Issues With Current GAAP System Accounting Essay

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Increased economic globalisation over the past twenty years has sparked demand for a single, worldwide set of high-quality accounting standards (Lewis and Pendrill 2004, pp.43-46). This demand for global harmonisation has recently led to the UK accounting standards board (ASB) announcing its future strategy to converge its Generally Accepted Accounting Practice (UK GAAP) with International Financial Reporting Standards, however this will result in the UK GAAP ceasing to exist. This essay seeks to analyse the concept of GAAP and whether it meets the needs of UK entities considering issues with the current system and proposed approach and its appropriateness.

Concept of GAAP

The UK currently uses UK generally Accepted Accounting practice (UK GAAP). The UK company law requires companies operating within the UK to abide by UK GAAP and this statement must be disclosed in the company account notes under the heading of accounting policies. KPMG (2003, p.5) states the generally accepted accounting practice has no formal meaning in the UK. The term is used informally in the UK to signify the amount of practices forming the basis for determining what constitutes a true and fair view. The body of standards known as UK GAAP sets broad in addition to specific rules that companies within the UK must follow when reporting and measuring their financial information. This information is used by both creditors and investors in order to make strategic decisions they need to be able to compare the financial information amongst differing companies. Because companies are following the guidelines set out by the UK GAAP it provides consistency in the reporting of companies so creditors and investors can view financial statements from different companies whilst following the same reporting procedures and rules. The basic accounting principles that set of company accounts comprises of under UK GAAP, includes the four accounting conventions, entity, monetary measurement, historical cost and periodicity. The four accounting concepts that the UK GAAP consists of include going concern, consistency, accruals and the prudence concept.

Jones (2010, pp.36-39) states that the entity convention simply implies that a business has a distinct and separate identity from its owners. For large entities such as a large limited company, it is fairly clear to see the distinction where shareholders own the company and managers manage the company. However, smaller entities such as a sole trader there is a theoretical distinction between personal and business assets the business is treated as a separate entity. Monetary measurement convention implies that only items which can be measured in financial terms are included in the accounts hence pollution would be exempt. The historical cost convention states that the amounts recorded in the accounts will be the original amount paid for the good or service. Periodicity concept denotes that accounts are prepared for a set period of time, such as audited financial statements which are prepared annually. Woolf (1997) mentions that the concept of going concern assumes that the business will continue into the foreseeable future. Assets, liabilities, income and expenses are calculated under this basis. An example is valuing machinery in the company accounts, under this assumption the machinery would have a higher value if the business is ongoing than if it was going bankrupt in which case it would have scrap value. This concept clarifies the understanding of the financial statements in understanding the companies trading and financial position. The consistency concept makes certain that similar items are treated similarly from year to year ensuring companies from adopting different accounting policies in different years. The accruals concept recognises income and expenses as they are incurred not when the money is received. Lastly the prudence concept comprises of an element of caution in accounting it states that liabilities should be recognised as soon as possible in the financial statements in contrast profits and incomes should be recorded when they are certain to result in an inflow of cash within the business.

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Does UK GAAP meet UK entities

Figure 1 represents the framework for the new structured tier system to replace UK GAAP for the different entities within the UK.

Figure 1: Represents the proposed approach by the UK accounting standards to replace the current UK GAAP and categorisation of the different entities. (ICAEW 2012, p.3)

Ernst & Young (2012) have reported the following key accounting differences for entities converting from UK GAAP to the IRFS. Financial instruments, any financial such as foreign currency derivatives are required to be recorded at fair value under the international financial reporting standards or new UK GAAP.

The previous UK GAAP accounting for financial instruments involved a lot of complexity. The new UK GAAP includes fewer categories of financial instruments in a sense of simplifying the rules however, reducing the available accounting options. The old UK GAAP required investment properties to be carried out at fair value, revaluations were put in the statement of gains and losses in contrast; the new UK GAAP also recognises the movement of values at fair value however, in the form of profit and loss. Employee benefits under the old UK GAAP group benefit pension schemes where recognised as assets under common control under the new IFRS it may not be recognised as multi-employer schemes. Good will and intangible assets are accounted differently under the old UK GAAP which gave entities a policy choice of expensing or capitalising this expenditure, the new UK GAAP may have a cash tax impact on this. Under the old UK GAAP entities could expense or capitalise all borrowing costs if specific conditions are met. The new approach by IFRS still requires borrowing costs on the qualifying assets to be capitalised, this could result in new processes being bought in to identify this information.

New UK GAAP will also allow merger accounting for group re-organisations. The new UK GAAP also requires lease classification based on risks and rewards, related to ownership similar to the old UK GAAP. Deferred tax under the old UK GAAP uses the 'timing differences approach' whereas the new UK GAAP incorporated with IFRS recognises it on the basis of temporary differences between carrying values recorded as tax base of assets and liabilities in the balance sheet. The New UK GAAP using the timing approach has additional adjustments in order to distinguish differed tax. These are the key reporting differences due to convergence of the UK GAAP and IFRS.

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Some of the problems with current UK GAAP can be aided with an example, such as two companies trading with overseas partners, where both enter into forward currency contracts in order to offset potential losses and gains incurred to these relationships (Martin and Green, 2012). The current UK GAAP will allow these companies to then accept differing accounting conducts this can then lead to differences in reporting profits. The old UK GAAP allows this diversity which can distort identical performances between the two businesses through the use of accounting. The accounting standards board want to counteract this by the use of derivatives such as forward currency contracts reported at fair value on the balance sheet. The Accounting Standards Board approach on replacing parts of the financial instruments sections of the financial reporting standards with requirements based on IFRS 9, which is still in the development stages by the International Accounting Standards Board (IASB) adds an element of uncertainty in the implementation of the new financial instruments.

Many issues have been raised about the convergence of UK GAAP and IFRS, but unlike the US Generally Accepted Accounting Principles and convergence of IFRS, the issues against rules versus principles based accounting does not arise. The journal of Agoglia, Doupnik and Tsakumis (2011) highlights this, it explains that rules based accounting encompasses a set of rules to be followed in the preparation of financial statements, the main advantage of following this method is that it reduces inaccuracies and ambiguity however, preparation under this method can also be troublesome due to the unnecessary complexity of these. Rules based accounting also offers less flexibility as it unable to adapt to different financial conditions as a result it can provide unreliable and inconsistent information. This was the case for Enron where the interpretation of the rules where altered in order for the outcome to be as the accountant wished, rather than providing a true a fair view of the performance of the company. Enrons' true company performance became transparent when the principles based accounting was used on its financial statements as oppose to rules based accounting.

Principles based accounting such as UK GAAP follows principles; this is similar to IFRS they are both based around giving a 'true and fair view' of the business through the preparation of financial statements. Principles- based accounting enforces fewer rules, a set of key objectives are set to ensure good financial reporting (O'raegon,). Principles based accounting shows a realistic representation as accountants can have different interpretations of the same economic transactions. Principles-based accounting allows accountants to accurately represent uncertainties that actually exist in the market whilst also allowing accountants to use reasonable judgements in the explanation of their interpretations as oppose to using rules to explain market volatility.

Issues with current GAAP system

The UK accounting standards board argues that there is a need for change because the UK GAAP does not recognise derivatives which are relevant to certain transactions such as an assessment of financial position of an entity (BOD, 2011). UK GAAP is also made up of a mixture of unclear standards that were developed in the UK over a long time span and have since converged with the European Union endorsed international financial reporting standards (IFRS). The UK GAAP has also failed to keep up-to-date with ever evolving pace of business transactions hence it is not tenable in the longer term. The UK accounting standards board believe the convergence of UK GAAP to IFRS will address these issues.

The replacement of the UK GAAP with the IFRS will also allow greater comparability (ACCA, 2012) between the reports of companies operating in the UK with companies around the world who have also implemented IFRS. Readers of the financial statements will sure that the information they are presented with are all produced using a similar guidelines also supporting its comparability. The preparation of the financial statements being produced in a similar way can also assist in cross-border trade. Another positive The time and costs involved in the maintenance of UK GAAP can be avoided; this can be more efficiently used in the development of IFRS.

Convergence to ifrs

The preparation of accounting information on a single • consistent basis would help simplify internal reporting and so reduce costs for companies.

Accountants preparing or auditing the financial • statements would have to be familiar with that one system. Although there might be significant disclosure differences for different types of entity, there should be less scope for confusion and complexity.

The costs and time involved in maintaining a separate • system of UK GAAP could be avoided and more efficiently used in influencing the development of IFRS.

The training and education of accountants and users • could be simplified by being similarly based on a single system of financial reporting.

replacing UK GAAP with another set of requirements that continue, in some areas, to conflict with full IFRS disadvantage

and what is ethical behaviour who is responsible and to what extent ethical behaviour in accounting is practiced

go to accounting bodies to find code of practice for ethical behaviour code of practice or code of behaviour using examples

ethics barry elliott

Ethics http://www.icaew.com/en/technical/ethics/icaew-code-of-ethics/icaew-code-of-ethics

Research papers on IRFS acc

Fair value accounting

Critics on convergence

Europe market reaction to adoption journal christoper Armstrong…

The ASB considers that the FRSME will have a number of benefits over existing UK GAAP.

These are that

•it is easy to apply;

•it allows simplified accounting;

•it reduces compliance and training costs; and

•brings greater consistency between listed companies and private companies.

It also believes that the reduced disclosure framework for subsidiaries will generate cost savings.

Conclusion

The introduction of IFRS in the UK did not change the fundamental requirement for accounts to

give a true and fair view.

References

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