GT - Financial reporting. Unravelling the future before the future unravels your business

Unravelling
future
the

future
your
before the
unravels
business
AN FD’S GUIDE TO FINANCIAL REPORTING

Contents

03 What is your financing strategy?

09 Risk and Capital management –
does your narrative reporting tell

Introduction the story?
13 What will forthcoming changes
in accounting standards
and regulation do to your
company’s financial position and

performance?
19 Are you seeking new opportunities
through organic growth or through
Financial reporting is changing acquisition?

Key outputs from the International Accounting Standards Board’s
23 Is your business structured so
major work programme are now appearing and more are on the as to optimise management and
way. 2013 will see major changes to international requirements on shareholder objectives?
consolidated accounts, joint ventures and fair value disclosures. Big 27 Are you geared up to make the
changes to international requirements are on the way for revenue
right choices given the proposed
recognition, financial instruments and leasing, which are expected to
changes to legislation and the
begin taking effect from 2015 onwards. After several years of relative
accounting regime in the UK?
stability, the biggest shake-up in UK GAAP for a generation is due to
take effect in 2015 when existing UK accounting standards are replaced 31 How might your business
by new requirements based more closely on IFRS. The front end of the operations be affected by market
annual report and accounts is set for an overhaul too as the Government and regulatory changes?
plans to replace the existing directors’ report with a new strategic report
and annual directors’ statement. 34 Navigation
38 Contact us
Grant Thornton’s FD’s guide to the future of financial reporting puts
these impending developments into the context of key issues facing
your business and highlights the key questions you need to be asking
about how the changes will impact on your business. To help you focus
on what is most relevant to you, we have flagged these issues according
to whether they are relevant where you prepare your annual report and
accounts under IFRS, UK GAAP or both.

Dynamic organisations know they need to apply both reason and
instinct to decision making. At Grant Thornton, this is how we advise
our clients every day. We combine award-winning technical expertise
with the intuition, insight and confidence gained from our extensive
sector experience and a deep understanding of our clients. We can help
you unlock the potential for growth in your business by providing
world-class advice on how the changing financial reporting landscape
will impact on your business and its key stakeholders.

This guide is based on standards and exposure drafts in issue at 30 June 2012.

Joyce Grant
Partner
National Assurance Services

2 AN FD’S GUIDE TO FINANCIAL REPORTING

1
What is your
ﬁnancing strategy
?
Challenging economic conditions make access to traditional
sources of funding difficult. Management might need to look

to alternative sources of funding to achieve growth or sustain
business and should be aware of any accounting considerations.
Expected changes in accounting standards could also impact
on accounting for existing and new sources of finance, as

well as financial covenants. Many transactions may have profit

implications which in turn could impact on the amount of
tax that your business has to pay. The tax consequences of
financial arrangements entered into may, therefore, need careful

consideration.

AN FD’S GUIDE TO FINANCIAL REPORTING 3

Existing sources of finance
Potential impact of future standards

Do you have any leasing Very simply, if planned changes go ahead,
IFRS arrangements?
operating leases will be brought onto the balance
sheet. A liability to make lease payments will be
Many companies typically enter into operating recognised as well as a right of use asset. Liabilities
lease arrangements. Under IAS 17 Leases the and assets will therefore increase. Profit or loss may
accounting treatment for an operating lease is also be impacted. Instead of recognising operating
straightforward and results in the recognition of an lease charges, an interest expense on the liability to
operating lease expense through profit or loss. No make lease payments and amortisation of the right-
asset or liability is recognised. of-use asset will be recognised. There may also be
Under proposals to replace IAS 17, accounting impairment losses and revaluation gains, if relevant,
for an operating lease will change. At the time of arising on the right-of-use asset. The amounts
writing the timing of the changes to the leasing ultimately recognised in profit or loss and the timing
standard is not yet certain, though it is not of their recognition may therefore be very different
expected to be before 2015. compared to the existing accounting treatment.

Do you have financial covenants and the amended IAS 19 from 2013 could be greater
IFRS than under the current IAS 19. Immediate
how sensitive are they to changes?
recognition of actuarial gains and losses could
Lenders often require the inclusion of financial also affect the net defined benefit asset or
covenants to protect themselves and the borrower. liability if you have previously deferred the
UK GAAP You may have covenants in place that relate to the recognition of actuarial gains and losses.
maintenance of specified ratios or the maintenance • Future of UK GAAP: For those expecting to
of the value of certain assets and liabilities above adopt the new Financial Reporting Standard
or below specified levels. Changes in accounting applicable in the UK and the Republic of
standards can inadvertently have an impact on Ireland (Draft FRS 102) there are numerous
financial covenants. changes that will not only impact on profit or
If your company is subject to loan covenants, loss but also financial position. Some of the key
you will need to assess the potential impact differences between existing UK GAAP and the
of changes in accounting standards on the proposed FRS 102 are discussed in more detail
measurement, recognition and presentation of in Section 3.
amounts in the financial statements on those • Potential changes in the recognition and
covenants. This may necessitate early discussion measurement of revenue as a result of the
with your lenders. It might also be worth talking proposed IFRS Revenue from Contracts
to them about whether stable GAAP covenants with Customers could affect your company’s
could be developed such that covenants are profitability and financial position. The amount
‘protected’ against the effects of future and timing of revenue recognised could change,
GAAP changes. as could the amount recognised in respect of
trade receivables.
Areas of future potential impact include: • Operating lease agreements: Proposals to
• Deﬁned beneﬁt pension scheme obligations: replace IAS 17 will impact on financial position
Changes to IAS 19 Employee Benefits will and profit and loss, as described above. It is
impact on the presentation of the net interest likely that both an asset and a liability will be
cost and may affect the recognition of actuarial recognised on the balance sheet, and amounts
gains and losses. This may impact on profit or recognised in profit or loss will also change.
loss and financial position. For example, the net
interest charged in the income statement under


Have you considered ways in which with changes recognised through profit or loss.
This will also be the case for those expecting to
you could manage the exposure of
adopt the proposed FRS 102. At present under
your business to financial risk? UK GAAP, non-small companies that do not
Entering into any financial arrangement can lead apply FRS 26 still need to disclose the fair value
to exposure to financial risk. For example, entering of derivative instruments, even if the derivative
into long term variable rate loan arrangements can instrument is not recognised in the financial
lead to volatility in interest charges, particularly statements. A fair value would therefore need
given the inevitable future rise in interest rates. to be obtained which could involve a
Some companies may consider entering into an professional valuation.
interest rate swap to manage the exposure to Entities may also enter into other derivative
the future variability in interest rates. However, contracts such as foreign currency forward
careful consideration will be necessary as swaps contracts, which would normally be accounted
do not always work to the advantage of the for at fair value through profit or loss under
party seeking to manage risk, and can be costly IAS 39 Financial Instruments: Recognition and
to exit before the contractual maturity date Measurement (or its UK GAAP equivalent FRS
has been reached. Further, under IFRS and for 26) and cause profit volatility. In some cases, the
those applying FRS 26 Financial Instruments: profit volatility can be managed through the use
Recognition and Measurement under UK GAAP, of hedge accounting, although this can be complex
these financial instruments are classed as derivative and requires action on formal documentation and
instruments and need to be carried at fair value effectiveness tests on a strict time critical basis.


New sources of finance
Impact of current standards

Do you have plans to raise funds has been contractually allocated on non-arm’s
IFRS from a listing?
length terms. In order to consider the accounting
substance, it can sometimes be necessary to
Companies seeking to expand and grow their use a valuation expert in order to arrive at an
business often look to achieve this through a appropriate allocation of proceeds. This can have a
UK GAAP public offering of their shares. If your company consequential impact on future finance costs.
has a growth strategy which includes listing on
a public exchange, depending on the nature of
Do you have working capital
financial instruments issued, there may be financial
instrument classification and measurement balances which could be used to
complications whether or not you prepare your secure asset-based finance?
accounts under IFRS or UK GAAP. This applies
In some cases traditional bank funding is proving
not only to an issue of shares, but also listed debt.
harder to find given the capital constraints
currently in place. One solution available to
Do you intend to issue new types of companies is to use the increasingly popular
financial instruments? working capital facilities collectively known as
asset-based lending. Receivables, or other assets
In order to raise finance, entities may issue
(eg inventories) against which finance is raised,
financial instrument contracts such as share capital
remain on balance sheet unless derecognition
with non-standard terms, options, warrants or
criteria are met and finance obtained against assets
some types of loans which include ‘embedded
is presented as a financial liability and classified
derivatives’. These terms can lead to complex
as either current or non-current. The associated
accounting treatments.
finance charges will impact on profit or loss.
For instance, some warrants and options over
own share capital would be accounted for as
derivative liabilities, depending on what is called Do you have intra-group funding
the ‘fixed-for-fixed’ test. Under IAS 39, or its UK arrangements?
GAAP equivalent FRS 26, fair value movements in
Funding arrangements may involve the creation
such derivatives may impact on profit or loss. This
of intra-group balances, for example, where a
can lead to volatility in results.
company in a group has access to external funding
Volatility can also arise in non-derivative
and lends to another group company. Where
liabilities such as some types of loans, where those
accounts are prepared under IFRS (and FRS
loans have potentially variable cash flows (such as
26 under UK GAAP), there can be valuation
contingent premiums). The treatment of fees paid
complications. Under IAS 39/FRS 26 loans will
in connection with raising finance should also be
need to be recognised initially at fair value, which
examined carefully.
may not be the same value as the actual amounts
The classification of financial instruments
loaned between the group companies. This is often
under FRS 25 Financial Instruments: Presentation
the case where the terms of the group arrangement
(and its international equivalent IAS 32) can be
are different to those that could otherwise be
difficult to determine, for example non-standard
obtained in the open market. For example intra
share capital. For those not familiar with FRS
group loans can often attract interest at rates which
25, there can be some surprises. Another issue
are preferential to those that a company could
is that if more than one instrument is issued in
obtain from an external source of finance.
combination to the same investor (eg equity
This would have an impact on the fair value on
shares and loans), the accounting allocation of the
initial recognition.
proceeds received might not necessarily follow the
legal form, particularly if one of the instruments


If you prepare your accounts under UK
GAAP a similar treatment is required for
companies which apply FRS 26. UITF Abstract
47 Extinguishing Financial Liabilities with Equity
Instruments repeats the guidance contained in
IFRIC 19.
However if your company does not prepare
accounts under IFRS and does not apply FRS 26,
there could still be implications for your accounts.
In certain situations it may be appropriate to
adopt a no gain/no loss policy in which case the
Are you contemplating a financial value of the equity issued is deemed to match the
restructuring? debt given up. However in other cases, where the
equity is of little value and in substance the debt
You may be considering a financial restructuring
has been waived, it may be more appropriate to
at some time in the future. For example you might
recognise a gain in profit or loss. In either case
want to improve your company’s gearing ratio or
there are likely to be tax implications.
financial position in anticipation of a public share
offering, or the financial restructuring might be
due to an evolving business plan or a challenging Are you considering a change in the
liquidity position. A financial restructuring could
be achieved in a number of ways. For example,
terms of your existing debt?
it is common for a company to issue equity Where debt is modified, the accounting treatment
instruments in return for a complete or partial will depend on whether the modification is
extinguishment of debt. Alternatively you could substantial or non-substantial and this will depend
agree with the lender to modify the terms of on the facts and circumstances of the modification.
the existing debt or effectively replace the debt IAS 39 contains guidance. If the modification is
with a new instrument. (These two examples are substantial, then extinguishment accounting under
discussed further below.) You could also decide to IAS 39 will result in the immediate recognition
repay debt early. of a gain or loss. In substantial modifications,
It is important to be aware that the way IAS 39 requires all fees to be expensed including
in which a restructuring is achieved will have those incurred during the restructuring. This can
accounting consequences, some of which can be sometimes appear harsh where companies feel
profit neutral whilst others may have a significant that at least some element of the fees relate to
impact on profitability, often introducing the future debt. However carry forward of those
unplanned-for volatility. fees might only be possible in some very narrow
circumstances. This contrasts with non-substantial
Are you considering a modifications where, typically, no gain or loss
need be recognised immediately.
debt-for-equity swap? Where debt is modified, companies under
Where equity instruments are issued in return UK GAAP which apply FRS 26 will need to
for a complete or partial extinguishment of debt, follow similar rules to those contained in IAS 39
often termed a ‘debt-for-equity swap’, any gain or described above.
loss arising on the difference between the carrying However if your company does not apply FRS
amount of the financial liability extinguished and 26, again there could still be implications under
the fair value of the equity instruments issued FRS 4 Capital Instruments.
in consideration will be recognised in profit
or loss. This treatment derives from IFRIC 19
Extinguishing Financial Liabilities with
Equity Instruments.


Potential impact of future standards

Do you intend to issue new types of financial liabilities that are classified as ‘other’ will
UK GAAP financial instruments?
need to be carried at fair value. This category will
include derivatives, but might also include some
Companies under UK GAAP will also have to other non-derivative items such as some non-
think about the impact of the proposed FRS standard loans.
102 on their financial instruments. Derivative Under the plans for FRS 102, basic instruments
instruments that are currently off balance sheet will be carried at amortised cost. The methods
may now have to be recognised at fair value used to apply amortised cost are similar to FRS
through profit or loss. As well as causing profit 26 and IAS 39, which can lead to more volatility
volatility this may also require the use of compared to FRS 4 Capital Instruments in existing
valuation experts. UK GAAP, particularly where there is potential
Under the proposed FRS 102, all financial assets for variation on the future cash flows of the
and financial liabilities will need to be analysed financial instrument.
between ‘basic’ and ‘other’. Financial assets and

Key actions/considerations
• If your company is subject to financial covenants, review them for

the potential impact of changes in accounting standards or business
decisions
• Discuss potential impact on covenants with lenders
• If you are planning to issue new financial instruments consider the

potential accounting impact of their terms
• Consider the impact of financial instruments that are currently off

balance sheet, which could require recognition under the proposed
FRS 102
• For existing financial instruments, if the company uses UK GAAP

then FRS 102 should be carefully considered in terms of whether an
instrument is ‘basic’ or ‘other’


2
Risk and Capital

?
management
– does your narrative
reporting tell the story

Changes to your company’s business model arising from the
continuing economic uncertainty mean that exposure to and
concentration of risk is constantly changing. Consequently, the
adequacy of capital and financial capital management policies

and objectives are also likely to be of increased importance.
Shareholders and other users of the financial statements

could misunderstand the company’s exposure to risk if it is not
communicated properly. There is also the possibility that if the
shares in your company are publicly traded, market expectations
of risk may have a negative impact on your share price, in which
case better communication of risk can enhance the value of your
company. You have the opportunity to manage the possibility that
shareholders and other users may misunderstand your company’s
exposure to risk by ensuring that relevant material risks and how
they are being mitigated and managed are explained clearly in
the annual report, and that shareholders and other users are
kept up to date as developments occur. Therefore, what are you
communicating with shareholders about how you identify and
manage risk and how you are managing capital?


Do you know what your investors Is the company’s business model
IFRS want to know about? explained clearly?
Much of the content of the front end of the annual The continuing economic uncertainty may have
report is determined by statute or other regulatory led to changes in your company’s business model.
UK GAAP requirements. However your key stakeholders, It is important that stakeholders are kept informed
investors, may want to see other information and have confidence that your company is able to
presented. It may therefore be useful to seek adapt to changing circumstances.
current views from your investors as to the kind of A description of the business is necessary to
information that they want to read about in your provide stakeholders with an understanding of
annual report and accounts. the industry or industries in which the company
operates, its main products, services, customers,
Are the key messages regarding business processes and distribution methods, the
structure of the business and its economic model,
risk and capital management clear? including an overview of the main operating
Does the front end of your annual report and facilities and their location.
accounts concentrate on the key messages and Discussion of external factors such as the
‘tell the story’ or are key messages obscured company’s major markets and competitive
by immaterial detail. In other words, is there position within those markets and the significant
unnecessary ‘clutter’ that could be removed? features of the legal, regulatory, macro-economic
Proposed changes to narrative reporting will and social environment that influence the business
mean that the current Business Review and may also be relevant.
Directors’ Report will be replaced with a Strategic
Report and an Annual Directors’ Statement.
The strategic report will provide key strategic
information about the company including
key risks and forward looking analysis. It will
incorporate the content from the business review
that is required by the Companies Act 2006
(CA2006). This is where companies will ‘tell their
story’ and should provide enough information
for users to make an assessment of the company’s
historic performance and future prospects. The
most significant changes will apply to the largest
companies - quoted companies as defined by
CA2006, but any company that is required to
produce a business review will be affected. At the
time of writing, the changes are expected to take
effect in 2013, though this may change.
Now may be a good time to rethink the
narrative reporting section of your annual report,
including the discussion of key risks together
with the steps taken by management to mitigate
the effect of these risks. Sometimes it can appear
that words used in previous years have simply
been updated rather than a fresh approach to the
narrative having been applied.


Have you considered recently what • Financial instruments: Fair value of ﬁnancial
instruments may be volatile and impairment
your key business risks actually are?
may be an issue.
Key business risks are likely to evolve over • Direct or indirect reliance on public contracts
time and are often influenced by changes in the for business: Government spending cuts could
external environment. It is important that the have a significant impact on your business.
narrative disclosures relating to these risks are • Economic stagnation continuing indeﬁnitely:
updated regularly. As mentioned above, the way There appears to be no immediate end to the
in which business risks are disclosed can have recession. How far into the future have you
an impact on the way in which the company forecast and how sensitive are your figures to
is perceived externally. The following list may potential changes in circumstances?
help you identify key issues which are relevant • Impact on business if interest rates increase:
to the continuing economic climate, and which In the UK we are currently experiencing low
may therefore be relevant to your discussion in interest rates but this cannot continue and
the annual report. The key risks that should be eventually they are likely to rise. Will your
disclosed are those that specifically affect the business be able to accommodate an increase
company and not those that are generic to any in rates?
company. The description of the risk should • Ability to meet banking covenants: Continuing
enable the user to understand the harm to the pressures on property values, impairment and
company that the risk may cause: fair value losses can impact on the ability to
• Foreign currency exposure: The current meet banking covenants and will have a knock-
volatility of exchange rates and trade with on effect on liquidity and the company’s ability
European countries that may be forced to, or to secure more finance. Potential changes to the
choose to, leave the Euro. way in which leases are accounted for will also
• Reliance on trade with customers in countries bring more liabilities onto the balance sheet.
facing local austerity measures: Overseas
countries may be subject to measures which
could impact on their ability to trade overseas.


Have you communicated your plan Have you reflected recently on what
to mitigate the impact of identified the business regards as capital and
business risks? what adequate levels of capital are
As well as communicating the key risks, it is considered to be?
important that you explain how you manage those If your company prepares accounts under IFRS (or
risks. Users of the accounts need to know that the applies FRS 26 Financial Instruments: Recognition
company has procedures or controls in place to and Measurement under UK GAAP) then there
manage the impact of those risks. The statutory are specific requirements regarding the disclosure
business review requirements also anticipate that of capital management policies and processes.
this explanation will be given, and regulators such as However even where accounts are prepared under
the Conduct Committee of the Financial Reporting UK GAAP, disclosures about capital and how it is
Council (formerly the Financial Reporting Review managed are considered necessary for a balanced
Panel) will also expect to see this discussed. The and comprehensive business review, which is a
way in which the company is perceived externally statutory requirement in the UK.
will also be affected by how clearly these plans are Things to consider and what shareholders want to
communicated. In the current environment, it is know include:
unlikely that business risks will remain unchanged • the nature of capital: equity, preference shares,
from one year to the next so it is important that you term loans, leases etc
revise your explanations at each reporting date. • dividend policy: including an indication of
constraints on future dividend growth
• return on capital employed
• capital headroom, eg against banking covenants,
and the availability of additional capital
• long-term funding plans designed to implement
business strategy.

• Seek investor views regarding the content of the annual report
• Review narrative reporting within the annual report for unnecessary clutter
• Refl
ect on the current key risks within the business
• Perform sensitivity analysis on profit and cash fl
ow forecasts in the event
of the difficult economic conditions continuing for a prolonged period

• Consider adequacy of principal risks and uncertainties and capital
management disclosures


3
What will forthcoming
changes in accounting
standards and regulation

?
do to your company’s
ﬁnancial position and
performance
Forthcoming changes in accounting standards and regulation are
likely to affect your existing business so you will need to be aware
of what those changes are and what they could mean for your
company’s financial position and financial performance. Changes

will have an effect on the financial statements of companies,

even where significant changes to the business model are not

anticipated. You will also need to communicate with shareholders
and other users of your company’s financial statements what the

impact of the changes is likely to be.


Do you have any operating lease Do you currently defer actuarial
IFRS agreements in place? gains and losses using the ‘corridor
We have already mentioned in Section 1 that method’?
the IASB is proposing to replace IAS 17 Under the amended IAS 19, all actuarial gains and
Leases although the effective date is not yet losses will be recognised immediately in other
certain. However under the proposed new comprehensive income. If you currently apply
standard, accounting for operating leases will the corridor method and defer certain actuarial
change. Therefore, if you have operating lease gains and losses, this method will no longer be
arrangements, you need to be aware that there permitted. The good news is that all actuarial
could be significant changes in the accounting gains and losses will be recognised in other
treatment. See Section 1 for more details. comprehensive income and hence profit or loss
will not be affected by the volatility of actuarial
Does your company operate a assumptions and experience gains and losses.
defined benefit pension scheme?
If you have a defined benefit pension scheme
What sort of sales contracts do you
your company will be affected by amendments to have in place with your customers?
IAS 19 Employee Benefits which take effect for It might be a good time to review your contracts
financial years commencing on or after with customers to ensure that the timing of
1 January 2013. recognition and measurement of revenue will
The amendments will impact on the income not be adversely affected by the proposed new
statement and financial position as a result of revenue recognition standard. The impact of the
changes to the way in which interest on the proposed changes to revenue recognition will vary
scheme deficit or surplus is calculated and from business to business. The proposed new
depending on how you currently recognise IFRS, Revenue from Contracts with Customers
actuarial gains and losses. is expected to take effect for financial years
At present the finance cost in profit or commencing on or after 1 January 2015.
loss typically includes the interest cost which
represents the increase in the present value of the
defined benefit obligation due to the time value
Does your sales model require you
of money and the expected return on plan assets. to provide a range of services over
Under the amended standard, the discount rate a period of time?
currently used to determine the interest cost on the
defined benefit obligation will be used to calculate The proposed revenue recognition standard will
the net interest on the defined benefit liability (or require identification of separate performance
asset). In effect, the expected return on plan assets obligations within a contract, determination of the
will be based on the market yields on high-quality transaction price which includes the consideration
corporate bonds rather than the higher rate the of factors such as variable consideration, the
market would expect to be achieved on the plan time value of money and collectability, and the
assets themselves. Reported profit is likely to allocation of the transaction price to distinct
reduce as a result of using a different method for performance obligations. These changes could
measuring the net interest charge/credit. affect the timing and amount of revenue
There is also less flexibility in how components recognised, particularly in situations where
of the defined benefit expense are categorised in contracts are complex and involve the performance
the income statement. of obligations over a period of time.


Do you prepare group accounts? Do you have any investments which
There are many changes that will affect companies are not treated as subsidiaries
which prepare group accounts as three new under IAS 27 but which could be
accounting standards take effect for financial
under IFRS 10?
years commencing on or after 1 January 2013,
subject to adoption by the European Union (EU). The criteria for determining control under IFRS
Changes in the definition of control under IFRS 10 are different to those under IAS 27. This could
10 Consolidated Financial Statements and the mean that in certain cases a different conclusion
classification of joint arrangements under IFRS would be reached as to whether an investment is
11 Joint Arrangements may have an impact on accounted for as a subsidiary.
accounting, presentation and disclosures. IFRS For example, if your company holds a
12 Disclosure of Interests in Other Entities will significant minority shareholding in an investment,
require enhanced disclosures, in particular in but other shareholdings are widely dispersed,
judgemental situations. You need to be thinking this could result in control under IFRS 10. If
about their impact now as although the new your company holds potential voting rights in
standards apply to financial years commencing on an investment which are substantive, either alone
or after 1 January 2013, changes are retrospective or in combination with other rights, this could
and so the restatement of balances at 1 January indicate that power exists over the investee which
2012 may be required. in turn would contribute to the determination
of control. Under IAS 27 there is a different
assessment of whether potential voting rights
Do you have investments in
contribute to control. Under IAS 27 the existence
subsidiaries? and effect of potential voting rights that are
If your company has subsidiaries and prepares currently exercisable or convertible are considered
consolidated accounts, IFRS 10 will be relevant when assessing control. Under IFRS 10, potential
to you. IFRS 10 provides a framework to assess voting rights are not required to be currently
when one entity controls another. In most cases exercisable but would need to be exercisable when
the decision as to whether an investment is a decisions regarding the activities of the investee
subsidiary is straightforward but borderline that significantly affect the investee’s returns
consolidation decisions taken under IAS 27 (‘relevant activities’) need to be made.
Consolidated and Separate Financial Statements or
SIC-12 Consolidation – Special Purpose Entities Do you have any joint
will need to be reassessed and this may lead to
arrangements?
changes in accounting. Investments previously
accounted for as a subsidiary may fail to meet If you have joint arrangements, IFRS 11 will
the control definition under IFRS 10 and vice apply. IFRS 11 replaces the three categories of
versa. The definition of control under IFRS 10 joint arrangement under IAS 31 Interests in Joint
consists of three elements and requires all three to Ventures (‘jointly controlled entities’, ‘jointly
be present for control to exist – power over the controlled operations’ and ‘jointly controlled
investee, exposure, or rights, to variable returns assets’) with two new categories: ‘joint operations’
from involvement with the investee and the ability and ‘joint ventures’.
to use power over the investee to affect the amount Joint arrangements classified under IAS 31 as
of investor’s returns. In some cases, the analysis jointly controlled entities will generally fall into
behind each element will require judgement, in the category of joint venture under IFRS 11 in
particular with regard to the determination of which case the accounting will be unchanged,
whether the company has exposure to variable unless proportionate consolidation was previously
returns, which has the potential to be interpreted applied (see below).
widely. However there are situations where jointly
controlled entities under IAS 31 will be classified
as a joint operation under IFRS 11. If a jointly


controlled entity was previously accounted for Are there significant non-controlling
under the equity method under IAS 31 but the
interests in your subsidiaries?
investment is classified as a joint operation under
IFRS 11, the accounting will be significantly Where a non-controlling interest in a subsidiary
different. Under equity accounting, an investment is material to the reporting entity, there is a new
is presented as one line within the balance sheet requirement in IFRS 12 to provide summarised
and income statement reflecting the investor’s financial information about the assets, liabilities,
share of the investee’s net assets and profit or loss profit or loss and cash flows of that subsidiary.
for the year. An investment in a joint operation
under IFRS 11 will be incorporated into the
balance sheet and income statement on a line-by- Does your balance sheet contain
line basis, reflecting the joint operator’s share of substantial financial assets?
assets, liabilities, income and expenses of the joint
arrangement. The IASB is gradually replacing IAS 39 Financial
Instruments: Recognition and Measurement for
financial instruments measurement with IFRS 9
Do you proportionately consolidate Financial Instruments. However, IFRS 9 is being
your jointly controlled entities? completed in stages. The effective date of IFRS 9
If you proportionately consolidate jointly is for periods commencing on or after 1 January
controlled entities under IAS 31, this will no 2015, subject to EU adoption. However, EU
longer be permitted. Joint ventures will be equity adoption of IFRS 9 has not yet taken place. In
accounted under IFRS 11. The effect of this on most cases, financial liability accounting in IFRS 9
the balance sheet will be to collapse the various is the same as IAS 39. The classification of financial
assets and liabilities currently included in the assets in IFRS 9 is different compared to IAS 39.
balance sheet into a single line item as described IAS 39 had four main classes, whereas IFRS 9
above. Similarly, the investor’s share of income and has only two main classes of financial assets, one
expenses will be reflected as a single line item in being at fair value, and the other at amortised cost.
the income statement, representing the investor’s Derivative assets will generally remain at fair value.
share of the joint venture’s profit or loss for Amortised cost will apply where both (i) the asset
the year. is held within a business model whose objective is
to hold assets in order to collect contractual cash
flows and (ii) the contractual terms of the financial
Do your investee relationships asset give rise to cash flows which are solely
expose you to any significant risks? payments of principal and interest.
The above changes will generally mean that
IFRS 12 integrates and makes consistent the
for non-financial services businesses, derivative
disclosure requirements for subsidiaries, joint
assets will be at fair value through profit or loss,
arrangements, associates and unconsolidated
while most other financial assets such as trade
structured entities. IFRS 12 specifies minimum
receivables will be at amortised cost, hence little
disclosures that an entity must provide. Some of
change compared to IAS 39. However, if the
this information will be new and its preparation
business involves lending, then the business model
will require careful planning. This includes
and contractual terms of the financial assets will
disclosure of the nature of, and changes in, the
require very careful consideration. The changes to
risks associated with any of these types
IFRS 9 are therefore of key interest to banks and
of investment.
other financial institutions.


Do you already apply or have profit and loss, and so there will be complexity in
arriving at the accounting entries.
you considered applying hedge
As in IAS 39, the plans for IFRS 9 will
accounting? only allow hedge accounting where formal
Many entities take out derivatives such as interest documentation has been prepared in advance.
rate swaps for hedging purposes. Those derivatives
can cause profit volatility. Hedge accounting exists Does the company have significant
in IAS 39 in order to mitigate that profit volatility,
items accounted for at fair value?
but is subject to strict rules. Those rules have
sometimes acted as a reason for entities not to The IASB have issued IFRS 13 Fair Value
apply hedge accounting. Measurement effective for periods commencing
As part of the IFRS 9 project, the IASB plans on or after 1 January 2013. IFRS 13 does not alter
to amend the hedge accounting model, although which items are carried at fair value but seeks to
these proposals are not yet finalised at the time provide principles and guidance for measuring
of writing. These proposals could provide more fair value. This is therefore relevant to any entities
opportunity than under IAS 39 for entities which have items carried at fair value such as some
to apply hedge accounting. In particular, the financial instruments and investment property. It
IASB plans to remove the ‘highly effective’ test is also relevant where fair value is determined at
which only allows hedge accounting in IAS 39 particular times such as in fair value calculations
to continue on a hedging relationship if that for the purpose of impairment reviews and relating
hedge has been highly effective. Instead, hedge to business combinations.
accounting could continue even if effectiveness IFRS 13 may in some cases alter how fair
reduces, but with a rebalancing of the hedging value has been determined compared to the past.
relationship leading to a greater potential for Fair value is based on ‘exit’ value and a market-
volatility in reported profit or loss and increased based view. In many cases, application of IFRS 13
complexity in the accounting. We anticipate that will not lead to any changes. However there are
whilst the plans for IFRS 9 would make hedge numerous points of detail where IFRS 13 could
accounting more accessible and more attractive, lead to a change from past practice. Entities that
there will still be complexity. In particular, actual have significant items measured at fair value should
ineffectiveness will be required to be taken to therefore consider whether IFRS 13 has any impact.

Do companies within your group and measurement of financial instruments (see
UK GAAP Section 1), accounting for lease incentives, the
prepare their accounts under UK
recognition of valuation movements in investment
GAAP? property through profit or loss, accounting for
The Accounting Standards Board (ASB) is and presentation of defined benefit schemes and
proposing changes to UK GAAP. Revised the calculation of deferred tax.
proposals were issued in January 2012 with an An alternative to the proposed FRS 102 is
effective date expected to be for accounting the proposed FRS 101 Reduced Disclosure
periods beginning on or after 1 January 2015. If Framework. This is an option of IFRS recognition
your company is intending to prepare its accounts and measurement with reduced disclosures
under (Draft) FRS 102 The Financial Reporting for qualifying parent company and subsidiary
Standard applicable in the UK and the Republic individual accounts.
of Ireland (see Section 6 for accounting choices) You will need to be aware of how the changes
there are some significant differences between the could affect your business. You will also need to
proposed FRS 102 and current UK GAAP that communicate changes to key users of the
need to be considered. Key areas of difference financial statements.
include the useful life of goodwill, the recognition


Is your company required to prepare matters (where necessary), key information on
IFRS a business review?
corporate governance and remuneration. This is
where companies will ‘tell their story’ and should
The content and structure of the front end of provide enough information for users to make an
the annual report and accounts will be changing. assessment of the company’s historic performance
UK GAAP The Government proposes to replace the current and future prospects.
requirements under the Companies Act 2006 The Annual Directors’ Statement will consist
(CA2006) for a Business Review and Directors’ of detailed disclosures that are required regardless
Report with a Strategic Report and an Annual of materiality or impact on the business as a
Directors’ Statement. If your company is required whole, as well as information provided voluntarily.
to prepare a business review, now might be a good The Statement will have a prescribed structure
time to review the front end of your annual report. with a set layout and standard headings. For
If your company is a quoted company, as defined quoted companies, it will include the Directors’
in CA2006, the changes will be greater. Remuneration Report, Corporate Governance
The purpose of the Strategic Report will be Statement and the Audit Committee Report.
to provide key strategic information about the
company including key risks and forward looking
Do you issue summary financial
analysis. It will incorporate the content from
the business review that is required currently by statements or is this something that
CA2006. It will be prepared for shareholders and you might consider?
describe the company’s performance, principal
Companies are currently able to ask shareholders
risks and uncertainties, key performance indicators
if they would like to receive Summary Financial
and key financial information.
Statements in place of the annual report.
For quoted companies, the Strategic Report will
Under the Government proposals for narrative
also include information on strategy, the business
reporting, Summary Financial Statements will be
model, social, environmental and human rights
incorporated into the Strategic Report.

• Consider the impact of changes in standards on existing balances and
transactions
• Review sales contracts for the impact of the new IFRS on recognition
of revenue
• Consider the potential classification of your investments under the new

IFRS consolidation standards, eg as subsidiaries or joint ventures
• Consider whether your accounting systems will be able to capture the
information required to be disclosed by IFRS 12
• Consider how your accounts might look under the proposed future
UK GAAP
• Review and update your business review


4
Are you seeking new

?
opportunities
through organic growth
or through acquisition

The challenging business environment is driving businesses to
refresh their business models and to seek new opportunities.
Rather than viewing the current economic climate as a barrier to
growth, many companies see it as an opportunity to refresh their
business model and pursue new business ventures. This may be
through organic growth, entering into new arrangements, joining
forces with third parties or through business acquisitions.


Organic growth

Is your company considering Are you considering trading in new
IFRS diversifying its range of products or geographical locations?
services? If you are looking to trade in new geographical
If you are intending to pursue new revenue locations, do you understand the environment
UK GAAP in which you plan to operate? There may be
streams, you will need to be aware of the
proposed new IFRS Revenue from Contracts economic barriers such as those linked to currency
with Customers. The proposed revenue and local trading practices. For example trade
recognition standard will require identification with countries with a volatile currency will
of separate performance obligations within a impact directly on your results unless you have
contract, determination of the transaction price a clear plan to minimise the impact. Entering
which includes the consideration of factors into forward currency contracts and possibly
such as variable consideration, the time value the adoption of hedge accounting under IAS
of money and collectability, and the allocation 39 Financial Instruments: Recognition and
of the transaction price to distinct performance Measurement (and FRS 26, where adopted under
obligations. These changes could affect the timing UK GAAP) may therefore be a consideration.
and amount of revenue recognised, particularly Local austerity measures may impact on your
in situations where contracts are complex. You ability to trade freely with that market. There may
therefore need to ensure that new sources of also be restrictions on the movement of resources
revenue will be accounted for as anticipated. out of a particular location such as assets and
Even where you prepare your accounts under profits. There may be unforeseen tax consequences
UK GAAP, the way in which new sources of or complex tax systems to negotiate. There may
revenue are measured and recognised will need to also be cultural differences to consider.
be assessed in conjunction with UK Accounting
Standards, principally FRS 5 Reporting the Have you considered hedging
Substance of Transactions, Application Note any potential exposure to foreign
G and the proposed FRS 102 The Financial
Reporting Standard applicable in the UK and the
exchange volatility?
Republic of Ireland. In order to minimise exposure to foreign
exchange volatility, IAS 39 (and FRS 26, where
Is your company considering adopted under UK GAAP) permits the option
of hedge accounting. An example of where hedge
revising the terms on which it trades accounting might be useful is in connection
with customers? with a foreign currency forward contract which
The current economic environment has forced may be used to hedge the foreign exchange risks
companies to be creative in terms of how they relating to future sales or purchases. IAS 39
seek to retain the trade of existing customers and requires such derivative contracts to be included
pursue new opportunities. For example, changes in the balance sheet at fair value. In the absence
in settlement terms with customers who might of hedge accounting, changes in fair value would
otherwise be unable to settle their debts could be recognised immediately in profit or loss. Cash
have implications under both the existing and flow hedge accounting allows gains or losses
proposed revenue standards. Some changes in on the forward contract to be included in other
terms could even be akin to financing transactions comprehensive income until the time of the
which could alter the way in which the financial related sales or purchase transactions. IAS 39
instruments standards apply. There may also be contains detailed rules in determining when hedge
net present value implications, depending on the accounting is available in which case the adoption
timescales agreed with customers for payment. of hedge accounting will require careful and
timely consideration.


Is your business able to benefit from IFRIC 12 will apply where contracts for servicing
IFRS the outsourcing of public services to
the infrastructure of public services such as roads,
bridges, tunnels, prisons and hospitals are entered
the private sector? into between private sector providers and
As part of the Government’s drive to increase government authorities.
efficiency and reduce costs in the public sector,
opportunities exist for private companies to Are you considering capital
enter into contracts with local authorities to
investment?
provide services. If relevant, are you aware of
any opportunities which might be available to In order to meet your plans for organic growth,
your business? Where there are opportunities to you may be considering investment in property,
take advantage of government contracts, you will plant and equipment. This may therefore involve
need to consider factors such as the way in which decisions as to how you finance the investment.
contract revenue is recognised and whether or not As we have already discussed in Section 1, the
assets and liabilities used in or generated by the proposed new IFRS on leasing could influence
arrangement should sit on or off balance sheet. your decision as to whether to lease new assets
Furthermore, in some situations IFRIC 12 Service or to choose another method of financing your
Concession Arrangements may also be relevant. capital additions.

Other methods of growth

Are you contemplating entering into You may be planning on acquiring subsidiary
IFRS strategic business arrangements
companies but changes in the definition of control
under IFRS 10 Consolidated Financial Statements
with third parties? may affect whether or not your investment is
If your plans for growth include entering into accounted for as a subsidiary undertaking. In
new arrangements with third parties you need to most cases it will still be evident that control exists
consider if and how these arrangements fit in to but in other situations it may not be so clear. For
the new consolidation standards and how they example, new specific guidance on arrangements
will need to be accounted for. These have been involving special purpose vehicles, large minority
discussed in Section 3. shareholdings, potential voting rights which are
not currently exercisable and principal and
agent arrangements may lead to unexpected
Does your business strategy involve
accounting consequences.
the acquisition of other businesses? The way in which acquisitions are structured
If your plans for growth include the acquisition can have an impact on the accounting. You
of other businesses you need to ensure that will therefore need to ensure that acquisition
you understand the implications of the new agreements carefully reflect the intended nature
consolidation standards and that the accounting of the arrangement such that the appropriate
treatment is as expected. accounting treatment is clear.


Do your plans for growth include a accounts, the group accounts must be prepared
IFRS listing on a public exchange?
under IFRS. This could lead to significant
differences in the recognition, measurement and
If your plans for growth include a listing on a disclosures of amounts included in the financial
public exchange, for example as a means of raising statements. You may therefore need to obtain
UK GAAP finance to facilitate growth and expansion, there advice on where the biggest accounting differences
will be a range of issues to consider such as specific are likely to arise in your specific circumstances.
legal requirements, the regulatory requirements However, even where a future listing is
of the relevant exchange and any accounting a medium to long term plan, you may be
consequences such as the requirement to prepare considering voluntary adoption of IFRS to
group accounts under IFRS. This is likely to be improve your prospects for external investment.
relevant where your current business consists of Conversion to IFRS can be a time-consuming
a group of companies which prepare consolidated exercise and will therefore require careful
accounts under UK GAAP. For example, where planning. Given the anticipated changes to UK
a parent is listed on AIM or has a listing on the GAAP now may be a good time to consider this.
London Stock Exchange and prepares group Accounting choices are discussed in Section 6.

• Understand the markets in which you intend to operate
• Consider the impact of the proposed new revenue standard on new or
revised revenue streams
• Ensure that you understand the impact of the new IFRS consolidation
standards on new business arrangements and investments
• Understand the accounting consequences of a transition to IFRS


5
Is your business
structured

?
so as to optimise
management and
shareholder objectives

The structure of a business can impact on the potential for
management and owners to realise strategic business objectives.
Now may be a good time to review the existing group structure
with a view to simplification or demerging distinct strands of the

business. However in all cases you will need to consider whether
there are any tax implications.


Is your group structure of the business has been overstated. Steps that
IFRS unnecessarily complex?
can be taken now to prepare for a future exit
could include:
Historically groups may have been set up with • a review of the current accounting policies
a large number of companies. Whilst there to ensure that they are the most appropriate
UK GAAP may have been legitimate business reasons for and reflect current best practice: A potential
creating a particular group structure, changes in purchaser may challenge policies adopted,
circumstances may mean that companies within a especially where they indicate that profits may
group are no longer required. For example certain be overstated
companies within a group may have little trade, • consideration of the value of off balance sheet
or may be dormant. These companies, however, assets: Arrangements or assets may exist
will still require a certain amount of management which have value to the business, but due to
time and involve some administrative tasks, which accounting requirements are not recognised
may lead to unnecessary costs. It may therefore in the accounts. For example there may be
be a good time to streamline the structure of intangible assets or business contracts in place.
your group, for example through the transfer It may therefore be worth considering which
of trade and assets, the paying up of dividends unrecognised arrangements and transactions
from subsidiaries to parent and the winding up of exist and how they could be valued if necessary
companies no longer required. However it is likely • improving the balance sheet position: Now
that there will be legal and regulatory implications could be a good time to review the balance
to consider, as well as a need to determine the sheet and key financial ratios. For example, are
necessary accounting entries to reflect credit control procedures as tight as they could
the transactions. be? Are all debtor balances collectible? Are
stock provisions adequate? Is there sufficient
Could your business benefit from a liquidity? Does the fixed asset register reflect
assets actually used within the business?
demerger?
• simplifying the corporate structure: A
In contrast to the situation described above, there complicated group structure can obscure the
may be advantages to splitting out an existing underlying business potential. As discussed
business into component operations. This could be above, streamlining the group structure could
useful where there is an intention to sell off part of make concentration of business activity and
the business or to isolate less profitable parts of the value more transparent. This could involve the
business which may be having an adverse impact consolidation of parts of the business or
on the more profitable parts. For example, access a demerger.
to funding may be hindered where unprofitable
parts of the business are masking those parts of the Is the business highly geared?
business which are profitable.
A highly geared business can be unattractive to
potential investors, purchasers, creditors and
Do the owners of the business intend
lenders for example. If your debt to equity ratio
to exit from the business at some is high, then it may be time to consider ways to
point in the future? redress the balance. For example there may be
scope to convert debt to equity (See Section 1
If the owners intend to exit from the business at
where debt-for-equity swaps are discussed further)
some point in the future then time needs to be
or to issue new shares using the funds obtained to
spent now in planning for that exit and maximising
partially or fully pay off any outstanding debt.
the value obtained for the business. It is important
Financial instruments which are legally shares
to remember that a potential purchaser will be
can sometimes be required under accounting
looking to minimise the amount that he or she
standards to be presented as debt due to the terms
is required to pay for the business so will be
of the instruments. This can adversely affect the
challenging areas that could suggest that the worth
gearing ratio. It may therefore be possible to alter


the terms of the instruments such that they meet there are still specific legal steps which need to
the definition of equity, although care would need be followed, including the requirement for the
to be taken to ensure that the relevant accounting directors to issue a solvency statement. Where a
requirements were met. Additionally care should company is a public company, a capital reduction
be taken when issuing new classes of shares to is still possible although the rules are tighter and
ensure that the terms on which they are issued do include the requirement to obtain Court approval.
not lead to an unintended classification as debt, Where there are significant distributable
rather than equity. reserves, a special dividend could be paid. A
special dividend is generally a ‘one-off’ dividend
Is there surplus equity in the payment, separate to any normal recurring interim
or annual dividends.
business?
On the other hand, surplus equity may exist Are you considering bringing in new
in the business. A capital reduction could be
used to remove dividend blocks within a group.
investors?
For example, negative reserves in a subsidiary If there are plans to broaden the investor base in
company could be preventing a profitable your business, have you considered how this will
subsidiary lower down in the group from paying be achieved? For example, in order to differentiate
dividends. A capital reduction could therefore the rights of the existing shareholders and new
create realised profits, which in turn absorb the investors it may be necessary to issue new shares
negative reserves in the subsidiary company thus with different terms. As noted in Section 1, the
removing the dividend block. However statutory way in which the terms of shares issued are
requirements apply to a capital reduction and contractually constructed, for example in the
will vary depending on whether the company articles of association or shareholders agreements,
is a private company or a public company. The can impact on the way in which they are
Companies Act 2006 simplified the capital accounted for, in which case care will be needed to
reduction process for private companies, although ensure that there are no unintended consequences.

• Ensure that the strategic objectives for the business and its owners
are clear
• Establish a clear plan to achieve the strategic objectives
• Consider whether a corporate restructuring might be beneficial
• Consider ways to improve the financial position of the business


6
Are you geared up to
make the right choices
given the proposed

?
changes to legislation
and the accounting
regime in the UK
The Department for Business, Innovation and Skills (BIS) is
proposing to widen the scope of the statutory audit exemption
and big changes to UK GAAP are also expected. These proposed
changes to legislation and the accounting regime in the UK will
therefore require management to balance stakeholders’ needs
with preparers’ costs. In many cases, management will have a
choice whether or not they take up these changes. You therefore
need to be able to make an informed decision and understand the
consequences of the choices made.


GT - Financial reporting. Unravelling the future before the future unravels your business

GT - Financial reporting. Unravelling the future before the future unravels your business

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