Standard-setting - UK GAAP at a crossroads

UK GAAP is at a crossroads, and it appears that the ASB will have to stay at that crossroads for some time, writes Peter Holgate.

The development and success of the International Accounting Standards Board (IASB) since 2001 has led to major changes in the role of not only UK accounting standards but also other national GAAPs around the world.

They are, to put it unkindly but realistically, less important than they were. It might be argued that US GAAP is an exception to this, given that it is both converging with International Financial Reporting Standards (IFRS) and competing with IFRS. But in another sense even US GAAP is 'just another national GAAP'.

In the EU, IFRS is used for the consolidated accounts of listed companies.

The extent of its applicability varies in other countries; indeed, in some economies, IFRS has been adopted for companies of all sizes. But, in the UK, the effect is that national GAAP has become a set of principles and rules that mostly apply to private companies, subsidiaries of listed companies and SMEs. Hence, while UK GAAP currently applies to the vast majority of UK companies, it does not apply to those that catch most of the headlines. It has lost much of its former visibility.

Tricky problem

This situation gives the UK Accounting Standards Board (ASB) a tricky problem. About three years ago, what to do about UK GAAP seemed quite straightforward. There was a consensus that (a) it had been agreed that IFRS and US GAAP would converge, and this was seen as self-evidently a good thing; (b) the resultant IFRSs should be brought into UK GAAP so that the two would become one and the same. In effect, UK GAAP would cease to have a separate existence. In retrospect, it is hard to see how this view was so easily established. At best it now seems naive; at worst, plain misconceived.

Some critics of the IASB's current strategy now argue as follows. US GAAP is fine (fine-ish, anyway) for the US-listed sector for which it is designed. But while the FASB is changing some of its rules to converge with IFRS, it is highly unlikely to be able to kick the habit of writing immensely prescriptive rules. The direction of IFRS, therefore, will be towards some US rules - which is probably acceptable - but also towards US-style standards - which is not.

It is not acceptable because of the wide range of situations to which IFRS applies: to companies listed on exchanges of varying sizes and sophistications, and to private companies and SMEs in some countries. For most of these categories, US-influenced-IFRS will not be suitable: they will be over-engineered, not fit for purpose and may be so complex that some of the companies that have to adopt them will not be able to cope with the complexity that they are likely to reach.

So the concern is that, if the IASB continues with its strategy of convergence with US GAAP, the resultant IFRSs will not be suitable for many or most of the contexts in which they apply. On the other hand, the IASB could change to a strategy of developing IFRSs that are suitable for its own constituency. This would mean abandoning detailed convergence with US GAAP, but it would not necessarily mean abandoning the idea altogether.

Indeed there would be much to be said for continuing the work on converging the IASB and FASB conceptual frameworks. It may also be possible, for individual topics, for the IASB and FASB to develop standards together in the sense of agreeing the basic principles, but then writing them up in different ways, specifically in different degrees of detail. This approach would give each constituency something suitable yet would achieve practical convergence in most circumstances.

Fit for purpose

These considerations strongly affect the UK ASB's own strategy. Simply put, if the IASB continues to converge with US GAAP, the resultant standards are unlikely to be suitable for implementation into UK GAAP. If, on the other hand, the IASB writes briefer standards that are converged with US GAAP only at the principles level, they are likely to be fit for purpose in the UK. They would also be fit for purpose in many other contexts around the world.

The ASB issued proposals for its future strategy on UK GAAP in May 2006 (see Accountancy, June, p16)). This proposed a mixture of downward extension of IFRS, for example to UK subsidiaries of listed groups, together with upward extension of the FRSSE from small companies to small and medium-sized companies.

Unfortunately, this left an awkward gap in the middle for large but private companies. These are economically significant but not publicly accountable in the way that, for example, listed companies and financial institutions are.

Responses to this ASB proposal were very mixed. The ASB appears to have concluded that there is no easy answer but also that there is no immediate rush. This stance is not as unsatisfactory as it sounds. The reason is that the IASB is developing its own International Financial Reporting Standard for small and medium-sized entities (IFRS/SME). The exposure draft of this is not yet published formally, though it is imminent and an advanced draft of it is available on the IASB's website (

Reasons to be optimistic

The ASB recognises that this exposure draft may help resolve its problem.

There are indeed reasons to be optimistic - not least that, despite its title focusing on SMEs, the document describes its scope in terms of entities that are not publicly accountable; so this would include the tricky large private company category.

At the same time, it is not clear how the SME version of the international standards would fit in with the broader questions of IASB strategy outlined above. Two main scenarios can be considered:

1. IFRS continues to converge with US GAAP at the detailed level. Arguably full IFRS will be too complex for many of its applications globally. IFRS/SME is certainly needed in this context.

2. IFRS takes a different course of simpler standards for its own constituency, based on convergence with US GAAP only at the principles level. Arguably, if this course is followed, there is less need for an IFRS/SME.

Until it becomes clear which of the above two routes is being followed, and until we know what the IASB will decide following exposure of the forthcoming IFRS/SME draft, it will be difficult for the ASB to decide what to do for UK GAAP. Although one hears about IFRSs being 'principles-based standards', they are really principles plus some rules, and the real question is whether the number of rules in IFRS grows or shrinks.

If a convincing pattern of shrinkage emerges, the ASB may find that mainstream IFRSs are indeed suitable for the UK. But a prudent ASB would want to be sure of that pattern before it bases its whole strategy on it. If they are not convinced on that point, following the IFRS/SME looks a better option. But it will be some time before that is finalised.

UK GAAP is indeed at a crossroads, and it appears that the ASB will have to stay at that crossroads for some time - perhaps two years or so - before deciding which road to follow.

Peter Holgate is senior technical partner with PricewaterhouseCoopers LLP. The views expressed are his own.

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