Next month, the Board will be issuing five new Financial Reporting Standards (FRS) as part of its strategy for convergence with International Financial Reporting Standards (IFRS) (see page 3). The scope of each standard is set out below, although entities applying the ‘Financial Reporting Standard for Smaller Entities’ (FRSSE) are exempt from all five.
Earnings per Share (EPS)
FRS 22 (IAS 33) ‘Earnings per Share’ will reflect the proposals in Financial Reporting Exposure Draft (FRED) 26 and will supersede the existing UK accounting requirements set out in FRS 14.
The FRS will be mandatory for accounting periods beginning on or after 1 January 2005 for all entities whose ordinary shares or potential ordinary shares are publicly traded, and by entities that are in the process of issuing ordinary shares or potential ordinary shares in public markets.
FRS 22 has the effect of implementing IAS 33 (revised 2003) in the UK and Republic of Ireland. The main change from FRS 14 is that basic and diluted EPS be disclosed on the face of the profit and loss account both for net profit or loss for the period and for profit or loss from continuing operations. Basic and diluted EPS for discontinued operations (if reported) may be shown either on the face of the statement or in a note. Any additional per share amounts must be disclosed in a note. Under FRS 14, basic and diluted EPS for net profit or loss are required on the face of the profit and loss account.
Foreign currency standards
FRS 23 ‘The Effects of Changes in Foreign Exchange Rates’ and FRS 24 ‘Financial Reporting in Hyperinflationary Economies’ will reflect the proposals in FRED 24 and will supersede existing UK accounting requirements set out in SSAP 20 ‘Foreign Currency Translation’ and the related UITF Abstact 9 ‘Accounting for Operations in Hyper-inflationary Economies’.
FRS 23 and FRS 24 have the effect of implementing IAS 21 and IAS 29 in the UK and the Republic of Ireland. They will apply only to entities that prepare their financial statements in accordance with FRS 26 ‘Financial Instruments: Measurement’ (see below) and become effective only when an entity first applies FRS 26. This means that listed entities will apply the standards for accounting periods beginning on or after 1 January 2005; for other entities within the scope of FRS 26 the standards take effect from the date that their accounting policies cause them to apply FRS 26.
FRS 23 introduces the terms ‘functional’ and ‘presentation’ currencies. An entity measures items using the functional currency (that of its primary economic environment) but presents financial statements in any currency. Other changes from current UK accounting requirements include the removal of the option to measure profit and loss at closing rate; actual (average) exchange rates should be used. Goodwill should be translated at closing rate.
IAS 21 requires exchange differences on a monetary item that is part of a net investment in a foreign operation to be recognised initially in the Statement of Total Recognised Gains and Losses (STRGL), then recycled to the profit and loss account on disposal of the foreign operation. Existing UK standards do not permit any gains and losses to be recycled. In FRED 24, the Board had proposed to retain the prohibition on recycling. However, while the Board continues to believe that, conceptually, recycling has no place in financial reporting, in the interests of convergence, FRS 23 implements the requirement in IAS 21 that certain gains and losses should be recycled.
The main change in FRS 24 from UITF Abstract 9 is that the UITF Abstract allows a choice of methods for eliminating the distortions that arise in hyper-inflationary economies: either the financial statements should be restated to reflect the impact of price changes or the entity should adopt a stable currency as its functional currency. If neither of those methods is considered appropriate, other methods can be used. FRS 24 requires adoption of the price changes approach.
Financial Instruments standards
FRS 25 (IAS 32) ‘Financial Instruments: Disclosure and Presentation’ and FRS 26 (IAS 39) ‘Financial Instruments: Measurement’ will reflect the proposals set out in FRED 30 and its three Supplements. The standards have the effect of implementing the requirements of IAS 32 and the measurement provisions of IAS 39. The rovisions of IAS 39 relating to derecognition of financial instruments have not been implemented in FRS 26, but as noted on page 1, the Board will be bringing forward proposals to introduce these provisions.
The presentation requirements of FRS 25 will apply to all entities for accounting periods beginning on of after 1 January 2005. As a result preference shares that are obligations will be classified as liabilities rather than shareholders’ funds, which corresponds with the amendments to the Companies Act 1985 resulting from the EU Accounts Modernisation Directive that also require the classification of items on the balance sheet to have regard to their substance.
The disclosure requirements of FRS 25 will apply for accounting periods beginning on or after 1 January 2005 for those entities applying FRS 26 requirements on measurement and hedging, and from 2007 for all other entities. Wholly-owned subsidiaries that are not themselves banks or insurance companies will be exempted, as will the single-entity accounts of parent companies. The existing UK standard on financial instrument disclosures, FRS 13, applies only to listed entities and to banks and similar institutions. Most of these entities will be required to adopt the measurement rules of FRS 26 and accordingly fall within the scope of FRS 25’s disclosure requirements. For such entities, FRS 13 is withdrawn. However, FRS 13 remains in force for any banking or similar institution that does not fall within the scope of FRS 26 and does not voluntarily adopt that standard.
FRS 25 also has the effect of withdrawing FRS 4 ‘Capital Instruments’, except for material on the measurement of debt and gains and losses on the repurchase of debt. This material is withdrawn for entities applying the measurement requirements in FRS 26, but remains applicable for other entities. FRS 25 will also supersede three UITF Abstracts: 11 ‘Capital instruments: issuer call options’; 33 ‘Obligations in capital instruments’; and 37 ‘Purchases and sales of own shares’. FRS 25 also replaces the offset rules in FRS 5 ‘Reporting the Substance of Transactions’.
FRS 26 implements the measurement and hedging requirements of IAS 39 in their full version rather than the EU-amended IAS 39. However, entities applying FRS 26 will still be subject to the provisions of the Companies Act, which restricts the use of fair value measurement for liabilities. These entities will not, as a result, be able to take full advantage of the fair value option in FRS 26. The ASB will include in FRS 26 guidance on the extent to which liabilities may be accounted for at fair value and whether in some circumstances a true and fair override may be appropriate.
FRS 26 will apply to 2005 year-ends for all listed entities still following UK standards, and from 2006 for certain unlisted entities whose financial statements are prepared in accordance with the fair value accounting rules set out in the Companies Act.
Consolidations
The ASB also expects to publish, before the end of the year, amendments to FRS 2 ‘Accounting for Subsidiary Undertakings’, reflecting changes in UK company law stemming from the Modernisation Directive, as foreshadowed in its 2004 exposure draft.
