It looks like the end is nigh for UK GAAP as we know it.
In August 2009, the Accounting Standards Board (ASB) published its consultation on proposed changes to UK Generally Accepted Accounting Practice (UK GAAP). If the proposal goes ahead as expected, then UK GAAP as we know it will disappear.
This will be a very significant change for the oil & gas sector as most UK subsidiaries of overseas parent companies prepare accounts under UK GAAP. The proposals will, however, also affect privately owned companies, private equity-backed companies and subsidiaries of UK listed entities.
The ASB’s suggestion is that a three-tier approach is adopted:
Tier 1
Public Accountable Entities (for example, publicly traded) – International Financial Reporting Standards as adopted by the European Union required (‘EU IFRS’)
Tier 2
Middle tier entities – International Financial Reporting Standards for Small and Medium-Sized Entities (‘IFRS for SMEs’) as adapted by the ASB, EU IFRS permitted
Tier 3
Small entities – Financial Reporting Standard for Smaller Entities (‘FRSSE’), IFRS for SMEs as adapted by the ASB permitted, EU IFRS permitted
All entities can choose to apply the financial reporting required for a higher tier.
The IFRS for SMEs, issued by the International Accounting Standards Board (IASB), is a simplified stand-alone text (85% shorter than full IFRS), based on the fundamental principles of IFRS, applicable for entities without public accountability.
It does not contain a fallback to IFRS (although entities can choose to apply its simplified requirements on financial instruments, or IAS 39 (Financial Instruments: Recognition and Measurement) and the disclosure requirements are significantly less onerous than IFRS.
The ASB are expected to make limited adaptations to the IFRS for SMEs for use in the UK, for example in relation to taxation. They are also proposing certain disclosure exemptions for non-publicly accountable subsidiaries applying Tier 1 or Tier 2. Under UK company law, it still applies that all companies can choose to (and some must) apply EU IFRS.
When is it likely to happen?
The ASB’s current proposed effective date for these changes is for accounting periods beginning on or after 1 July 2013, however this date is still subject to change.
This might seem to be a long way off, but the timeframe to action is shorter than one might initially think as the new GAAP must be applied from the transition balance sheet date (the start date of the comparative period for the first set of financial statements under the new GAAP).
Therefore companies should start to think about the proposed changes to UK GAAP now. We know from the experience of listed companies back in 2004/2005 that those who planned their conversion well in advance enjoyed a much smoother process than those who waited until the deadline for conversion loomed closer.
What impact would the changes have on the oil & gas sector?
Both EU IFRS and IFRS for SMEs could have a significant impact on the oil & gas sector in, for example, the accounting treatment of joint arrangements, deferred tax, take or pay arrangements, derivative and other financial instruments, acquisitions (including the definition of a business) and goodwill.
There may be significant differences in the accounting between EU IFRS and IFRS for SMEs in some of these areas. Goodwill, for example is amortised under IFRS for SMEs, unlike EU IFRS where goodwill is not amortised, but is tested annually for impairment.
Of particular importance to the oil & gas sector is the accounting for Exploration and Evaluation (E&E) costs. The Specialised Activities section of IFRS for SMEs contains some (albeit extremely limited) guidance for financial reporting by companies in extractive activities. It is not immediately clear in IFRS for SMEs what companies should do with E&E costs, although possible interpretations are that:
E&E costs fall within the scope of the Specialised Activities section of IFRS for SMEs and are accounted for in accordance with the recognition principles for property, plant and equipment or other intangibles. Since E&E costs would generally fail to meet these recognition criteria, E&E costs incurred going forward would not be capitalised; or
E&E costs are outside the scope of the Specialised Activities section of IFRS for SMEs, that is, the section only applies to property, plant and equipment and other intangibles used in extractive activities. If this is the case, E&E costs are not dealt with by the standard. Using the hierarchy for developing a relevant and reliable accounting policy may result in referring back to the guidance in EU IFRS, and hence potentially capitalisation of these costs could be permitted.
Until companies begin to implement the guidance and an established industry practice emerges, or the IASB clarify their intent, it is difficult to conclude on what the IASB intended.
Is IFRS for SMEs the right answer?
IFRS for SMEs is not “IFRS light”; it is simply different. It is very important for corporates to consider their own business and conclude whether IFRS or IFRS for SMEs is the right answer for them. There are important commercial aspects to this decision.
Many companies in the oil & gas sector already report to an overseas parent under IFRS or may do so in the future (such as a US parent).
It may be easier for a UK subsidiary company to apply Tier 1 (EU IFRS) and take advantage of any disclosure exemptions made available for subsidiaries.
This might be slightly more onerous than IFRS for SMEs, but the benefits of having local statutory accounts, management accounts and group reporting all coming from one general ledger and everyone in the business using the same numbers to make decisions far outweighs the additional burden.
The starting point for taxable income is the profit and loss in the financial statements. Given that EU IFRS or IFRS for SMEs will impact on the criteria for recognition and measurement of some assets and liabilities, it follows that the conversion from UK GAAP may have an impact on the cash tax charge.
So what should management be doing now?
IFRS in some shape or form will be replacing UK GAAP, and thus we would encourage management to consider the implications for their business.
For example, if a parent company will be adopting IFRS (for example, US), is there an opening to ‘volunteer’ to be a pilot for IFRS adoption and thus an opportunity to shape the IFRS accounting policies of the group?
If considering entering into any major new contracts, what will the accounting look like under EU IFRS or the IFRS for SMEs?
Whilst accounting should not be responsible for driving commercial decisions, if there are a number of commercially sound options, but one has a better impact on reported results, then it is important to know about that now.
Now is the time to think about the choice between EU IFRS and IFRS for SMEs and the tax implications of both, as well as considering the impact on debt covenants, distributable profits, performance related pay, forecasts going forward and changes that will be required to accounting systems.
With careful planning and consideration at an early stage, entities can mitigate the pain and take advantage of the opportunities arising from the changes to UK GAAP as we know it.
In addition, we strongly recommend reading and responding to the ASB’s Exposure Draft, which is expected to be published in October 2010.
Often, the real impact of the changes only comes to light from a careful analysis of the detail (including the requirements on transition to the new GAAP). The proposed changes are a very significant change to financial reporting in the United Kingdom, and this is likely to be the final chance to influence the outcome of the changes to UK GAAP as we currently know it.
Suzanne Robinson is director of Ernst & Young’s assurance services team.