UK Regulatory framework and uses of accounting standards


In this essay we have to look for the regulatory framework in UK and uses of accounting standards. First we have to know who issue and implement the international standards so, for harmonisation and creation of mutual standards IASB issues standards this organization was set up in April 2001, it publishes its standards called IFRSs. What are IFRS?

IFRS are accounting rules that are issued by a central organizing body called IASB. They set the rules that would equally apply to financial reporting by companies all over the world. (Bay, 2003)

Purpose of financial reporting

"To provide information about the financial position, financial performance and cash flows of an entity that is useful to a wide range of users in making economic decisions." (Melville, 2008 p. 34) Financial reporting provides information that is useful to present and potential investors and creditors and other users in making rational investment, credit and similar decision. The information should be comprehensible to those who have a reasonable understanding of business and economic activities and are willing to study the information with reasonable diligence. (Nobes & Parker, 2008) However, financial statements do not provide all the information that users may need to make economic decisions since they largely portray the financial effects of past events and do not necessarily provide non-financial information. (IASC, 2009)

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Financial reporting provides information to help users in assessing the amounts, timing and uncertainty of prospective cash receipts from dividends or interest and the proceeds from the sale, redemption, or maturity of securities or loans. Financial reporting provides information about the economic resources of an enterprise, the claims to those resources and provides enterprise earnings based on accrual accounting generally provides a better indication of an enterprise's present and continuing ability to generate favourable cash flows than information limited to the financial effects of cash receipts and payments. Financial reporting also made for the purpose to provide information about enterprise's financial performance during a period. (Nobes & Parker, 2008)

The regulatory framework for financial reporting in the United Kingdom

In the most countries, as in UK, the regulatory framework has changed over time. Since accounting has grown more complex, so has the regulatory framework which governs it.

The company law, accounting standards and stock exchange regulation are frameworks by which financial reporting is regulated. (Melville, 2008)

The overall aim of regulatory framework is to protect the interest of all those stakeholders who are involved in the corporate model. It's truly based on true and fair view of presentation. (Jones, 2006) Here it is worth mentioning the meaning of true and fair view, it means that the financial statements such as Profit and Loss and Balance sheet should state true and fair view of the company's profit or loss, and fair view of company's financial position at the end of the year respectively.

All UK domestic companies are required to comply with UK company law, a fundamental principle of which is that all companies, regardless of size or ownership structure, are subject to the same legal regime. The company law is enforced by The Department of Trade and Industry (DTI). Companies Acts lays down the legal requirements for companies including regulation for accounting. (Jones, 2006)The Companies Act includes a requirement for accounts to show a true and fair view and comply with law and accounting standards. The true and fair view can be used, where it can be justified, to override other legal requirements and accounting standards. (Bay, 2006) Companies Act, require companies to produce, as primary financial statements, a profit and loss account and a balance sheet, supplemented by additional information disclosed as notes to those statements. (Davies, 2000) When companies financial reports are approved by company's directors, with the exception of very small companies, their accounts must be audited by a UK registered auditor, (Fearnley, Hines, 2003) and then filed with the Registrar of Companies within the deadlines allowed by law. (Davies, 2000) it is the company's responsibility to give its financial reports to its shareholders and should make it available to public for inspection. (Melville, 2008)

Company law generally sets out the broad rules, while the detail rules governing the accounting treatment of transaction and other items shown in those statements are set by accounting standards. (Melville, 2008)

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"Accounting standards are authoritative statements of how particular types of transaction and other events should be reflected in financial statements and accordingly compliance with accounting standards will normally be necessary for financial statements to give a true and fair view." (Jones.2006, p. 270)

In order to restore credibility in UK accounting, the Financial Reporting Council (FRC) was set up. The FRC is an independent private sector body funded by the accountancy profession. The FRC has three subsidiary bodies: the Accounting Standards Board (ASB), the Urgent Issues Task Force (UITF), which opines on emerging accounting issues for which no standards exist; and the Financial Reporting Review Panel (FRRP) which is responsible for enforcement. (Feamley, Hines, (2003) The increase in international trade and globalisation has led to a need for convergence, or harmonisation, of accounting rules and practices. (Tony and Tony, (2005)

Any company whose securities are listed on any UK stock exchange must comply with rules and regulation of that stock exchange. Some stock exchanges may ask companies to present their financial reporting on interim basis like, semi-annually or quarterly. Stock exchanges may ask companies to provide detail analysis of their reports which may not be required by law or any accounting standards. (Melville, 2008) All the companies registered in London Stock Exchange, have to follow company law to prepare financial statements for their shareholders. These accounts are the legal responsibility of the directors and must comply with UK GAAP and company law.

For understanding IFRS we have to look for its advantages and disadvantages for different users, preparers and standard setters.

The basic idea behind national or international accounting standards is to minimise or eliminate the variation in accounting practice and bring uniformity in financial reporting of different companies. So, that the users are able to compare the financial reports of organisation over time and with other organisation's financial reports to identify different trends and asses the financial performance and financial position. (Melville, 2008)

Financial reports made in accordance with accounting standards are reliable and relevant, so users specifically investors and creditors can determine the company's liquidity and performance and can take economic decisions.

If preparers of financial reports follow the rules and regulation of accounting standards so that it is likely that financial performance and financial position presented in financial reports is complete and faithful. (Melville, 2008)

The preparers can not make their own accounting treatment for certain set of transaction. (Melville, 2008) For example, if preparers use straight line depreciation method for machinery at one place so, they cannot use other depreciation method for the same machinery at another (in order to minimize or maximize profits). Misunderstanding and inefficiency also is major problem for preparers because when standards form part of the pre-existing laws and regulation of a country. Often, laws and regulations overlap or become inconsistent with each other so lack of correlation become difficult for the preparers. (UNCTAD, 2007)

There may be shortage of accountants and auditors who are technically competent to implement the IFRS, which require additional cost for the company to train or hire sufficient number of professionals who could competently apply international standards. The preparers may face difficulty in coping with the rapid frequency and volume of changes made by the IASB to existing IFRS, as well as keeping pace with new standards. (UNCTAD, 2007) Preparers face difficulty in obtaining reliable measures and data where fair value presentation is not present.

Fair value measurement requirement in IFRS pose yet another significant technical challenge. In particular where trading volume is low and capital market are not sufficiently liquid, obtaining reliable fair value for IFRS measurement purposes becomes difficult. (UNCTAD, 2007)Separate institutions are needed to enforce the standards in a country. (UNCTAD, 2007)Standard setter have to look for the company's size while setting standards (Elliot & Elliot, 2009), because it may be easy to implement the standards for large companies but smaller companies may find it difficult to do so, keeping the resources they have in mind. Another standard setting problem rises when national and international accounting standards do not comply. For example EU-endorsed IFRS is not the same as IFRS which led to confusion and audit problems. (Nobes & Parker, 2008) Sometimes standard setters do not take account of economic consequences when setting standards, leading to additional work and cost to the preparers. (Elliot & Elliot, 2009) some times standards are influenced by those who have greater interest in that, which leads to problems for other companies. (Elliot & Elliot, 2009)

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Although there are some disadvantages of IFRS but over all it is very effective and necessary for the harmonization of unique standard which will be followed by the whole world. For this purpose countries have to implement IFRS effectively which requires careful planning and extensive public education, the allocation of resources, a legal and regulatory support system and institutional support with strong management systems. All stakeholders should be integrally involved in development plans and communication system for informing user of the change in reporting must be effective. Continuous training of preparer should be made in order to remain up to date.