realised in the period?
Yes. We are not sure, however, that FRED22 as drafted quite achieves the effect claimed above. Our answer to Q3 above notes a number of items in this connection whose treatment needs clarification.
Q8. The Board is keen to elicit respondents' views in the light of experience in applying FRS 15 regarding the allocation of recognised losses on fixed assets between sections of the performance statement, and how (for revalued assets) recognised gains arising in subsequent periods should then be reported. On the arguments laid out in Appendix IV (paragraphs 43-48):
(a) do you believe that all falls in value of fixed
assets from carrying amount to recoverable amount should be treated as
impairments (whether those assets have previously been revalued or not)?
(b) do you believe that recognised increases in value arising in
subsequent periods should be treated as revaluation gains or do you think
they should be treated as reversals of previous impairment losses (to the
extent of those previously recognised losses)?
Alternatively, do you
believe that the existing treatment in FRS 15 is satisfactory?
We are in favour of leaving the existing treatment in FRS15 unchanged. Impairments could represent corrections to estimates of either revaluations or of depreciation. Essentially those losses which reverse revaluation gains down to depreciated historical cost should go to the other section of a SFP, and everything else to the operating section. We recognise that this is a pragmatic answer, but also that the distinction probably becomes less important with a single performance statement.
Q9. Applying the
logic of the proposals in the FRED, the fair value gains and losses
arising on investment properties would be reported in the 'operating'
section of the performance statement (see page 5 above and Appendix IV,
paragraphs 49-51). This conforms to the approach taken in IAS 40
'Investment Property', but would necessitate an amendment to SSAP 19,
which requires such gains and losses to be reported in 'other gains and
losses'. Do you agree that the Board should consider such an amendment?
Yes. We consider that for an investment property company these gains/losses would be an operating item. A clear distinction, however, from other operating items (for example net rental income) would be important for users in terms of the prediction of future earnings.
Q10. Do you agree with the proposals relating to:
(a) exceptional items (paragraphs 61-66); and
(b) extraordinary items (paragraphs
67-69).
Yes. We think the deletion of the "super exceptional" category from paragraph 20 of the existing FRS3 is an improvement
Q11. The draft FRS sets out modified requirements in respect of certain entities in recognition of their regulatory environment and type of business.
(a) Do you agree with the proposals in relation to:
(i) banking companies and banking groups (paragraphs 79-81);
(ii) insurance companies and insurance groups (paragraphs 82-85); and
(iii) investment companies (paragraphs 86 and 87)?
(b)
Do you agree that further guidance for these and other bodies can be
provided in relevant Statements of Recommended Practice (SORPs), or do you
think that additional guidance would be needed in a standard?
Yes, to both parts (a) and (b).
Q12. The
Board considered how conglomerates might best report their diverse
activities within a single performance statement. For such groups, further
disaggregation of the of the primary results may be necessary, for which
SSAP 25 'Segmental reporting' provides a framework. Do you believe that
SSAP 25 is adequate for this purpose?
The principles seem adequately covered by SSAP25.
Q13. The FRED proposes (in paragraphs 93-100) that certain information should be shown as memorandum items at the foot of the performance statement on the basis that, although not gains and losses of the period, they provide valuable information about company performance:
· all earnings per share figures
· dividends paid and proposed for the period, both in total and per share
· cumulative adjustments recognised in the period that arise from prior period adjustments.
Do you
agree that any, some or all of these should be shown as memorandum items
at the foot of the performance statement?
Yes. See our comments concerning dividends above. The disclosure of the effect of prior period adjustments on the face of the SFP will be useful in highlighting any restatement of the accounts which has affected results. We also think that the number of shares used in the dividends per share calculation should be specified, as it is for earnings per share.
Q14. Do you agree that basic earnings per share, calculated as required by FRS 14 'Earnings per Share', should be based on 'operating and financing income after tax and minority interests' that is attributable to ordinary shareholders (paragraph 93)?
Yes. This would be consistent with treating the operating/financing subtotal as the equivalent of profit after tax.
Q15. The Board is minded to delete the requirement in FRS 3 for a note of historical cost gains and losses because it believes that the note has limited informational content. However, user respondents to the Discussion Paper expressed support for retaining the note. The FRED proposes to make the note non-mandatory. Do you believe that the note of historical cost profits and losses, as drafted in the FRED, should be:
(a) mandatory (as in FRS 3 at present);
(b) optional (as proposed in the FRED); or
(c) not mentioned in the standard at
all?
We
consider that the note of historical cost profit and losses should be
retained as a mandatory item. The note would clearly have informational
content. The question would seem more over the usefulness of the
information. We think that the information could be relevant to users as:
- a familiar benchmark, to aid comparability between different enterprises while various measurement options remain.
- an indicator of the extent of realised profits in the current
year
and - to deal with some of the concerns raised by those in favour of recycling, and thereby as an aid to international comparability.
Other Items
We also noted the following matters which were not covered by the specific questions.The treatment of minority interests (divided between the combined operating and financing sections and the other section) is clear from the examples but is not dealt with in the text of the standard.
We note that the presentation for discontinuing operations in an SFP should be adjusted as a result of post balance sheet events up to the date of preparation of the financial statements (see paragraph 51). Recognition of the financial effects of the discontinuance would not be similarly adjusted however. For example, any associated provisions for redundancies might not be able to be recognised in that year because there would have been no unavoidable commitment at the year end, because perhaps no announcements had been made. Any impairments evident from discontinuance might be recognised in either year. We think, therefore, that where simply the initial disclosures of paragraph 49 are being made, as good an indication as can be managed of the prospective effects of the discontinuance should also be provided.