Accounting principles: National and international standards

In the United Kingdom, there is a set of standards in place for annual financial accounting called the UK GAAP (United Kingdom Generally Accepted Accounting Principles). These principles are set in place by the UK Financial Reporting Council (FRC), and are a national version of the international accounting standards set by the IFRS. The accounting principles contained in the UK GAAP are only required for listed companies, though many non-listed businesses choose to follow them as well. Following the principles helps to guarantee consistency and accuracy in financial reporting, which helps companies to secure the trust of their investors and other stakeholders.

Accounting standards exist to ensure that accounts are made in a unified and reasonable way. They should be comparable: so it is easy to compare the financial standing of similar entities. They should be transparent: leaning in the direction of openness when deciding how to provide information to observers. Standards make sure the information in the financial statements is relevant: this makes it more difficult for organisations to misdirect observers.

The aim of the standards is to organise a company in such a way as to provide all of the necessary information to any independent observer. The UK GAAP system actually functions under 8 basic standards, all intended to promote the consistency and transparency of official financial records.

It goes without saying that capital-market-oriented companies are obliged to protect the interests of their investors and shareholders. Compliant annual financial statements aim to provide an objective insight into the economic situation of a company within the scope of the shareholder protection principle so that those shareholders can form their own estimation of possible returns and risks. Commercial books and financial statements also assist in tax planning and optimisation. While the UK GAAP is aimed primarily at private companies, publicly listed companies can turn to the IFRS for their statement of compliancy standards (FRS 102 Section 1A).

Creditor protection, shareholder protection, and tax structuring are reflected in two basic functions of the annual financial statements: How easily the business can pay its bills and the profitability of the business.

  • The income of the business year serves as a basis for the taxation of a company as well as the determination of performance-related distributions (dividends and profit sharing)
  • The balance sheet displays the financial health of a company at a point in time and serves as the basis for financial planning and resource allocation.

Annual consolidated financial statements, when prepared according to uniform accounting standards, are reliable and meaningful sources of information. The UK GAAP has six basic standards, FRS 100 - FRS 105, to help govern financial statements in the UK. There are also two additional standards, SORPS and FRSSE, that apply to companies within specific industries or sectors.

What are accounting standards?

Accounting standards are national or international principles set in various areas of business accounting. The aim is to regulate bookkeeping and accounting in relevant legal areas by means of statutory requirements, thereby standardising the process of reporting on company finances and making statements relevant and comparable.

For accountants in the UK, this means a divide between the national standards of the UK FRC and the international standards of the IFRS. The standards laid out by the FRC in the UK GAAP translate easily to many international markets. UK companies that have non-UK subsidiaries preparing financial statements using an IFRS framework or UK companies that are listed should keep up-to-date on IFRS developments.

National accounting standards

Accounting standards have a long tradition. As early as 5,000 years ago, merchants in Egypt and Mesopotamia organised their business using an ancient version of financial statements and accounts. In the Roman Empire, bankers were obliged to use systematic accounting. Even double-entry accounting, the most commonly used system of commercial business income and expenditure recording today, found its origins in 17th century northern Italy.

In the United Kingdom, accounting standards were first introduced by the Joint Stock Companies Act in 1844. This required the preparation of balance sheets to be presented to shareholders. After the global economic crisis of the 1920s and the stock market crash of 1929, the overly lax accounting practices of many businesses shouldered a lot of the blame. Without strict standards of financial presentation, companies could manipulate their reports to suit whatever needs they had, making their finances appear in better shape than they actually were. The 1929 Companies Act introduced stricter legislation for company accounting in an effort to promote a higher level of disclosure and more uniform accounting practices. Multiple other developments followed over the next several decades, including the creation of various governing bodies in charge of standardisation. Accounting standards in the UK are now monitored by the FRC, a government committee that is funded jointly by the accountancy profession, the financial community, and the British government.

While the accounting principles contained in the UK GAAP only apply to UK companies, there are national accounting principles in Canada, France, Germany, the US, China, India, Nepal, and Russia.  Though there is some overlap (for example, Germany has voluntarily signed the US GAAP in addition to their own standards), principles are only really applied to domestic business. Any companies doing business with or from foreign nations typically apply international accounting standards, such as the IFRS format.

The application of the IFRS standards is fairly prevalent in the UK, as it allows companies more flexibility in foreign business while maintaining international compliancy. IFRS is also required for the consolidated accounts of EU listed companies as well as any stock listed companies.

While operating according to IFRS is generally all that’s required for conducting foreign business, the following table will provide a quick overview of the national accounting standards for the DACH countries (Germany, Austria, and Switzerland) as well as the other major players in Europe: the UK (a brief overview), France, Spain, and Italy.

Accounting standards in Europe
Germany Handelsgesetzbuch (HGB) The German Commercial Code (HGB in German) forms the legal basis for the management of business books and creation of annual financial statements in Germany. This requires every merchant to disclose transactions and assets in accordance with proper accounting principles. Details on these can be found in the Commercial Code and aren’t explicitly defined by the legislature. Instead, the principles are formed based on educated recommendations and generally accepted practice. Deutsche Rechnungslegungsstandards (DRS) German accounting standards (DRS in German) must be used if the company in question is a parent company. These standards are set by the German Accounting Standards Committee (DRSC), a private accounting body that operates on behalf of the Federal Ministry of Justice (BMJ). Financial statements can also be voluntarily prepared in accordance with the IFRS. These replace HGB and DRS standards, as long as the supplementary trade regulations are observed. International Financial Reporting Standards (IFRS) Capital-oriented parent companies, on the other hand, are not held to HBG or DRS standards. Instead, the international accounting standards of IFRS recognised by the EU are applied throughout Europe.
Austria Unternehmensgesetzbuch (UG) The German Corporate Code (UG in German) is used in Austria for drawing up annual financial statements. Austrian law also refers to the principles of proper accounting. Unlike in Germany, these are described directly in the legal text and so are official legislative standards. IFRS Similar to the situation in Germany, parent companies in Austria have the right to choose between IFRS and the national standard. According to EU regulations though, capital-market-based parent companies must account in accordance with IFRS.
Switzerland Obligationenrecht (OR) The Swiss Code of Obligations (OR in German) contains statutory minimum requirements for accounting in Switzerland. The OR regulations are binding for all commercial transactions of companies and organisations with account obligations. Strict rules apply to companies listed on the largest Swiss stock exchange, SIX Swiss Exchange. In this case, it’s required to either follow the recommendations for accounting (Swiss GAAP FER) or international accounting standards (IFRS). Swiss GAAP FER For Swiss companies listed on the SIX Swiss Exchange in the secondary segment, the recommendations for accounting (Swiss GAAP FER) apply as a minimum standard. Companies that aren’t listed can choose to use Swiss GAAP FER for their accounting as well. These recommendations include:
  • A framework concept
  • Core expert recommendations
  • Swiss GAAP FER 30 for consolidated financial statements
  • Swiss GAAP FER 31 for listed companies
Small companies only have the option to align themselves with the framework concept and select expert recommendations. Medium-sized organisations must observe all standards for their accounting. The Swiss GAAP FER 30 is also required for companies, coordinated with the consolidated financial statements. Exchange-listed companies also must take the Swiss GAAP FER 31 (“Complementary recommendation for listed companies”) into account. Industry-specific recommendations are offered for insurance companies, pension institutions, non-profit organisations, health insurers, and building insurers. IFRS or US GAAP Since 2005, a financial statement prepared according to international standards (IFRS or US GAAP) has been mandatory for Swiss companies listed on the SIX Swiss Exchange in the main segment.
UK New UK GAAP Generally Accepted Accounting Practice (New UK GAAP) New national accounting standards have been in place in the UK since January 1, 2015, called the New UK GAAP. The accounting framework is aimed at non-capital-oriented companies and covers the six standards FRS 100 to FRS 105.
  • FRS 100 - Application of Financial Reporting Requirements: FRS 100 explains the framework for financial statements prepared in accordance with national laws, regulations, and accounting standards.
  • FRS 101 - Reduced Disclosure Framework: FRS 101 presents a reduced accounting concept that allows companies to prepare consolidated financial statements in accordance with the international IFRS requirements, without having to comply with all IFRS disclosure requirements.
  • FRS 102 - The Financial Reporting Standard Applicable in the UK and Republic of Ireland: FRS 102 is the actual financial reporting standard for the UK and Ireland. This covers 250 pages and replaces all previous Old UK GAAP standards.
  • 103 - Insurance Contracts: FRS 103 contains separate accounting standards for companies that issue insurance contracts.
  • FRS 104 - Interim Financial Reporting: FRS 104 is based on the international standard for interim reporting, IAS 34, and serves as a basis for the preparation of interim financial statements for companies that use FRS 101 or FRS 102 accounting.
  • FRS 105 - The Financial Reporting Standard Applicable to the Micro-entities Regime: FRS 105 is a modified version of FRS 102, directly tailored to the requirements and needs of micro-enterprises.
The FRS is issued by the Accounting Standards Board (ASB), a division of the Financial Reporting Council (FRC). IFRS Listed companies also have to prepare accounts according to the IFRS international accounting standards in the UK.
France Plan comptable général (PCG) The Comptable Général (PCG) is the minimum standard for the accounting of non-listed companies in France. The framework contains the following content:
  • Overview of the topics and principles of the accounting
  • Definition of core concepts such as the balance sheet, profit and loss account, liabilities, assets, income, as well as profits and losses
  • Presentation of accounting and valuation rules
  • Account management and naming rules
  • Documentation requirements
  • Special accounting rules
  • Statements by the National Audit Office (Conseil National de la Comptabilité) and the Committee on Urgency (Comité d’Urgence)
IFRS Like any other EU member state, France also requires listed parent companies to prepare consolidated financial statements in accordance with the IFRS.
Spain Código de comercio (CCom) and Ley de sociedades anónimas (LSA) Merchants and trading companies in Spain are also obligated to prepare business books according to commercial principles. Corresponding requirements can be found in the Spanish Commercial Code (Código de comercio, CCom) and the Spanish Stock Corporation Act (Ley de sociedades anónimas, LSA). These are largely based on the European guidelines and differ only slightly. Plan general de contabilidad One criticism of the CCom and LSA accounting standards concerns their overall account plan (Plan general de contabilidad, PGC), which was approved by Royal Decree 1514/2007 and is a broad adaptation of the international accounting standard IFRS. A simplified account plan for small and medium-sized companies is available in accordance with Decree 1515/2007. IFRS Spanish capital-oriented parent companies report according to the IFRS, just like all other EU member states.
Italy Codice Civile The legal basis for accounting standards in Italy is contained in Article 2423 of the Italian Civil Code (Codice Civile, CC). The possibility of a condensed financial statement is the subject of Article 2435. Accounting principles of the OIC An interpretation and clarification of the Italian Civil Code of accounting principals is available to companies by the accounting principles of the Organismo Italiano di Contabilità (OIC). In the case of regulatory gaps in the national guidelines, resorting to international standards (generally IFRS) is possible. IFRS Listed companies and insurance agencies in Italy are required to create individual and consolidated financial statements according to IFRS. Non-listed companies are allowed to choose between IFRS and the national standards.

International accounting standards

To make annual and consolidated financial statements that are comparable across national borders, international harmonisation has been underway for a number of years. The goal is to provide companies with a uniform framework for financial statements. The international accounting standards in use today are the IFRS, created by the IASB, as well as the US GAAP, which are used primarily in America but are also applied abroad. The following is a brief overview of these standards.

Internationally recognised accounting standards
IFRS   The International Financial Reporting Standards (IFRS) were published by the International Accounting Standards Board (IASB) as basic principles for international company accounting. The goal was to achieve a worldwide harmonisation of the accounting system. The framework consists of three parts:
  • Framework: The IFRS framework forms the theoretical basis of the standards as a framework concept. It describes the goals and the main premise of the international requirements, as well as qualitative requirements for the IFRS financials statements. It also provides framework definitions of the central terms such as assets, liabilities, income, or expenses.

  • Standards (IFRS/IAS): The actual accounting and valuation requirements are in the form of individual standards. These include both the IFRS from the IASB as well as the IAS (International Accounting Standards) from the predecessor organisation, the IASC (International Accounting Standards Committee).

  • Interpretations: To unify the understandings of the international requirements, the third part of the framework includes official interpretations of the standards published by IFRS Interpretations Committee (IFRS IC).
Application of the IFRS: In the event of a conflict, the IFRS standards and interpretations have a higher liability as special regulations than the overall specifications of the framework. The framework itself doesn’t have a default status. Since 2005, all capital-oriented parent companies with locations in Europe are required to create financial statements according to the IFRS.
US GAAP The United States Generally Accepted Accounting Principles (US GAAP) are accounting standards issued by the Financial Accounting Standards Board (FASB) for the US. They obtain legal status with the approval of the US Securities and Exchange Commission (SEC) as well as the largest professional association of American auditors, the AICPA (American Institute of Certified Public Accountants). US GAAP also enjoys a high international status, since a listing on the US stock exchange requires reporting in accordance with the rules of the SEC. Until 2007, foreign companies wishing to meet their capital requirements on the US capital market were also required to fulfill the US GAAP or a compliant transition to the US standard. But since December 21, 2007, with the acceptance of the IFRS by the SEC, this requirement has been omitted.

UK GAAP: Eight main accounting standards

The New UK GAAP, in place since 2005 and available in the most current version since 2015, provides guidelines for the consolidated financial statements of listed groups in the UK. The six standards are aimed at non-capital-oriented companies, and are required accounting standards for listed companies - though those companies may choose to adhere to IFRS accounting in addition. These standards, FRS 100 - FRS 105, are issued by the Financial Reporting Council and are as follows:

  • FRS 100 - Application of Financial Reporting Requirements: This lays out the applicable financial reporting framework for businesses preparing their financial statements in the UK and Ireland. While it contains no actual accounting requirements, it provides direction toward the relevant standard(s) and provides guidance to be used when interpreting meanings of equivalence or deciding on an applicable standard.

  • FRS 101 - Reduced Disclosure Framework: A reduced disclosure framework is introduced here which allows IFRS recognition and measurement bases to be used in individual financial statements, without requiring full IFRS compliancy. It can only be applied by qualifying entities following shareholder notification and a summary of adopted exemptions in the financial statement.

  • FRS 102 - The Financial Reporting Standard Applicable in the UK and Republic of Ireland: The single coherent financial reporting standard replacing the old UK GAAP, FRS 102 spans 250 pages and covers accounting requirements for a number of different areas. A group must be a parent or subsidiary of a group that prepares public consolidated accounts in order to be able to take advantages of the disclosure exemptions contained in FRS 102.
  • FRS 103 - Insurance Contracts: This section consolidates existing guidance on insurance contracts contained within the IFRS and requires disclosure that identifies and explains financial statements resulting from insurance contracts, relates the financial strength of the entities, and helps users of the financial statements comprehend them.
  • FRS 104 - Interim Financial Reporting: Intended as a basis for the preparation of interim financial reports for entities applying FRS 102, this standard can also be applied by entities that prepare their interim reports according to FRS 101. It outlines the minimum content of a financial interim report and the necessary disclosures.
  • FRS 105 - The Financial Reporting Standard Applicable to the Micro-entities Regime: This late addition is a modification of the FRS 102, and is directly tailored to suit micro-enterprises. This eliminates the need for qualifying entities to prepare some primary statements which are required for larger companies, and requires fewer disclosures than FRS 102.
  • FRSSE: The Financial Reporting Standard for Smaller Entities (FRSSE) combines all of the standards for small companies, and can also be extended to micro-entities. It is applicable to any companies or groups that qualify as small under the 2006 Companies Act.
  • SORPS: The Statements of Recommended Practice (SORPs) are supplementary standards that exist for a range of specific entities and industries. Their current version reflects the requirements of the FRS 102, and is intended to be used in cooperation with those standards of the UK GAAP.

Accounting standards in the UK: Comparison of the GAAP and IFRS

While the accounting standards of the UK GAAP specify practices for certain types of business, the IFRS is still widely accepted in the United Kingdom as the international standard. Companies can choose to conform to IFRS standards even if their business category is one of those governed by the UK GAAP, which can be particularly helpful when conducting global business. Listed groups, regardless of whether they choose to integrate IFRS, are required to follow the UK GAAP for their financial statements.

Any businesses that operate in the public sector are not governed by the UK GAAP, and so instead must follow the rules laid out by the IFRS.

The following table presents the main differences between the UK GAAP and IFRS, as shown in financial statements with regard to itemisation and content:

  UK GAAP IFRS
Assets held for sale
  • No definition or required reclassification of held for sale
  • Considers items as held for sale if their value will be recovered through sale rather than use
Discontinued operations
  • Items are considered discontinued when they are sold or terminated
  • Shift of operational focus causes items to be considered discontinued
Goodwill
  • Goodwill is liquidated over 20 years and annually tested
  • Tested annually for impairment and not liquidated
Impairment
  • All assets reviewed for indicators of impairment at the balance sheet due date
  • All assets reviewed for impairment indicators at each reporting date, and indefinite assets reviewed annually
Pension costs
  • Calculated based on percentage of pensionable pay and liquidated on a straight line basis
  • Calculated based on scheme assets and liabilities and adjusted annually
Deferred taxation
  • Provided on all timing differences, but not on revaluation gains
  • Recognised on all temporary differences, including revaluation of assets
Cash and cash equivalents
  • No equivalent definition
  • Defined as short-term, highly liquid investments with a maturity of less than 90 days and readily convertible into cash
Dividends
  • Recognised as an expense in the period of declaration
  • Recognised as a reserve in the period of approval

Summary of significant differences between New UK GAAP and IFRS accounting standards / Source: http://www.wikinvest.com

Prudence principle vs. accrual principle

The focus on the capital market means that investment-oriented finance reports based on international standards are aimed at meeting needs within a given period. IFRS statements are based on the accrual principle  - income and expenses are recorded in the period in which they’re generated and not in the period in which the payment receipts or payments actually appear. By contrast, the UK GAAP places a larger emphasis on the prudence principle that strives to remove speculation from the reporting of fact-based financial data. The prudence principle is intended to protect lenders from the overly optimistic presentation of financials. For example, revenue is not recognised unless it is certain. Please note the legal disclaimer relating to this article.

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