Select Committee on Treasury Minutes of Evidence

Memorandum submitted by the Accounting Standards Board



  1.1  This paper responds to a request dated 22 March 2002 from the Treasury Committee, for the Accounting Standards Board to submit written evidence in connection with the inquiry into the financial regulation of public limited companies.

  1.2  It provides information on:

    —  the structure and organisation of the independent bodies concerned with the regulation of annual financing reporting, including the role of the Financial Reporting Review Panel in enforcing UK accounting standards [sections 2 to 4];

    —  current UK accounting standards [section 5]; and

    —  the current strategy and agenda of the Accounting Standards Board [sections 6 and 7].


  2.1  The Financial Reporting Council (FRC) and its two operational bodies, the Accounting Standards Board (ASB) and the Financial Reporting Review Panel (FRRP), were set up in 1990.

  2.2  The regime was established in line with the recommendations of a committee under the chairmanship of Sir Ron (now Lord) Dearing, set up in the wake of several spectacular corporate failures and other financial scandals involving poor financial reporting[1]. There was widespread acceptance in business, government and the profession of the need for improved accounting standards and a stricter enforcement system. There was also widespread support for the recommendation that the regulatory bodies should be independent of sectional interest and also of government. Until that time, accounting standards had been set solely by the accountancy profession.

  2.3  Annex A provides an organigram of the current independent regulatory structure concerned with annual financial reporting.

  2.4  The FRC, the over-arching body, plays a central role in the success of the system. It is funded by contribution—one-third each—from government, from the accountancy profession and from business, the latter largely through a levy now administered by the Financial Services Authority (FSA)[2]. The Chairman and Directors of the FRC are appointed by the Secretary of State for Trade and Industry and the Governor of the Bank of England.

  2.5  Members of the FRC[3] are drawn from the business, financial, professional and other communities at senior levels. It provides broad guidance to the operational bodies and administers their funding. Its Appointments Committee, which includes the Chairman and Directors, makes appointments to the ASB and FRRP.


  3.1  The ASB makes, amends and withdraws accounting standards, the ultimate authority for which derives from the recognition of the ASB by the Secretary of State for Trade and Industry under section 256 of the Companies Act 1985. The ASB has up to 10 Board members[4], of whom two (the Chairman and the Technical Director) are full-time, and the remainder, with a variety of backgrounds, are part-time. Three observers also attend ASB meetings—from the Department of Trade and Industry, from HM Treasury and, since 1 April 2001, from the International Accounting Standards Board (IASB).

  3.2  The ASB's predecessor body issued "Statements of Standard Accounting Practice" (SSAPs). Early in its life the ASB adopted these standards and began developing its own, contained in "Financial Reporting Standards" (FRSs). Both SSAPs and FRSs fall within the legal definition of accounting standards. Many of the SSAPs have been superseded by FRSs but some remain in force.

  3.3  Accounting standards apply to the annual financial statements of all companies, and of other kinds of entities that prepare accounts that are intended to provide "a true and fair view". They also apply to other accounting information published by companies (and for example the preliminary announcements and interim financial statements of listed companies) insofar as relevant regulators require this.

  3.4  The Foreword to Accounting Standards[5] explains the authority, scope and application of accounting standards. The principles that guide the ASB in establishing accounting standards are contained in the ASB's Statement of Principles for Financial Reporting.

  3.5  The ASB's policy is to consult widely on all its proposals. Generally the development of a new accounting standard involves at least two formal consultation documents, a Discussion Paper and a Financial Reporting Exposure Draft (FRED). Responses to such consultations are made publicly available. Published Financial Reporting Standards provide commentary on the development of the standards, including how the main aspects of responses to consultation have been dealt with.

  3.6  As indicated in Annex A, the ASB has a number of sub-committees, principal amongst which is the Urgent Issue Task Force (UITF). The work of these sub-committees is described in paragraphs 5.5 to 5.9 below.

  3.7  Throughout its history, the ASB has collaborated with accounting standard-setters from other countries and the International Accounting Standards Committee (IASC), the predecessor body of the current International Accounting Standards Board (IASB), in order to ensure that its own standards are developed with due regard to international developments. The ASB now has a particularly close working relationship with the IASB, which is described in more detail in section six below.

  3.8  The Chairman of the ASB makes an annual report to the FRC on its activities, published in the FRC's own Annual Review. In addition, the ASB publicises its activities through press releases, its website[6] and its quarterly newsletter "Inside Track" which provides a broad, non-technical report on the ASB's activities. The Chairman, Technical Director and staff also meet regularly with groups from business and the accountancy profession to discuss the ASB's work; these meetings are important in shaping the Board's thinking.


  4.1  The Dearing Committee, in setting up the present regulatory regime, concluded that improved standards alone would not secure better financial reporting. Indeed, as standards became more rigorous they believed that pressures on auditors would increase and securing compliance would become more difficult. The committee thus recommended the creation of a separate body—the Financial Reporting Review Panel (FRRP)—to oversee this compliance. It was set up as a second operational body under the FRC.

  4.2  At the same time, the arrangement recognised that primary responsibility for high quality financial reporting must continue to rest with the company's board of directors. It recognised too that the auditor remains the first line of defence against the pressures of defective financial reporting.

  4.3  The FRRP was given authority by the Secretary of State to enquire into the annual accounts of public companies and large private companies where they do not appear to comply with the requirements of the Companies Act 1985, including applicable accounting standards. The FRRP's power is confined to the statutory accounts. It cannot consider other financial material such as the auditor's report or chairman's statement; nor can it consider preliminary announcements; interim reports or financial material included in prospectuses.

  4.4  It relies on matters being brought to its attention either directly by complainants or by press comment. However, the FRRP has also considered and reported to the FRC on the case for, and the questions raised by, introducing an element of proactivity into its procedures. It is continuing to review this matter.

  4.5  When there is clearly a case to answer, it is heard by a Group (normally of five Panel members) including the Chairman, who selects the Group, and the Deputy Chairman. If, having questioned the accounts and heard the company's explanations, the Panel Group is still not satisfied, it seeks to persuade the company voluntarily to adopt a more appropriate accounting treatment. The directors may then voluntarily correct the accounts, taking the remedial action agreed with the FRRP. Should the FRRP fail to effect a voluntary correction, it can exercise its powers to secure revision of the original accounts through a court order. The FRRP maintains a legal cost fund of £2 million for this purpose.

  4.6  So far, the FRRP has succeeded in resolving all cases brought to its attention without having to apply for a court order. Since 1 January 1997 the FRRP has required corrective action to be taken in 28 cases. Its pronouncements on such cases provide a useful additional analysis of contentious issues. More important than the statistics however is the support the Panel provides to preparers of accounts and to auditors in reinforcing commitment to good financial reporting. The deterrent effect of the FRRP should not be underestimated although there are no statistics to show the instances where its findings—or indeed its existence—have discouraged an unhelpful accounting treatment.

  4.7  A further strength of the FRRP is the fact that its member[7] are held in high regard and command a wide range of professional financial and business expertise.

  4.8  The focus of the Panel is the quality of company accounts on the public record. However, it does liaise with other regulators, specifically with the professional bodies of auditors and directors involved in Panel cases, as well as other regulators who may have an interest in the material drawn to its attention.


  5.1  A list of the ASB's extant standards and related documents is set out on page 79 of the 2001 Annual Review of the Financial Reporting Council. A number of these standards, developed against the background of the corporate scandals of the 1980s, are targeted at practices previously considered to represent abuses. Principal amongst these are:

    —  FRS 4 "Capital Instruments", to prevent companies' debt being characterised as equity;

    —  FRS 5 "Reporting the Substance of Transactions", focused on ensuring that operational assets and related finance are shown on the balance sheet and on curbing early revenue recognition;

    —  FRS 7 "Fair Values in Acquisition Accounting" and FRS 12 "Provisions, Contingent Liabilities and Contingent Assets" which have curtailed the shifting of profits from one accounting period to another; and

    —  FRS 8 "Related Party Disclosures".

  5.2  Of more recent standards, FRS 17 "Retirement Benefits" highlights the pension funding obligations that companies have entered into, and the resources available to meet those obligations. FRS 18 "Accounting Policies", which replaced SSAP 2 "Disclosure of Accounting Policies", includes the requirement that a company adopt accounting policies "most appropriate to its particular circumstances for the purpose of giving a true and fair view".

  5.3  Each of the above-named standards has requirements that are, in their different ways, more stringent than the present equivalent standards of the IASC/IASB.

  5.4  UK standards are written in a style which emphasises principles of financial reporting and which calls for the exercise of judgement. By comparison with US Financial Accounting Standards and the related rulings of the US Securities and Exchange Commission, the absence of "bright line" rules in the UK regime does not easily allow loopholes to be exploited. It also permits auditors to challenge company directors as to whether their proposed accounting treatments reflect a "true and fair view" within the context of the standards.

  5.5  If issues of concern begin to emerge within this regime, the ASB's Urgent Issues Task Force (UITF)[8] has shown itself robust in issuing Abstracts to combat discreditable interpretations of the UK standards. Abstracts are issued in draft for public consultation and, once agreed in their final form by the UITF, are reviewed by the ASB prior to publication.[9] They are regarded as definitive statements on the interpretation of standards.

  5.6  Accounting standards and UITF Abstracts normally address issues that affect the generality of companies. Statements of Recommended Practice (SORPs) are the acknowledged vehicles for guidance on application of accounting standards in particular industries or sectors.

  5.7  The ASB itself does not issue SORPs; that is the responsibility of the SORP-making bodies. The ASB's statement "SORPs: Policy and Code of Practice"[10] sets out the requirements which recognised SORP-making bodies are expected to follow. The code of practice aims to maintain the quality of SORPs and to ensure due process in their development, whilst at the same time giving SORP-making bodies freedom to develop their guidance in the most useful way for their industry or sector.

  5.8  The ASB appends a statement, where appropriate, that the SORP does not appear to contain any fundamental points of principle that are unacceptable in the context of current accounting practice or to conflict with an accounting standard or the ASB's plans for future standards. Two sub-committees of the ASB—the Financial Services and Other Special Industries Committee (FSOSIC)[11] and the Public Sector and Not-for-profit Committee (PSNC)[12]—provide advice to the Board in its review of SORPs.

  5.9  One further sub-committee, the Committee on Accounting for Smaller Entities (CASE), advises the ASB: on its policies with regard for accounting standards for non-public companies which meet the requirements for treatment as small companies under the Companies Act 1985.


  6.1  Two events in 2001 had a significant bearing on the current strategy of the ASB.

    —  the reconstitution of the IASC to set up the IASB; and

    —  the publication of a draft Regulation to implement an earlier decision of the Council of Ministers that the group financial statements of listed companies in the EU should comply with international rather than with national accounting standards.

  6.2  These two events are fully discussed on pages 22 to 28 of the 2001 Annual Review of the FRC. Of particular note is the mission of the reorganised IASB to achieve a single, internally consistent, high-quality set of accounting standards for use across the globe. To achieve this, it works in partnership with major national standard-setters, drawing on the expertise and resource of those bodies; the national standard-setters also take particular responsibility for ensuring that the views of their domestic constituents are heard in the international debate.

  6.3  The ASB is one of the eight standard-setters named as "partners" in the current work of the IASB—together with the standard-setters of Australia/New Zealand, Canada, France, Germany, Japan and the USA. Individual projects on the IASB's agenda are being developed by staff either at one of the national standard-setters or at the IASB or, in many cases, on a co-operative basis. The ASB currently has a substantial share of the international workload.

  6.4  EU Ministers have proposed that from 1 January 2005, all listed companies in the EU should prepare their consolidated financial statements in accordance with adopted international accounting standards. A draft Regulation to this effect is at a late stage of negotiation and EU Ministers are expected to approve it in early May. The intention is that the IASB's standards will form the basis of those adopted international accounting standards. It is therefore now virtually certain that the IAS-based regime for the group financial statements of listed companies will begin in 2005.

  6.5  Present International standards are acknowledged as less robust in many respects than their UK equivalents. The IASB accepts that improvements are necessary for many of its existing standards and has an extensive on-going programme of work.

  This seems likely to result in many—if not most—of the IASB's standards being revised before 2005.

  6.6  Against this background, the ASB's current strategy is focused on:

    —  working with the IASB and with "partner" standard-setters around the world to improve and extend the existing International standards; and

    —  seeking to adopt International standards—once they are agreed—within the UK regime, in order to effect a smooth transition towards 2005 and a congruence of the standards applied by listed and unlisted companies. In this connection, the ASB intends shortly to issue six UK FREDs proposing the adoption of International standards that have recently been reconsidered by the IASB (together with related material), in place of their current UK equivalents.


  7.1  The Committee's terms of reference make specific reference to the Enron collapse; there are as yet insufficient facts available to reach conclusions on how the activities of that group would have been accounted for under UK accounting standards. The ASB has, however, already resolved that, as the facts do emerge, it should consider whether any existing UK standards might need specific re-consideration.

  7.2  In addition, the ASB's current workload already includes a number of projects which appear to be relevant to problems encountered at Enron and in other recent "profile" cases. These are summarised below.

Accounting for financial instruments

  7.3  The IASB will shortly publish a revision of its existing (and complex) standard on the valuation of financial instruments (IAS 39). The UK currently has no standard requiring financial instruments (and including derivatives) to be accounted for other than at historical cost, although FRS 13 "Derivatives and other Financial Instruments: Disclosures" does require substantial information on fair values to be provided in the footnotes to the financial statements. The new IASB text will be published as a FRED in the UK, together with a commentary from the ASB, with a view to the ensuing International standard being adopted in the UK. However, adoption will not be possible without changes in the EU Company Law Directives and the UK Companies Act, which it is understood may take until 2004 to complete.

Revenue Recognition

  7.4  Given increasing complexity in business' terms of trade, there is a need for a revenue recognition standard in the UK, to supplement material in FRS 5 "Reporting the Substance of Transactions" and a related UITF Abstract. The current International standard on revenue recognition is relatively simplistic and out-moded; there is no general US standard (although the US SEC and various US committees have issued a substantial volume of rules). An ASB Discussion Paper was issued in July 2001; work is in hand to develop a draft standard, which the ASB intends to discuss with the IASB this year.

Consolidation Policy and Practice

  7.5  The current international standard (IAS 27) and interpretation (SIC 12) on consolidation methodology provide rather less guidance than equivalent UK standards. There is, in addition, some debate internationally as to whether the global standard should be based on "control" (used in the UK) or "ownership" (used in the USA) and, indeed, how an international standard should be written (ie whether it should, as in the current US model, include "bright line" ownership criteria as a basis for deciding whether or not to consolidate a dependent entity). The ASB is running a project for IASB, working with the other national "partner" standard-setters to try to resolve the current debate, which is particularly relevant to special purpose entities [SPEs]. A first paper will be presented to the IASB in May.

Recognition and De-recognition

  7.6  The IASB has no standard dealing comprehensively with recognition and de-recognition issues (for example, when an asset has been sold or merely offered as security for loan finance). The UK standard, FRS 5 "Reporting the Substance of Transactions", has proved successful in curbing "off balance sheet finance". The ASB has been asked by the IASB to develop an overall framework approach to recognition and de-recognition issues, for consideration for international use.


  7.7  Concerns have been expressed with regard to the current model for accounting for leases, which makes an artificial distinction between finance leases (where obligations are recorded on the balance sheet) and operating leases (where they are not). An equivalent distinction is made in UK, US and International standards. In 1999, the ASB published an international discussion paper proposing a single model for lease accounting; it is now developing the ideas in that paper to prepare a draft standard. The IASB is monitoring this project, with a view to taking it onto its agenda in due course.

Operating and Financial Review

  7.8  Encouraging boards of directors to set out their explanation of factors significant to prospects for the business is paramount in assisting investors to understand the financial statements. In 1993, the ASB issued its statement "Operating and Financial Review" (OFR) to encourage high quality explanations. It is now working on a revision to that statement and is currently discussing proposals with the FSA and others. The ASB intends to issue a consultation paper on its revision in the next two months.

  7.9  It should be noted that the current OFR statement has persuasive rather than mandatory effect; the ASB does not currently have the authority to make standards in this area. It is understood, however, that the government may bring forward for adoption in law, the recommendation of the recent Company Law Review Steering Group that the OFR statement should be made mandatory for public limited and other large companies.

Insurance Accounting

  7.10  One area of financial reporting remains a particular challenge. Insurance accounting has developed under the twin pressures of financial reporting and regulatory control; this latter aspect means that the accounting practices adopted are quite different from one country to another, and generally regarded as unsatisfactory. The ASB has been contributing to an international project on insurance accounting since 1996 and continues to participate in what has now become an urgent priority for the IASB.

  7.11  Further detail of the above projects, and of the other items on the ASB's and IASB's agendas. Is given in the report from the Chairman of the ASB included in the enclosed 2001 Annual Review of the FRC.

  FRC—Financial Reporting Council.

  ASB—Accounting Standards Board.

  FRRP—Financial Reporting Review Panel.

  CASE—Committee on Accounting for Smaller Entities.

  FSOSIC—Financial Sector and Other Special Industries Committee.

  PSNC—Public Sector and Not-for-Profit Committee.

  UITF—Urgent Issues Task Force.

Annex B


  "The Making of Accounting Standards", a report published in 1988 by a committee chaired by Sir Ron Dearing.

  2001 Annual Review of the Financial Reporting Council.

  The Foreword to Accounting Standards (published 1993).

  The Statement of Principles for Financial Reporting (published 1999).

  SORPs: Policy and Code of Practice (published 2000).

15 April 2002

1   The report of the Dearing Committee-"The Making of Accounting Standards"-was published in 1988 and is annexed in evidence (not printed). Back

2   Summary financial information, for the year ended 31 March 2001, is provided on page 76 of the annexed 2001 Annual Review of the FRC (not printed). Back

3   The members of the FRC at 31 December 2001 are set out on page 66 of its 2001 Annual Review. Back

4   The membership of the ASB is set out on page 69 of the 2001 Annual Review of the FRC. Back

5   Annexed in evidence. Back

6 Back

7   The membership of the FRRP is set out on page 74 of the 2001 Annual Review of the FRC. Back

8   The membership of the UITF is set out on page 70 of the 2001 Annual Review of the FRC. Back

9   UITF Abstracts extant at 31 December 2001 are listed on page 80 of the 2001 Annual Review of the FRC. Abstract 33 "Obligations in Capital Instruments" has since been issued, and two further draft Abstracts, already issued for consultation, are awaiting final review by the ASB. Back

10   Annexed in evidence. Back

11   For membership of FSOSIC, see page 71 of the 2001 Annual Review of the FRC. Back

12   For membership of PSNC, see page 72 of the 2001 Annual Review of the FRC. Back

13   Not reproduced. Back

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