If IAS is not extended to all UK companies, there will be two accounting frameworks used in the UK, one for listed groups and another for everyone else

Re-acquired Own Equity Instruments

Perceived costs of move to IAS

In general, the majority of companies appear to be of the opinion that a move to IAS will not result in substantial costs. When asked for an overall assessment, 73% of the companies surveyed considered that transition costs would be small. Only 24% anticipated large transition costs. Additionally, 63% of companies anticipated the ongoing cost of IAS after transition to be the same as maintaining UK GAAP, while only 34% anticipated higher ongoing costs. However, we found that perceptions varied greatly by category of company surveyed. Surprisingly, the category showing most concern over a transition to IAS were parent companies of UK listed groups, 43% of which expected a large cost of transition with 62% expecting increased ongoing costs. Parent entities of listed groups is the category for which the case for a move to IAS would appear most obvious as it would result in consistent accounting treatment with the parent' s consolidated accounts. However, the survey evidence appears to dispute this.

The differences identified in the accounting treatment for employee benefits, financial instruments and cashflow statements gave the greatest cause for concern in the majority of categories.

Employee benefits

For employee benefits, the different basis used for pension calculations under

IAS 19, Employee Benefits, as opposed to SSAP 24, Accounting for Pension Costs, was thought likely to cause problems. For those companies that have adopted FRS 17, Retirement Benefits, early, the cost of a move to IAS in this area should be less (however such companies have already incurred related costs in adopting FRS 17). It should be noted that costs for such a change in accounting basis will have to be borne by all UK companies, whether under IAS or UK GAAP, when FRS 17 (or something similar) becomes mandatory in 2005.

Financial instruments

In relation to financial instruments, the main areas of concern noted were the required fair valuing of certain financial instruments under

IAS 39, Financial Instruments, Recognition and Measurement, and the restrictions on the use of hedge accounting. A lot of the related costs will be incurred in the adoption (planned for 2004) of FRED 30, Financial Instruments: Disclosure and Presentation; Recognition and Measurement, however companies still anticipate high costs in this area. Specifically parent companies of UK-listed groups showed their concern for the restricted use of hedge accounting with 50% expecting large transition costs and 69% higher ongoing costs. They also anticipated higher ongoing costs for the fair valuing of financial instruments.

Cashflow statements

For cashflow statements, anticipated problems mainly stemmed from the lack of an exemption for 90%-owned subsidiaries. All entities, including wholly-owned subsidiaries, will have to prepare a full cashflow statement under

IAS 7, Cash Flow Statements. As would be expected, subsidiaries showed most concern in this area. The usefulness of a cashflow statement for a subsidiary is debatable. A solution could perhaps be to include a similar 90% exemption under IAS, but include a clause that the minority interest could request a cashflow to be presented if required.

Other issues to be resolved

The survey also probed other anticipated problems or benefits of IAS, for example problems in relation to the effect on covenants, distributable income and tax, and benefits arising from increased usefulness of information and reduced consolidation costs. Parents of UK-listed groups showed some serious concerns, with 54% expecting problems to arise in relation to distributable profits and tax. Subsidiaries of these groups also noted these problems, but indicated that they believed IAS would result in more useful figures. These results suggest that there are significant broader issues to be resolved over the implementation of IAS. For example, the DTI and the Treasury will need to consider how far a move to IAS profit measurement will affect the calculation of distributable profit and taxable income.

Financial Reporting Accounting solutions

Translation differences

A UK company preparing its financial statements in sterling (Company A) has a defined benefit pension scheme, the assets of which include overseas equity investments. Company A' s Dutch subsidiary, Company B, also has a defined benefit pension scheme, the assets and liabilities of which are denominated entirely in euros. On consolidation, Company B' s financial statements are translated into sterling using the closing rate/net investment method and the p&l account is translated at the average rate. How are the translation differences in respect of both pension schemes dealt with in Company A' s consolidated financial statements?

For Company A,

FRS 17, Retirement Benefits, requires that the scheme assets are measured at fair value at each balance sheet date. Hence, the assets will be translated into sterling at the rate of exchange at that date. The expected return on scheme assets will be determined to take account of not only the rate of return on the underlying investment, but also any expectations of currency movements during the year. For example, if the overseas investments are expected to return 7% in the year, but sterling is expected to depreciate against the foreign currency by 1%, then the expected rate of return for the purposes of Company A' s consolidated financial statements will be 8%. Any difference between this amount and the total return on scheme assets is recorded in the statement of total recognised gains and losses (STRGL). The element of the total return that relates to exchange differences will not be separately identified.

As regards Company B, its entire financial statements, including amounts in respect of its pension scheme, will be translated according to the closing rate/net investment method. This means: All balance sheet items are translated at the closing rate of exchange.

•    Exchange differences that arise on retranslation of the opening net investment to the closing rate are recorded as a movement on reserves and in the STRGL.

•    Items in the p&l account and STRGL are translated at an average rate for the period. The difference between translating these items at the average rate and translating them at the closing rate is recorded as a movement in reserves and in the STRGL.

•    Items in the cash flow statement are also translated at an average rate. Differences relating to currency movements are recorded in the reconciliation to net debt.

Accordingly, scheme assets and liabilities will be translated at the closing rate, while items to be recorded in the p&l account and STRGL, as well as contributions to the scheme, are translated at the average rate. Exchange differences arising on retranslation to closing rate of both the opening surplus or deficit in the scheme and the items in the performance statements are treated as a movement in reserves and recorded in the STRGL.

Multi-employer schemes

Company D is part of a large group, E plc. It participates in the group defined benefit pension scheme and is unable to determine its share of the assets or liabilities in the scheme. Consequently, following paras 9 and 12 of FRS 17, the company accounts for the scheme as a defined contribution scheme and gives the appropriate disclosures. If the use of International Accounting Standards is extended to D, will it be able to take the multiemployer exemption?

Under current IAS, there is no such exemption.

IAS 19, Employee Benefits, states that defined benefit plans that pool the assets contributed by various enterprises under common control are not multi-employer plans (para 34). Therefore, each company within the E group would have to treat the scheme as a defined benefit scheme. This is the position under IAS at the moment, but the IASB has agreed that it will introduce a multi-employer exemption for groups. However, as we do not know when this might happen, we recommend that the group should discuss the problem with its actuaries to determine how best the total pension cost in the group accounts should be allocated. Whatever the basis used, it is important that D' s financial statements indicate that it is a member of a group scheme and explain the allocation basis.

Accounting Solutions is compiled by Peter Holgate, Michael Gaull and Angela Courtney of the PricewaterhouseCoopers Accounting Technical Department. They are contributing authors to PwC' s Manual of Accounting, published by Gee.

PwC inform To read these and 900 other real-life questions and answers, register for your 60-day free trial at www.pwcinform.com

International accounting solutions Financial Reporting

Derivatives on own shares

Q1: On 1 January 20X3, the price of Alpha shares is 60. On that date, Alpha writes a put option to ' Space' Company on 100 of Alpha' s own shares with a strike price of 55 per share (55 x 100 = 5,500). Expiry date of the option is 31 March 20X3. Space pays Alpha 2.30 per share for the put (2.30 x 100 = 230). The premium of 2.30 paid for the option approximates the fair value of the option at inception. Space has the right to require a cash settlement of the put option.

Should Alpha record the 230 of proceeds as a liability or as credit to equity?

Alpha should record proceeds received from issuance of the put option as a liability. Alpha (the issuer of the put) may be required by the holder of the put option (Space) to settle in cash. As a result, Alpha has an obligation to deliver cash or exchange financial instruments (receive shares and deliver cash) under conditions that are potentially unfavourable. Therefore, the put option is a liability (under para 8 of

IAS 39, Financial Instruments: Recognition and Measurement, and IGC 11-1, Liability vs Equity Classification). It is accounted for as a derivative and marked to market through the income statement.

Q2: Company ' Proton' has recently introduced an employee stock option plan (ESOP) for its employees. According to this plan, Proton' s employees will be entitled to purchase Proton shares for the price of 120 per share starting from 1 January 20X4 until 30 June 20X5. Currently Proton shares are priced at 105 per share.

To hedge itself against additional future cashflows related to the ESOP, Proton has purchased a call option on 10,000 of own shares with the strike price of 105 per share. The expiry date of the option is 31 December 20X3. drops, so it has bought a put option on 5,000 of own shares with a strike price of 85. Shares of Highly Leveraged are currently priced at 100. The company paid a premium of 0.85 per share (0.85 x 5,000 = 4,250). The option requires net cash settlement (ie, the company will not deliver any own shares to the issuer of the option).

Should the company record 4,250 of premium paid for the put option as an asset or as a reduction to equity?

Premium paid by Highly Leveraged should be recorded as an asset and the put option should be treated as a derivative and fair valued subsequently. The option meets a definition of a financial asset given in para 8,

IAS 39, namely a contractual right to receive cash or another financial asset from another enterprise. No own shares are re-acquired and therefore para 16, IAS 32 and SIC-16, Share Capital -

, do not apply.

Q4: Background information is the same as in Q3. However, instead of buying a put option Highly Leveraged, Inc has entered into the forward contract where it would be required to sell 5,000 of own shares at the price of 85 per share. The contract allows only for a net cash settlement.

1. Should this contract be treated as a financial instrument or as own equity instrument?

2. Would the answer be different if gross cash settlement would be required according to the contract terms (ie, the company would be required to actually sell own shares)?

1. The net cash settled forward is a financial instrument and should be marked to market through income.

2. Yes, the answer would be different. A forward contract resulting in the issue of own shares is an equity instrument.

Proton paid a premium of 1.15 per share (1.15 x 10,000 = 11,500). The option allows only for a gross physical settlement (ie, Proton will be required to pay cash to buy own shares) and does not allow for a net cash settlement.

1. How should the call options issued to employees under the ESOP be accounted for?

2. Should Proton record 11,500 of premium paid for the call option as asset or as a reduction to equity?

1. International Financial Reporting Standards do not yet include recognition and measurement requirements for stock compensation, although

IAS 19, Employee Benefits, requires various disclosures including any amounts that have been recognised in the financial statements.

2. The premium paid by Proton should be recorded as a reduction to equity (and therefore should not be marked to market). Under para 16,

IAS 32, Financial Instruments: Disclosure and Presentation, the cost incurred by an enterprise to purchase a right to re-acquire its own equity instrument from another party is a deduction from its equity, not a financial asset. Further, para A8 of the Appendix to IAS 32 indicates that an option or other similar instrument acquired by an enterprise that gives it the right to re-acquire its own equity instruments is not a financial asset of the enterprise. Proton will not receive cash or any other financial asset through exercise of the option.

Q3: Company ' Highly Leveraged, Inc' has a debt obligation to bank ' Well Capitalised' . The terms of this obligation are such that the company is required to make periodic fixed payments to the bank plus additional payments if the share price of Highly Leveraged drops.

The company wants to protect itself against additional payments to the bank in case its share price

International Accounting Solutions is compiled by Robert Dove, a director in PricewaterhouseCoopers' Global Corporate Reporting Group.

Publications PwC has published Making the Change to IFRS which can be downloaded from PwC' s website at www.pwcglobal.com/ifrs

accountancymagazine.com May 2003


Financial Reporting Reports & accounts

Related parties

Two different fair value treatments are presented by fund manager Seymour Pierce for a transaction involving related parties.

The first disclosure, which reflects the accounting treatment adopted, reduces the book value of investments acquired and results in substantial profits on their subsequent disposal. The second method, which Seymour defines as an ' alternative treatment' , is to equate the fair values to net sale proceeds which would result in a small adjustment to book values.

Seymour discloses that, on acquisition of a business, financial assets are reduced from a book value of £14.2m to £4.8m. A note discloses that the fair value adjustment reflected the directors' valuation of the investments after taking into consideration the marketability of individual shareholdings within the portfolio. Subsequent to the acquisition, all the investments have been either fully provided against or sold. Total sale proceeds amounted to £11m net of costs and a profit on disposal arose of some £8.3m.

It is noteworthy that such significant profits are made following substantial downward fair value adjustments and it is open to discussion whether such a practice is in accordance with

FRS 7, Fair Values in Acquisition Accounting, which states that, where quoted market prices are not available, subsequent sales of acquired assets may provide the most reliable evidence of fair value at the time of acquisition.

A further twist is provided as Seymour goes on to disclose that the ' alternative treatment' in relation to the fair value of the investments sold is to equate their fair value with the net cash received. The company adds that if it had adopted this treatment, the profit on disposal would have been wiped out. Seymour would not say why it did not value its acquired assets at a fair value and so recognised substantial profits on their subsequent disposal

Seymour discloses that the above acquirer is a company controlled by trusts, the beneficiaries of which include members of a director' s family. Another note discloses that the portfolio of investments obtained as a result of the acquisition is managed by a company controlled ultimately by a trust, the beneficiaries of which include members of this director' s family.

A performance fee of some £0.6m has been paid to the company based on the profit on disposal of some £8.3m. The directors' report discloses a shareholding by a company controlled by a trust whose beneficiaries include members of the same director' s family. Had Seymour followed its ' alternative accounting treatment' in relation to the fair value of investments acquired, there would have been a reduced performance fee payable to the investment management company.

In more than half of cases, companies are going the extra mile with much of their segmental disclosures exceeding the statutory reporting requirements of SSAP 25, . Innovative segmental disclosures include: (i) goodwill amortisation; (ii) EBITDA and EBITA; (iii) capex; and (iv) operating performance ratios.

However, on a less positive note, Company Reporting' s analysis indicates that 2% of companies state that they have not published segmental reasons because to do so could be seriously prejudicial.

Developments in IAS

Many companies that follow IAS have a December year end and, as a result, there are few up to date financial statements available currently. New adopter Rockwool International moves to IAS and extends its segmental disclosures, recognises deferred tax assets and liabilities and publishes its financial instruments risk management policies. Meanwhile, Telekomunikacja Polska which, although it adopts

IAS 39, Financial Instruments: Recognition and Measurement, embedded derivatives are excluded as it does not have systems to measure these items.

Segmental disclosures

Reports & accounts Financial Reporting

Revenue recognition policy changes

These are top of the agenda with leisure company MyTravel, housebuilder Crest Nicholson, Jersey Electricity and IT company Innovation all changing policy.

Making a similar policy change to fellow property company Berkeley, Crest Nicholson now recognises revenue on house sales at exchange of contract and completion of build. Previously, the point of sale was determined at exchange of contract and completion of plastering work.

As a consequence, the results for the previous year are reduced by £2.6m and opening net assets at the beginning of the current year are decreased by £17m; according to Crest it is not practical to quantify the effect on the current year. Under the new policy, the point at which revenue is recognised is significantly closer to legal completion which is the method that most other housebuilders adopt. However, Crest notes that the use of legal completion could lead to compromised quality and service and that it is appropriate to separate completion of formalities from hand-over to the customer to maintain a high level of quality and service. Berkeley stated similar reasoning.

Innovation changes its policy and improves disclosure in the light of an increasing significance of US revenues on its business, and comments from the investor community.The company considers that US GAAP provides superior guidance for software revenue recognition. Accordingly, it has adopted US SOP 97-2, , and so defers revenue to later periods. It adds that the current year effect cannot be estimated as the operations of the business and revisions to methods of contracting make it impractical.

Following industry practice, Jersey Electricity now recognises both revenue from recorded meter readings plus an estimate of unrecorded readings. Previously, revenue was accounted for on an invoiced basis with no account being taken of unrecorded readings. As a result, profit in the current year decreases by £437,000.

Changes are made in respect of three of MyTravel' s revenue streams: (i) commission earned on sales; (ii) treatment of holiday insurance; and (iii) indirect selling costs related to future periods.

In the past, profits on holiday insurance and commission on sales were recognised on the dates on which the related holidays were booked or policies provided. Under the new policy, the revenue recognition date for sale of inhouse travel products is moved to the date of departure and commissions from sales of third party travel products is recognised upon receipt of the full payment. Meanwhile, indirect selling expenses, which were deferred previously, are charged to the profit and loss account as incurred. Consequently, profit before tax decreases by £20.3m and £19m for this year and last year respectively with shareholders' funds reduced by £59m.

Netting off transactions

Consumer goods company McBride incurs a £15.8m goodwill write-off which reduces the carrying value of its joint venture to nil. It transpires that this amount is made up of two separate transactions: the purchase of 50% of a joint venture for £12m under a put option; and the transfer of the original 50% of the joint venture for a nominal fee. McBride discloses that both a profit on disposal and goodwill on acquisition have been generated. However, the directors believe that, as these transactions are the result of a single legal agreement and that the transactions are so interlinked, to disclose the profit on disposal and goodwill on acquisition separately would be misleading. Therefore, the net effect of the transaction is shown as a £15.8m write-off of goodwill. McBride makes no mention of the true and fair override.

Incentive compensation factors

Nine out of 10 companies include incentive-based compensation as part of their directors' remuneration. However, directors are missing an opportunity to show the tough performance targets they have set themselves; instead only the factors that are considered are disclosed.

At 52%, earnings is the factor used most commonly in assessing incentive compensation with economic profit referred to in many circumstances. Following closely behind is earnings per share (eps) and total shareholder return at 51% and 40% respectively. However, in 8% of cases, the performance factors are not disclosed.

Common place is that a combination of factors are disclosed for both short and long-term incentives. For example, Vodafone, which states that performance measures are related to: EBITDA; free cashflow; ARPU (average revenue per customer); total shareholder return (TSR) in comparison to its peer group; and eps.

Meanwhile, one of the better disclosures is published by Chrysalis which, for its short-term bonus, sets out the factors that are considered in each director' s bonus.

Future of share-based payments

Financial Reporting Exposure Draft 31, , proposes changes to the way share options are treated such that the fair value of share options will hit the p&l account. EasyJet informs analysts that, had this treatment been mandatory for all share options issued up until 30 September 2002, the p&l account would have been subject to an additional charge of £4.3m. The Accounting Standards Board is proposing that the standard should be implemented in the UK from the effective date set by the International Accounting Standards Board, suggested for all accounting periods ending on or after 1 January 2004.

Reports & accounts is compiled from information supplied by companyreporting.com

Financial Reporting IASB update

Recent standards

Standard Issued Effective from
IAS 41: Agriculture February 2001 Accounting periods
beginning on or after
1 January 2003
IAS 19: Employment Benefits. Limited Amendment in Relation to May 2002 Annual financial statements covering
Asset Ceiling periods ending on or after 31 May 2002

Other recent documents

Document (and status) Issued Effective from
Changes in the IASC Foundation Constitution Related
to the International Financial Reporting Interpretations Committee March 2002 5 March 2002
Preface to International Financial Reporting Standards May 2002 Effective on issue

Current projects

What next?
Amendments to IAS 39, Financial Instruments: Recognition
and Measurement, and IAS 32, Financial Instruments: Disclosure and
Presentation Board redeliberations underway
Business Combinations (Phase 1) (including amendments to IAS 36
and IAS 38) Comments being analysed
Business Combinations (Phase 2) Exposure draft expected second quarter 2003
Convergence - Short-term Projects Exposure draft expected third quarter 2003
Deposit-taking, Lending and Securities Activities: Exposure draft expected third quarter 2003
Disclosure and Presentation
First-time Application of IFRSs IFRS in preparation
Improvements to International Accounting Standards Board redeliberations underway
Insurance Contracts (Phase 1) Exposure draft expected second quarter 2003
Reporting Performance Exposure draft expected fourth quarter 2003
Share-based Payment Board redeliberations underway


(comment period expired)
Document (and status) Issued What next?
G4+1: Joint Ventures November 1999 Awaiting agenda decision
G4+1: Leases: Implementation of a New Approach March 2000 Research work being undertaken
Extractive Industries (issues paper) November 2000 Research work being undertaken
Financial Instruments and Similar Items (Financial Instruments JWG) December 2000 Awaiting agenda decision


May 2003 accountancymagazine.com

APB update Financial Reporting

Recent standards

Standard Issued Effective from
SAS 610 (Revised): Communication of June 2001 Financial statements for
Audit Matters to Those Charged with (Accountancy, periods beginning on or
Governance August 2001) after 23 December 2001

Recent bulletins

Bulletin Issued Effective from
2002/1: The duty of the auditors in the July 2002 July 2002
Republic of Ireland to report to the
director of corporate enforcement
2002/2: The United Kingdom Directors' October 2002 October 2002
Remuneration Report Regulations
2002/3: Guidance for reporting November 2002 November 2002
accountants of stakeholder pension
schemes in the UK

Other recent documents

Document (and status) Issued Effective from
PN 19 (I): Banks in the Republic of Ireland February 2002 -
PN 23: Auditing Derivative Financial April 2002 -
PN 11 (Revised): The Audit of Charities May 2002 -
in the United Kingdom
PN20 (I): The Audit of Insurers in the August 2002 -
Republic of Ireland
PN24: The Audit of Friendly Societies in the September 2002 -
United Kingdom
Effective communication between audit September 2002 -
committees and external auditors

Documents issued for comment

Issued Comments by
The scope and authority of pronouncements November 2002 7 February 2003
PN14 (Revised): The Audit of Registered
Social Landlords in the United Kingdom February 2003 12 May 2003

Financial Reporting ASB update

Recent standards

Standard Issued Effective from
Amendment to FRS 17 ' Retirement Benefits' and Financial Reporting December 2002 -
Standard for Smaller Entities (effective June 2002) November 2002 (Accountancy, February 2003)

Recent UITF abstracts

Abstract Issued Effective from
34: Pre-contract Costs May 2002 Accounting periods ending on or after
(Accountancy, July 2002) 22 June 2002
35: Death-in-Service and Incapacity Benefits May 2002 Accounting periods ending on or after
(Accountancy, July 2002) 22 June 2002
36: Contracts for Sales of Capacity March 2003 Accounting periods ending on or after
(Accountancy, May 2003) 22 June 2003

Other statements

Document Issued Effective from
Operating and Financial Review January 2003 -
(Accountancy, February 2003)

Current proposals

Document (and status) Issued Comments by
Amendment to FRS 5 ' Reporting the Substance of Transactions' : February 2003 30 May 2003
Revenue Recognition (exposure draft) (Accountancy, April 2003)

Current proposals

Document (and status) Issued What next?
FRED 23: Financial Instruments: Hedge Accounting May 2002 Comments being analysed
(Accountancy, July 2002)
FRED 24: The Effects of Changes in Foreign Exchange Rates. May 2002 ASB has sent comments to IASB
Financial Reporting in Hyperinflationary Economies (Accountancy, July 2002)
FRED 25: Related Party Disclosures May 2002 ASB has sent comments to IASB
(Accountancy, July 2002)
FRED 26: Earnings per Share May 2002 ASB has sent comments to IASB
(Accountancy, July 2002)
FRED 27: Events After the Balance Sheet Date May 2002 ASB has sent comments to IASB
(Accountancy, July 2002)
FRED 28: Inventories. May 2002 ASB has sent comments to IASB
Construction and Service Contracts (Accountancy, August 2002)
FRED 29: Property, Plant and Equipment. May 2002 ASB has sent comments to IASB
Borrowing Costs (Accountancy, August 2002)
IASB Proposals to Amend Certain International Accounting May 2002 ASB has sent comments to IASB
Standards (consultation paper)
FRED 30: Financial Instruments: Disclosure and Presentation June 2002 ASB has sent comments to IASB
& Recognition and Measurement (Accountancy, September2002)
IASB Proposals for First-time Application of International July 2002 ASB has sent comments to IASB
Financial Reporting Standards (consultation paper)
FRED 31: Share-based Payment November 2002 Comments being analysed
(Accountancy, January 2003)
IASB Proposals on Business Combinations, December 2002 Comments being analysed
Impairment and Intangible Assets (consultation paper)

UITF Abstract 36 Financial Reporting

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