1. Corporate Financial Reporting I
Lecture 2
The UK Regulatory Framework

2. Aims and Outcomes Aims:
This lecture aims to outline the regulatory framework for financial reporting that has developed in the UK.
Learning outcomes
After the lecture and recommended reading students should be able to:
Discuss generally various ways that financial reporting may be regulated
Outline the development of statutory regulation in the UK, give an overview of the current Companies Act ands outline possible future developments
Explain the nature of the true and fair override in company law and state the accounting principles given therein
Discuss the development of accounting standard setting in the UK
Discuss the relationship between law and accounting standards in the UK

3. Remember from last weeks lecture and your reading:
Financial reporting is part of the accountability element of the UK system of corporate governance
There are arguments that certain features of this system indicate the need for its regulation (there are also arguments against this)

4. How might we regulate financial reporting?
Puxty et al (1987) – theoretical framework
Three “ideal” ways company reporting can be regulated
Market
Each company chooses own rules pressured by capital markets
State
Decrees the rules and provides enforcement mechanism
Community
Spontaneous solidarity
Within this exists a continuum
Liberalism – Associationism – Corporatism – Legalism
Associationism – regulation through organisations formed to represent its members
UK = associationist

5. Further dimensions to the model
Also consider there may be two further aspects to the analysis:
The creation and approval of rules
Their enforcement
The most important types of regulation with respect to the UK are the law and accounting standards (and the stock exchange for listed companies).
Regulation covers:
Disclosure
Valuation/measurement
Presentation
Audit and Publication

6. Company Law – The development
Joint Stock Companies Act : Incorporation by Registration, audited balance sheet required
J.S.C.A.: Creation of Limited Liability
J.S.C.A.: Consolidation of 1844 and 1855 Acts, model accounting procedures made optional
Companies Act: Compulsory audit of balance sheet required
Companies Act: Profit statement required (unaudited), disclosure of balance sheet items required
Companies Act: Balance sheet and profit and loss to be true and fair, minimum disclosure levels introduced, audit requirements established, group (consolidated) accounts required
Companies Act: EC Second Directive – public/private company definitions
Companies Act: EC Fourth Directive – formats, true and fair override, principles, measurement and valuation rules, extended disclosure, modified accounts for small and medium businesses
Companies Act: Consolidating Statute
Companies Act: EC Seventh and Eighth Directives – role of accounting standards, rules for consolidated accounts, regulation of auditors

7. The growth of legalism
The early years of statutory regulation reflected more a ‘market’ approach to regulation
Even as late as 1980 company law was limited to ensuring minimum disclosures levels of accounting information
The result of this limited legislation was to allow a high degree of flexibility to UK financial reporting
The significant change since the 1980s represents implementation of EU harmonisation requirements with respect to financial reporting
This introduced more detailed rules into UK law and significantly reduced the flexibility that had been characteristic of UK regulation.

8. The current framework
The current framework for financial reporting involves an overriding true and fair requirement, the adoption of a number of accounting principles and the following of a number of detailed accounting rules
True and fair override (s. 226)
Directors are required to prepare a profit and loss account and balance sheet in respect of each financial year that give a true and fair view and complies with Schedule 4
Where compliance with the Act does not give a true and fair view Directors may provide further information or may depart from the Act
Accounting principles (Schedule 4)
Going concern
Consistency
Prudence (including realisation and the recognition of post-balance sheet events)
Accruals (matching)
Separability

9. The scope of company law accounting provisions
Keeping of accounting records
Publication
Formats (Schedule 4)
A true and fair view (s. 226)
Accounting principles (Schedule 4)
Accounting rules (Schedule 4)
Disclosure requirements (Schedule 4)
Distributions (s. 263 and s. 264)
Consolidated accounts
Small and medium sized companies
Audit (s A)
Role of accounting standards (s. 256 and Schedule 4)

10. Accounting Standard setting in the UK – a brief history
1942: ‘Recommendations’ of the ICAEW
1960s: Scandals/catastrophes e.g. GEC/AEI and Pergamon/Leasco
1970: Accounting Standards Steering Committee established by ICAEW (renamed ASC in 1976) as a Committee of the Consultative Committee of the Accounting Bodies (CCAB). Issued Statements of Standard Accounting Practice (SSAPs)
Given the legislative context at the time the UK regulatory framework could be described as ‘associationist’

11. Problems of authority, independence and coherence
1988: Dearing Report
1989: Solomons Report
1990: Accounting Standards Board (ASB), which issues Financial Reporting Standards (FRSs)
Financial Reporting Review Panel (FRRP) and
Urgent Issues Task Force (UITF)
Established under the remit of the Financial Reporting Council (FRC)
“Foreword” to Accounting Standards (1993): discusses authority, scope, compliance and the true and fair view with respect to the ASB

12. The relationship between the law and accounting standards - Authority/enforcement
True and fair requirements and its override
The auditor’s report shall state whether the accounts have been prepared in accordance with the Act and, in particular, whether a true and fair view has been given in accordance with the relevant financial reporting framework (s. 235)
Accounts must also state whether they have been prepared in accordance with applicable accounting standards with particulars of any material departures (Schedule 4, s. 36A)
Accounting standards are recognised as those statements issued by bodies prescribed by regulation.
There is provision for the establishment of such a body as well as provision for the revision of ‘defective accounts’ (s. 245 and s. 256)

13. The relationship between the law and accounting standards - Authority/enforcement
The law does not give statutory backing to accounting standards
However, the ASB is a recognised body for the issuance of accounting standards that are to be complied with under the provisions of the Companies Act. FRSs issued and SSAPs adopted by the ASB are ‘accounting standards’ for the purposes of the Act
The councils of the CCAB bodies expect their members, whether in their role as Directors or auditors, to observe accounting standards
Compliance with accounting standards will normally be necessary to give a true and fair view (see Arden, 1993)
Only in exceptional circumstances will departure from standards be necessary to give a true and fair view
FRRP is authorised (via the law) to investigate departures from the Companies Act, including the requirement to give a true and fair view

14. Opinion of Mary Arden QC
In a legal opinion sought by the UK Accounting Standards Board (ASB), Hoffman and Arden (1983), while concluding ‘true and fair view’ is a legal concept, stated
That the courts will treat compliance with accepted accounting principles as prima facie evidence that accounts are true and fair, and equally the converse would apply
The Companies Act 1989 gave statutory recognition of accounting standards
Arden (1993) wrote that an accounting standard upheld by the law becomes an authoritative source of law itself
Yet case law would suggest that compliance with the rules is in itself insufficient to comprise a ‘true and fair view’ or ‘fair presentation’

15. Forward to the Accounting Standards (paras 18 & 19)
The requirement to give a true and fair view may in special circumstances require a departure from accounting standards. However, because accounting standards are formulated with the objective of ensuring that the information resulting from their application faithfully represents the underlying commercial activity, the Board envisages that only in exceptional circumstances will departure from the requirements of an accounting standard be necessary in order for financial statements to give a true and fair view.
If in exceptional circumstances compliance with the requirements of an accounting standard is inconsistent with the requirement to give a true and fair view, the requirements of the accounting standard should be departed from to the extent necessary to give a true and fair view.

16. Aim & Coverage
Both the law and standards aim for the profit and loss account and balance sheet to give a true and fair view
FRSs are developed within the context of current legislation with the aim of ensuring consistency between accounting standards and the law
Both the law and standards cover measurement rules, disclosure and format items
Accounting standards
Amplify the law (e.g. SSAP 13 Research and Development)
Add to the requirements of the law (e.g. FRS 1 Cash flow statements)
Overlap certain areas of the law

17. Overlap
The law and standards overlap on a number of topics in the area of accounting measurement. There is no problem with respect to formats and disclosure. The following types of overlap occur:
Restrictions of the law by accounting standards, e.g. the use of LIFO (SSAP 9)
Restrictions of accounting standards by the law, e.g. accounting for government grants (SSAP 4)
The use of clever definitions in accounting standards to effectively remove legal options, e.g. extraordinary items (FRS 3)
The use of the true and fair override in accounting standards to contradict the law, e.g. accounting for investment property (SSAP 19)

18. When rules conflict…
The use of the true and fair override in practice:
In the UK 39% of FTSE 100 companies invoke the override
Most often it is the Companies Act that is overridden where it conflicts with accounting standards
The most common overrides are:
Investment properties
Omission of goodwill amortisation
Consolidation
Government Grants

19. From 2005
Legal requirements will impose accounting standards in certain circumstances
From 2005 onwards, the consolidated statements of listed companies must by law comply with International financial reporting standards (IFRS)
The legal mechanism is a Regulation of the EU
In the UK other financial statements may also adopt IFRS rather than UK rules
Where IFRS are adopted there is no requirement to follow any of the accounting requirements of the Companies Acts or ASB standards.
Under the Puxty model the regulatory system for financial reporting is becoming increasingly ‘corporatist’