Financial Reporting Council - Students

FAQs

Here are some of the questions that students often ask the ASB. The answers have been prepared by the ASB's staff and, of course, do not represent the official position of the ASB.

What are accounting standards?
Are accounting standards mandatory?
It is sometimes suggested that accounting standards are not necessary, because the market can decide what accounting principles to demand. What are your views on this?
How many staff does the ASB have?
How does the ASB decide what subjects to add to its agenda?
How does the ASB obtain views before issuing an accounting standard?
What has the ASB done about "creative accounting"?
What are the ASB's views on international harmonisation of accounting standards?
What is the ASB's Statement of Principles for Financial Reporting? What role does it play in the setting of accounting standards?
What are the ASB's views on putting brand names and other intangible assets on the balance sheet?
Why does the ASB think that the balance sheet is more important than the profit and loss account? After all, earnings is what is most important to the market.
What does the ASB think are the biggest problems in financial reporting today?
Will accounting standards ever be complete?
If I write to the ASB, will it help me with my project/assignment/dissertation?

What are accounting standards?

Accounting standards are authoritative statements of how particular types of transaction and other events should be reflected in financial statements. Accordingly, compliance with accounting standards will normally be necessary for financial statements to give a true and fair view.

Accounting standards issued by the Accounting Standards Board are designated "Financial Reporting Standards" (or FRSs). Those issued by its predecessor bodies, and adopted by the Board when it was created in 1990, are designated "Statements of Standard Accounting Practice" (or SSAPs). Adoption by the Board gave the SSAPs the status of "accounting standards" within the terms of Part VII of the Companies Act 1985. The Board reviews these SSAPs individually as appropriate opportunities arise during the course of its work: so far, of the 22 SSAPs adopted in 1990, four have been withdrawn and superseded by FRSs and five more are in the process of withdrawal.

The consensus pronouncements of the Board's Urgent Issues Task Force, which are contained in UITF Abstracts, do not have the same legal status as accounting standards, but the courts are likely to hold that compliance with Abstracts is also necessary for financial statements to give a true and fair view.

For further detail, see the Foreword to Accounting Standards.

Are accounting standards mandatory?

Companies legislation does not directly require compliance with accounting standards. However, the Companies Act 1985 requires accounts (other than those prepared by small or medium-sized companies) to state whether they have been prepared in accordance with applicable accounting standards and to give particulars of any material departure from those standards and the reasons for it.

Directors of companies are required by the Act to prepare accounts that give a true and fair view of the state of affairs of the company and of its financial position at the end of the financial year. The accountancy profession (as represented in the Consultative Committee of Accountancy Bodies) is committed to promoting and supporting compliance with accounting standards by its members, whether as preparers or auditors of financial information.

Under the Companies Act, both the Financial Reporting Review Panel and the Department of Trade and Industry have procedures for receiving and investigating complaints regarding the annual accounts of companies in respect of apparent departures from the accounting requirements of the Act, including the requirement to give a true and fair view.

The Accounting Standards Board has received and published legal advice that the courts would be likely to hold that compliance with accounting standards is necessary to achieve a true and fair view, as required by the Act.

In short, accounting standards should be regarded as mandatory (except in very rare and special circumstances where the requirement to give a true and fair view makes it necessary to depart from accounting standards).

It is sometimes suggested that accounting standards are not necessary, because the market can decide what accounting principles to demand. What are your views on this?

Most of the accounting scams of the 1980s, such as off balance sheet finance, window dressing, the presentation of debt as equity and the abuse of reorganisation provisions, were practised in areas of accounting that were not the subject of accounting standards. Experience shows therefore that, in the absence of regulation, financial reporting may not give the information that users need to make informed assessments of companies. Accounting standards aim to promote comparability, consistency and transparency, in the interests of users of financial statements. Good financial reporting not only promotes healthy markets, it also helps to reduce the cost of capital because investors can have faith in companies' reports.

How many staff does the ASB have?

The Chairman and Technical Director of the Board are both full-time members of the Board. The staff are employed by the Financial Reporting Council and serve the three related bodies (the FRC, the ASB and its committees, and the FRRP) as the work demands. The technical staff mainly engaged on ASB work include an Assistant Technical Director, a Principal Project Director, six Project Directors and a consultant. In addition the ASB is served principally by six administrative and secretarial staff.

How does the ASB decide what subjects to add to its agenda?

In the ASB's early years its agenda for new standards was influenced by the legacy of unfinished projects it inherited from its predecessor body and the need to take resolute action to clean up the inadequacies revealed by the accounting scams of the 1980s. In other words, some of the early standards were of the nature of anti-abuse regulation. In recent years, however, the ASB's work has been driven largely by the need to get ahead of the agenda of the International Accounting Standards Committee, to enable the views of the business community in the UK and the Republic of Ireland to be properly represented and taken account of in the international debates in which the ASB participates.

However, the ASB remains sensitive to the need to deal with important domestic issues that are of no international interest: an example is the development, and issue in 1998, of a mandatory Application Note to FRS 5, giving guidance on the treatment of Private Finance Initiative and similar contracts.

How does the ASB obtain views before issuing an accounting standard?

In accordance with the ASB's 'due process' new standards normally go through a lengthy, formal two-stage process of public consultation before they are issued.

The first stage is the publication of a Discussion Paper, which describes and analyses the problem in question and sets out possible ways of dealing with it. At that stage the ASB may not necessarily have decided on a preferred option. The Paper will typically set out a list of questions that respondents are invited to address, and a comment period of, usually, three months is given.

The ASB analyses and considers the responses it receives. It will give far greater weight to the quality of the arguments advanced than to the volume of responses. It will then develop firm proposals, which are eventually published as a draft standard in "exposure draft" form as a Financial Reporting Exposure Draft (or FRED).

Again, at this second stage of public consultation, respondents are usually invited to comment within a three-month period, but on the basis of the specific proposal.

Again, the ASB analyses and considers the responses. Having modified its proposal as appropriate, the ASB will then issue its accounting standard as an FRS.

In addition, throughout this two-stage formal process the ASB typically meets and discusses its proposals with a wide variety of interested parties, including representative organisations, companies and others.

What has the ASB done about "creative accounting"?

"Creative accounting" is primarily a journalistic term; it has no official standing and no agreed definition.

The ASB's task is to improve the quality of financial statements, a task that obviously took as its starting point the standards of financial reporting that existed when the Board was established in 1990. In its Statement of Aims (1991), the ASB adopted certain guidelines for conducting its affairs. The first was

"To be objective and to ensure that the information resulting from the application of accounting standards faithfully represents the underlying commercial activity. Such information should be neutral in the sense that it is free from any form of bias intended to influence users in a particular direction and should not be designed to favour any group of users or preparers."

If, for convenience, it is assumed that 'creative' accounting is the opposite of what the ASB favours-ie accounting that does not faithfully represent the underlying commercial activity and is not neutral-then it would be correct to say that the ASB aims to eliminate 'creative' accounting.

In developing accounting standards, the ASB set itself five principal objectives:

Exclude from the balance sheet-the statement of assets and liabilities-items that are neither assets nor liabilities
Make 'off balance sheet' assets and liabilities more visible by putting them on the balance sheet whenever practicable
Ensure that all gains and losses are reported prominently so that nothing can be overlooked
Reverse the 'bottom line' mentality by focusing performance reporting on the components of income
Use up-to-date measures, when appropriate, if other measures such as historical costs are ineffective.

These objectives have underpinned the ASB's work, and it could perhaps be argued that the more successfully the ASB attains them, the more honest and faithful financial reporting will become. Much of the ASB's earlier work focused initially on eradicating the worst problems it perceived in financial reporting practices in the 1980s. For example, FRS 3 'Reporting Financial Performance' dealt with the abuse of "extraordinary items"; FRS 4 'Capital Instruments' tackled the problem of debt being portrayed as equity; off balance sheet finance was addressed by FRS 5 'Reporting the Substance of Transactions'; the abuse of acquisition provisions was dealt with by FRS 6 'Mergers and Acquisitions' and FRS 7 'Fair Values in Acquisition Accounting'; and the problem of hidden related party transactions was tackled in FRS 8 'Related Party Disclosures'.

To the extent that these standards have been reflected by improved financial reporting, users may now feel able to place greater reliance on financial statements. On the other hand, given the ingenuity of the human mind in circumventing the purpose of any regulations, it would perhaps be a delusion to think that it was possible to prevent the future development of accounting practices whose purpose was to mislead the user. All the ASB can hope to do is to remain alert to the possible abuse of the existing rules and to act promptly. Indeed, it was exactly this thought that lay behind the ASB's establishment of its Urgent Issues Task Force.

Many of the practices the ASB has sought to eradicate-for example those mentioned above-have been described in the media as 'creative accounting'. Further reading is available in 'Creative Accounting: The effectiveness of financial reporting in the UK' by Trevor Pijper (Macmillan, 1993). Other works on the subject are 'Accounting for Growth; Stripping the camouflage from company accounts' by Terry Smith (of which a new edition appeared in 1996) and 'New Creative Accounting' by Ian Griffiths (Macmillan 1995).

What are the ASB's views on international harmonisation of accounting standards?

The ASB's Statement of Aims (1991) sets out the fundamental guidelines that the ASB follows in conducting its affairs. One of the guidelines is:

"To ensure that through a process of regular communication, accounting standards are produced with due regard to international developments."

The ASB accepts that, in principle, there should be only one way of accounting for similar transactions throughout the world. The ASB therefore tries to ensure that its standards are consistent with International Accounting Standards (IASs), and every FRS includes a section explaining how it relates to the relevant IAS. Ideally, adherence to the provisions of the ASB's standards should result in compliance with IASs.

However, on certain topics the ASB believes that the international solution is not appropriate for conditions in the UK, or that the international approach is simply out of date. The ASB will therefore support harmonisation with IASs but reserves the right to disagree with the international consensus where a better solution to UK problems exists. In cases where the ASB has adopted an accounting standard that differs from the predominant practice internationally, the ASB believes the position should be reviewed after some experience has been gained to see if, in the light of that experience, there is scope for further harmonisation. Ideally, the ASB will persuade others that its view should prevail and become the international standard (FRS 12 was an example of this) but if the ASB's view is not accepted the ASB would debate the issue after a few years to decide whether to come into line with international practice.

What is the ASB's Statement of Principles for Financial Reporting? What role does it play in the setting of accounting standards?

An Exposure Draft of the Statement of Principles for Financial Reporting was published on 11 March 1999 for public comment by 11 June.

The Statement of Principles is a description of the fundamental approach that the ASB believes should, in principle, underpin the financial statements of profit-oriented entities. The Statement is intended to be a comprehensive and reasonably detailed description of that approach, and the approach itself is intended to be internally consistent, up-to-date and in line with the approaches adopted elsewhere in the world.

Although the Statement describes fundamental principles, it does not contain requirements on how financial statements should be prepared or presented. (Company accounts will therefore continue to be prepared under the requirements of company law and accounting standards.) Instead, the Statement's primary purpose is to provide a frame of reference to help the ASB as a standard-setter in developing and reviewing accounting standards. As such the Statement will be one of the factors that the ASB takes into account in developing and reviewing standards.

Other factors taken into account will include legal requirements, implementation issues, industry-specific issues, cost-benefit considerations and the desirability of evolutionary change. Indeed, experience shows that the influence of these other factors may result in an accounting standard adopting an approach that is different from the approach suggested by the Statement.

What are the ASB's views on putting brand names and other intangible assets on the balance sheet?

The ASB's views on this question are set out in Appendix IV of FRS 10 'Goodwill and Intangible Assets', which was issued in December 1997. The ASB thinks that brands, mastheads and many other intangible assets are actually similar in nature to goodwill and so should be accounted for in the same way as goodwill. FRS 10 allows goodwill to be capitalised only if it has been purchased (rather than generated internally). So it also allows most intangible assets to be capitalised only if they have been purchased.

The ASB is aware that internally generated intangibles can be just as important to a business. But it does not believe that this in itself justifies putting such intangibles on the balance sheet, especially given the difficulties in arriving at a reliable value for them. Instead, the ASB has encouraged companies to discuss significant intangibles in the operating and financial review (OFR) that accompanies their financial statements. Many companies now do this, disclosing, for example, the amount that they have spent on building up their brands in the year and/or statistics demonstrating the strength of these brands.

Why does the ASB think that the balance sheet is more important than the profit and loss account? After all, earnings is what is most important to the market.

The draft Statement of Principles places great emphasis on assets and liabilities and even defines the items that are to be included in the profit and loss account in terms of assets and liabilities. It is, incidentally, the approach that has been adopted in the framework documents of all the major financial reporting standard-setters around the world.

Adopting such an approach does not, however, mean that the ASB thinks the balance sheet is more important than the profit and loss account. Users focus primarily on financial performance and, therefore, on the profit and loss account and other performance statements. The ASB can see no reason to try to change that focus and has not sought to do so. Similarly, it recognises that the balance sheet is, and is likely to remain for the foreseeable future, an accounting statement that has some limitations.

The ASB believes that the approach adopted in the draft Statement will lead to improvements in the quality of financial statements in general and, through the discipline that the definitions will impose on the recognition of gains and losses, improvements in the quality of the profit and loss account in particular. Quite simply, every expenditure is either a charge to the profit and loss account or an asset. Similarly, every source of funds is either income or has to be repaid (a liability). By defining assets and liabilities the ASB makes clear that all other items are either income or a charge to the profit and loss account. In this way all income and all expenses will appear in the profit and loss account and will not be deferred on the balance sheet as pseudo-assets or pseudo-liabilities. This clear-cut approach should protect the profit and loss account from manipulation.

What does the ASB think are the biggest problems in financial reporting today?

It would be foolish to single out one issue, or even several issues, as being "the biggest problems in financial reporting today", but there are several topics that must be mentioned in any consideration on this point.

Financial instruments-including derivatives such as forward contracts and swaps-are clearly one of these. The number and complexity of these instruments has grown hugely in recent years and has outpaced innovations in accounting practice. One of the problems in this area is that instruments can be acquired for small cost, and yet their value can quickly change leading to large profits and losses. Under present accounting practice these profits and losses can go unreported until the instrument is settled. There is also no clear answer in present practice to the many questions that arise in connection with hedge accounting-ie departures from normal accounting that are made because it seems to be necessary to reflect the intent underlying the transactions. There is no consistent approach in practice to defining precisely what the circumstances are in which hedge accounting should be used (if any) and how hedge accounting itself should work. The ASB has on its agenda a project that has already resulted in a standard that requires detailed disclosures in this area and work is in hand towards a standard that would prescribe how financial instruments should be treated in the main financial statements.

Another problem area is that of leases. Existing lease accounting standards require a radically different treatment depending on whether a lease is an 'operating lease' or a 'finance lease'. Operating leases are treated simply as short-term rental agreements, whilst finance leases are treated as equivalent to the purchase of an asset on credit. Hence a lessee shows a large asset and liability in the case of a finance lease, and no asset or liability at all for an operating lease. As the difference between an operating lease and a finance lease may in some cases be very small, this approach does not result in similar transactions being accounted for similarly.

The ASB has a project in hand that seeks to identify the assets and liabilities arising under all lease contracts and to ensure that all are accounted for similarly.

Will accounting standards ever be complete?

Accounting standards need to keep abreast of changes in the law, business practice and users' expectations. Since these are constantly changing it is difficult to envisage a time when accounting standards will not need to change.

If I write to the ASB, will it help me with my project/assignment/dissertation?

Sorry, no. The ASB's resources do not enable it to respond to students' individual requests for help with their studies.

For information about the reasons behind specific FRSs, you should read the appendix 'The development of the FRS' that is contained in each FRS.

Other sources of useful material are:

The latest FRC annual review (see related site) and previous years' editions of the review (obtainable on request from the FRC)
the publications lists of the ASB, UITF and FRRP
press reports at the time of the publications
books on creative accounting (mentioned in the answer to Question 7)
'Company Reporting', a monthly review of financial reporting practice that gives statistical evidence of reporting practices (e-mail: info@comrep.co.uk)
The sets of responses to ASB Discussion Papers and exposure drafts. These are available, for purchase, direct from the ASB.

If there is any information you would like to see on the ASB Website that is not there (or on its related sites), please send an e-mail to students@asb.org.uk.