Technical update

IASB

The IASB has filled a gap in international accounting guidance by issuing International Financial Reporting Standard 2, Share-based Payment (IFRS 2) on accounting for share-based payment transactions, including grants of share options to employees.

Before the issue of IFRS 2, there was no international accounting standard covering the recognition or measurement of share-based payment. As a result, transactions in which share options are granted to employees have not typically been recognised in an entity�s financial statements, causing the entity�s expenses to be understated and its profits overstated.

The IFRS requires an entity to recognise share-based payment transactions in its financial statements, including transactions with employees or other parties to be settled in cash, other assets, or equity instruments of the entity. There are no exceptions to the IFRS other than for transactions to which other standards apply.

In principle, transactions in which goods or services are received as consideration for equity instruments of the entity should be measured at the fair value of the goods or services received, unless that fair value cannot be estimated reliably. If the entity cannot estimate reliably the fair value of the goods or services received, the entity is required to measure the transaction by reference to the fair value of the equity instruments granted.

For transactions with employees and others providing similar services, the entity is required to measure the fair value of the equity instruments granted, because it is typically not possible to estimate reliably the fair value of employee services received. The fair value of the equity instruments granted is measured at grant date.

For transactions with other parties (i.e. other than employees and those providing similar services), there is a rebuttable presumption that the fair value of the goods or services received can be estimated reliably. That fair value is measured at the date the entity obtains the goods or the counterparty renders service. In rare cases, if the presumption is rebutted, the transaction is measured by reference to the fair value of the equity instruments granted, measured at the date the entity obtains the goods or the counterparty renders service.

For goods or services measured by reference to the fair value of the equity instruments granted, the IFRS specifies that, in general, vesting conditions are not taken into account when estimating the fair value of the shares or options at the relevant measurement date. Instead, vesting conditions are taken into account by adjusting the number of equity instruments included in the measurement of the transaction amount so that, ultimately, the amount recognised for goods or services received as consideration for the equity instruments granted is based on the number of equity instruments that eventually vest.

The IFRS requires the fair value of equity instruments granted to be based on market prices, if available, and to take into account the terms and conditions upon which those equity instruments were granted. In the absence of market prices, fair value is estimated, using a valuation technique to estimate what the price of those equity instruments would have been on the measurement date in an arm�s length transaction between knowledgeable, willing parties.

The IFRS also sets out requirements if the terms and conditions of an option or share grant are modified, or if a grant is cancelled, repurchased or replaced with another grant of equity instruments.

For cash-settled share-based payment transactions, the IFRS requires an entity to measure the goods or services acquired and the liability incurred at the fair value of the liability. Until the liability is settled, the entity is required to remeasure the fair value of the liability at each reporting date and at the date of settlement, with any changes in value recognised in profit or loss for the period.

The IFRS also sets out requirements for share-based payment transactions in which the terms of the arrangement provide either the entity or the supplier of goods or services with a choice of whether the entity settles the transaction in cash or by issuing equity instruments.

The IFRS prescribes various disclosure requirements to enable users of financial statements to understand:

• the nature and extent of share-based payment arrangements that existed during the period
• how the fair value of the goods or services received, or the fair value of the equity instruments granted, was determined, and
• the effect of share-based payment transactions on the entity�s profit or loss for the period and on its financial position.

Copies of IFRS 2, Share-based Payment, are available at £15 each (24 euros/US$23) including postage from IASB Publications Department, 30 Cannon Street, London EC4M 6XH, UK. E-mail: publications@iasb.org.

Paul A Volcker, chairman of the IASC Foundation Trustees, has invited senior officials from European banking, securities and insurance regulators and from the accounting, banking, and insurance industries to form a high level European consultative group to advise the IASB. The group will focus specifically on certain basic issues related to the application of accounting standards to financial institutions.

The concept of such a group grew out of discussions with the European Commission, which is invited to participate in the consultative group�s discussions as an observer. Improvements to the international standards on financial instruments (IASs 32 and 39) were due to be finalised by the end of March. However, the Trustees felt more debate was required on issues related to fair value accounting and its use. In particular, the IASB will in future need to address the application of fair value accounting for regulated financial institutions in the banking and insurance industries. The question of fair value accounting raises related accounting issues, such as the approach towards provisions and core deposits. The consultative group will therefore focus its attention on these issues.

IFAC

IFAC�s International Auditing and Assurance Standards Board (IAASB) has released a revised International Standard on Auditing (ISA) requiring auditors to be more proactive in considering the risk of fraud in an audit of financial statements.

The new ISA, The Auditor�s Responsibility to Consider Fraud in the Audit of Financial Statements, builds on the new audit risk standards issued in 2003 and requires the auditor to focus on areas where there is a risk of material misstatement due to fraud, including management fraud. The revised standard emphasises the need for the auditor to maintain an attitude of professional scepticism throughout the audit, notwithstanding the auditor�s past experience about the honesty and integrity of management and those charged with governance.

The standard, effective for audits of financial statements for financial periods beginning on or after 15 December 2004, requires the engagement team to discuss how the financial statements may be susceptible to material misstatement due to fraud and what audit procedures would be more effective for their detection. The standard also requires the auditor to design and perform audit procedures to respond to the identified risks of material misstatement due to fraud, including procedures to address the risk of management override of controls.

The IAASB has also issued new quality control guidance for audit and assurance engagements. International Standard on Quality Control 1 establishes a firm�s responsibilities to set up and maintain a system of quality control for all audits and assurance engagements. In addition to setting out guidance on client acceptance and retention criteria that firms should consider, the standard requires that an engagement quality control review must be performed for audits of listed entities and such other engagements as a firm determines.

The review, which must be completed before the audit report can be released, includes consideration of:

• significant risks identified during the engagement and the responses to those risks
• the significance and disposition of corrected and uncorrected misstatements identified during the audit, and
• whether appropriate consultation has taken place on difficult or contentious matters and the conclusions arising from those consultations.

A second new quality control standard, ISA 220, Quality Control for Audits of Historical Financial Information, establishes standards for the specific responsibilities of firm personnel for an individual audit engagement and is premised on the requirements of the firm-wide quality control standards set out in ISQC1.

Both of these standards are effective from 15 June 2005.

A new study has identified the four key determinants of corporate success and failure as being: the culture and tone at the top; the chief executive; the board of directors; and the internal control system. The findings are contained in Enterprise Governance: Getting the Balance Right, a study released by IFAC and CIMA.

The study includes an in-depth analysis of corporate successes and failures in 27 case studies from 10 countries. The study found that although poor corporate governance can ruin a company, good governance on its own cannot make a company successful. Companies need to balance conformance (defined as corporate governance) with performance (which focuses on strategy and value creation). However, the report says that a strategic oversight gap exists in many companies. Several of the high-profile companies highlighted in the study fell into difficulties as a consequence of their strategic choices.

An analysis of the case studies showed that several key strategy issues contributed to corporate success and failures, including choice and clarity of strategy, strategy execution, the ability to respond to abrupt changes and/or fast-moving market conditions, and the ability to undertake successful mergers and acquisitions.

The report also introduces the concept of the strategic scorecard as a means of addressing the strategic oversight gap and offers guidance on other issues such as enterprise risk management.

The study may be downloaded free of charge from IFAC�s website by going to www.ifac.org/store.

EFRAG

Johan van Helleman, EFRAG�s chairman, has written to the EC�s director-general for the Internal Market supporting the adoption of the revised international accounting standards as published by the IASB on 18 December 2003.

EFRAG has evaluated the revised IASs, including their Bases for Conclusions and the consequential amendments to other IFRSs, drawing on input from standard setters and market participants in accordance with EFRAG�s due process. As a result, EFRAG has concluded that the revised IASs are in the European interest and should be adopted.

However, EFRAG does make some criticisms of the revised standards. For example, while supporting most of the changes made to IAS 16, Property, Plant and Equipment, EFRAG draws attention to one change that has given rise to adverse comment - namely that companies are required to review each year the estimated residual value of their fixed assets. Any increase in the estimated residual value will reduce the depreciation charge with the effect that, in a period of inflation, the depreciation charge may be expected to reduce year by year. EFRAG considers this requirement conceptually unsound since the depreciation charge is affected by a mixed measurement system: depreciation is usually based on the difference between original cost and residual value - the former being historical cost; the latter being current market value. Furthermore, EFRAG says, a number of preparers have advised that they consider an annual reassessment potentially burdensome.

All responses to the Proposals for the Enhancement of Role and Working Process of EFRAG are now available for viewing on EFRAG�s website. The responses include one from ACCA which suggests that the paper concentrated too much on the working processes of EFRAG and not enough on the enhancement of its role. ACCA says it might have helpfully identified the key achievements of EFRAG and then those matters where more should be done in future, before moving to the measures needed to achieve them.

In ACCA�s view the major achievements of EFRAG have been:

• its establishment as the EU�s technical input into the development of the standards at the IASB, and
• the prompt circulation of high quality draft comments on IASB proposals to assist input from other European entities.

ACCA says that three main objectives are still to be realised by EFRAG. First, it says it is important that EFRAG becomes more proactive to raise its profile within Europe and gain influence on the international stage. EFRAG could, for example, provide early stage input to the IASB on key issues in the forward agenda of the IASB (such as leasing) or on items not being tackled by IASB (such as a comprehensive consideration of fair value accounting). This input could include the results of round table discussions of interested parties, which could also help to raise EFRAG�s profile within Europe.

ACCA says that a second key objective that EFRAG has not yet achieved is adequate profile and visibility among parties interested in financial reporting in Europe. EFRAG needs to be more active in making parties aware of its proposed comments on IASB proposals and in promoting debates and information on the development of the standards.

Thirdly, ACCA says, EFRAG has not addressed reporting by small and medium size entities. It believes this is a critical issue for EFRAG because of the extension of the IFRS regulation to unlisted companies and IASB�s project on the issue. EFRAG should have a separate panel of experts who could advise on SME matters on an ongoing basis.

All responses to EFRAG, including ACCA�s, are available via the EFRAG website (www.efrag.org).

FEE

FEE has issued a discussion paper, Risks and Audit Implications of Electronic Service Delivery in the Public Sector, calling on management and external auditors of public sector entities to adopt a positive approach to electronic service delivery, while also being aware of the potential risks.

Auditors are encouraged to be supportive of electronic service delivery initiatives, and the paper notes that this is not solely a matter for computer audit specialists. FEE believes the paper provides timely advice, given that European public sector bodies are being encouraged to deliver an increasing number of services electronically. The paper may be downloaded free of charge from FEE�s website (www.fee.be).

UK

Financial reporting

The ASB has published a discussion paper, UK Accounting Standards: A Strategy for Convergence with IFRS, which presents and seeks views on the ASB�s development of UK accounting standards. The paper proposes a phased approach to convergence, including:

• new standards effective in 2005 and 2006 that will enhance existing UK financial reporting requirements, maintain their position as highly regarded internationally and adapt to changes in the law, and thereafter
• a series of step changes replacing one or more existing UK accounting standards with standards based on IFRS as prospective IASB projects are completed.

The ASB aims to minimise the burden of change on companies by avoiding two changes of accounting policy in respect of the same issue within a short period. On this basis, the paper discusses a number of ongoing IASB projects for which the ASB recommends retention of equivalent UK standards, and also sets out the Board�s specific intentions for new UK standards based on IFRS in the next two years. Comments are requested by 30 June.

The ASB has announced that it will issue an accounting standard on share option schemes and other share-based payments, which will come into effect for accounting periods beginning on or after 1 January 2005 for listed companies and 1 January 2006 for all other companies. FRS 20, Share-based Payment, will be based on IFRS 2 Share-based Payment, published by the IASB (see p46). IFRS 2 requires that, with effect from 1 January 2005, an expense measured at fair value should be recognised in the profit and loss account for all share-based payment transactions entered into by the reporting entity. The requirements of FRS 20 are identical to those of IFRS 2, except the implementation of the standard for unlisted companies has been deferred one year to allow more time for implementation.

Auditing

The Auditing Practices Board has published an exposure draft of Practice Note 12 (Revised), Money Laundering, which reflects the requirements of the new anti-money laundering legislation that came into force on 1 March 2004. The exposure draft focuses on the impact of the anti-laundering legislation on auditors� responsibilities when auditing and reporting on financial statements. Comments are invited by 15 May.

The Auditing Practices Board has adopted six new international auditing standards recently released by the International Audit and Assurance Standards Board. The new standards will apply to audits of accounting periods commencing on or after 15 December 2004. The new standards are:

• ISA 315, Understanding the Entity and its Environment and Assessing the Risks of Material Misstatement
• ISA 330, The Auditor�s Procedures in Response to Assessed Risks
• ISA 500, Audit Evidence
• ISA 240, The Auditor�s Responsibility to Consider Fraud in an Audit of Financial Statements
• ISA 220, Quality Control for Audits of Historical Financial Information
• ISQC 1, Quality Control for Firms that Perform Audits and Review of Historical Financial Information and Other Assurance and Related Services Engagements

When finalised, the standards will supersede: SAS 110, Fraud and Error; SAS 210, Knowledge of the Business; SAS 240, Quality Control for Audit Work; SAS 300, Accounting and Internal Control Systems and Audit Risk Assessments; and SAS 400, Audit Evidence.

Employment law

Tribunal procedure
In Roberts v Skelmersdale College, an employee claiming unfair dismissal failed to attend a tribunal hearing and gave no reason for non-attendance. The tribunal threw out his complaint but the Employment Appeal Tribunal allowed an appeal. The Court of Appeal restored the tribunal�s decision. When an applicant fails to attend or be represented at a hearing, the tribunal rules do not impose on a tribunal a duty to investigate the case before it or to be satisfied that the employers have established a good defence to the claim of the absence applicant. The tribunal may adjourn the hearing to a later date, dismiss it or dispose of it in some other way.
In Bolch v Chipman, the EAT ruled that a tribunal erred in treating the employer�s conduct in threatening the employee with physical violence as a ground for striking out the employer�s defence. The EAT emphasised that, generally, a striking-out order is not to be regarded simply as a punishment. A key question is what remedy is appropriate and proportionate. For instance, an employer who is debarred from taking any further part in the case on the merits may still be allowed to take part on the question of compensation.

Subsidies for trade unions
The Government is proposing to amend the Employment Relations Bill with regard to a new funding scheme for trade unions. The Secretary of State for Trade and Industry will have the power to make funds available to independent trade unions and federations of trade unions to modernise their operations. It is anticipated that the fund will be in the region of £5m-10m in total, with expenditure (expected to start in 2005/06) spread over several years. The funding scheme is to be used to support projects in such areas as: - training union representatives to help promote the development of high performance workplaces:
- supporting more efficient management systems within unions
- assisting communications between unions and their members
- making training more accessible to under-represented groups, and
- employment agencies.

Employment agencies
The Department of Trade and Industry has produced useful guidance on the new regulations covering employment agencies and businesses. It explains terms used in the new Conduct of Employment Agencies and Employment Businesses Regulations and suggests ways of tackling issues that might arise when utilising the services of employment agencies.

Taxation

Many existing rates and limits are frozen or only increased in line with inflation. Major new proposals relate to:
- anti avoidance
- small companies distributions, and
- pre-owned assets.
While general anti avoidance rules (GAAR) were seen as a possibility, the chancellor opted for what at first sight is a simpler alternative. Under new rules to be published in the Finance Bill scheme promoters will have to provide a detailed description to the Inland Revenue. The scheme will then be registered and anyone using it will have to include the registration number in their tax return. There are similar rules for VAT schemes.
Some action to prevent small companies taking advantage of the NIL rate band and then distributing this untaxed profit in the form of dividends was expected. Whilst the most commonly forecast action was the imposition of national insurance on offending dividend distributions, the budget proposal effective from 6 April 2004 is a minimum 19% rate of corporation tax on distributed dividends.
The proposed legislation on pre-owned assets is note-worthy for two reasons. It will apply to gifts after 17 March 1986 where the donor continues to enjoy any benefit and will impose an income tax charge akin to a benefit-in-kind charge. How this will be administered is a matter for conjecture.
Last, but not least, the merger of Customs & Excise has been announced. Policy matters are to be transferred to the Treasury. According to the chancellor this will substantially reduce the number of staff required, with concomitant administrative cost savings. In the short term expect trouble.

Partnership losses
Anti avoidance legislation, effective from 10 February 2004, will be in the next Finance Bill. The new rules are intended to prevent artificial schemes and will not affect partners who spend a significant amount of time working in the partnership business.
Examples are given on the Inland Revenue website (www.inlandrevenue.gov.uk).

Trust taxation
Various consultation meetings have now been held and the minutes can be accessed on the Inland Revenue website.

Interest rates
With effect from 16 February 2004, the rate of interest charged on underpaid corporation tax is increased from 4.75% to 5%.

Double tax treaties
A new double taxation agreement with France has been signed, but will not enter into force until the appropriate Parliamentary and diplomatic procedures are complete.

New and revised forms
- IHT 35 - used to claim a loss on shares sold within 12 months of death, has been revised.
- IHT 38 - used to claim a loss on the sale of land and buildings within 4 years of death has been revised.
- D3a - used to provide information about gifts made out of income can be accessed on the Inland Revenue website.
- E24 - Tips, Gratuities, Service Charges and Troncs is a new booklet intended for use by the catering and service industries.
- CA 04 - Class 2 & Class 3 NI Contributions - Direct Debit the Easy Way to Pay, has been revised.
- CA 92 - National Insurance Services to Pensions Industry - an information guide, has been updated.
- Tax + U - an on-line brochure aimed at students can be found on the Inland Revenue website.
- COP 9 (Northern Ireland) - Special Compliance Office Investigation in Northern Ireland has been published and is available on the Inland Revenue website.

The child trust fund
Draft regulations have been published. Providers must accept contributions of £10 or more and charges will be capped at 1.5% p.a. There are also requirements concerning statements, etc. The final version of the regulations will be laid in May.

Statutory instruments
SI 173/2004 - The Social Security (Contributions) (Amendment) Regulations 2004 has come into force. These regulations amend Schedule 3, part 10, p5 of the Social Security (Contributions) Regulations 2001 and make it clear that NI contributions are due on payments by:
- trusts to beneficiaries who are employees, and
- persons connected with the employer.
Tips and gratuities to waiters and others providing services will still be exempt from NI, even if they are made to persons related to the employer, provided that the employer does not make or allocate the payment directly or indirectly.
SI 220/2004 - The Social Security (Contributions) (Amendment No.2) Regulations 2004 specifies the levels of the lower and upper earnings limits, etc, for Class 1 Contributions as follows:
- lower earnings limit primary class £79
- upper earnings limit primary class £610
- primary and secondary thresholds £91.
SI 372/2004 - The Tax Credits (Appeals) (Amendment) Regulations 2004 came into force on 16 March 2004. The regulations omit p7(3) of the Tax Credits (Appeals) Regulations 2002, which would have substituted �Board� for �Secretary of State�
SI 438/2004 - The Capital Gains Tax (Gilt Edged Securities) Order specifies further securities which are exempt from CGT on disposals as follows:
- 4% Treasury Stock 2007
- 4% Treasury Stock 2009
- 4% Treasury Stock 2015.
SI 439/2004 - The Urban Regeneration Companies (Tax) (Designation) Order 2004 designates various companies as urban regeneration companies for the purpose of S79B ICTA 88. The Order came into force on 24 February 2004, but is effective from various earlier dates in 2003. Businesses can claim contributions to urban regeneration companies as expenses deductible from taxable profits.
Sl 3075/2003 - The Money Laundering Regulations came into effect on 1 March 2004.

Land tax recycling
A report prepared for the Treasury on the possible options for recycling land tax revenues has been published on the Treasury website at www.hm-treasury.gov.uk. Options considered include:
- enhanced capital allowances, and
- a tax credit scheme aimed at increasing diversion of waste from land fill.

Tax law rewrite
The Inland Revenue has added to its website documents showing responses received to its consultation papers on the following subjects:
- Paper CC/SC (03) 05 - deep gain securities
- Paper CC/SC (03) 06 - beneficiaries incomes from estates in administration
- Paper CC/SC (03) 09 - guaranteed returns on futures and options
- Paper CC (03) 15 - receipts from intellectual property, and
- Paper CC (03) 16 - settlements.
The website also shows the way on which comments have been followed up.

International accounting standards
The Finance Bill 2004 is to include measures designed to ensure that companies adopting international accounting standards will receive broadly similar treatment to companies using UK GAAP.
In general terms the legislation will:
- ensure that accounts prepared under IAS or UK GAAP are acceptable for UK tax purposes
- ensure that the research and development rules continue to allow relief in the year in which the expenditure was incurred regardless of the accounting treatment
- continue the current tax treatment of most hedging arrangements, etc, and amend the corporate debt and derivative contracts legislation as necessary.

Deficiency relief schemes stopped!
Artificial schemes designed to create deficiency relief in connection with life insurance policies have been stopped with effect from 3 March 2004.
Relief will in future be restricted to an amount not exceeding the total of any earlier gains which formed part of that same individual�s income.
A draft clause and explanatory note are on the Inland Revenue�s website.

Chairman retires
Sir Nicholas Montagu retired as chairman of the Board of Inland Revenue on 19 March 2004.
Deputy chairman, Ann Chant, has taken over as acting chairman.

Taylor v MEPC Holdings Ltd
In this case, an investment company sought to surrender excess charges to other group companies. In the year in question, the company had made chargeable gains, but also had losses brought forward which exceeded the gains.
The Inland Revenue argued that S403(8) ICTA 88 prevented the company from setting losses brought forward against the current year capital gains, thereby reducing the excess charges available for surrender in group relief.
The special commissioners accepted the taxpayer�s argument, but the High Court and the Court of Appeal found for the Inland Revenue.
The House of Lords has now found for the taxpayer on the grounds that group relief was only concerned with income and could not be limited by a deduction relating to chargeable gains.

Lessex Ltd v Spence
In this case, a company made a late return for the third time. The case concerned the transition from the penalties given, laid down for CT Returns made late, to the provisions for CTSA Returns made late.
The case is noteworthy only because the special commissioner rejected a literal reading of the legislation on the grounds that it clearly did not achieve its intention. He held that there was clear authority for rejecting a nonsensical or absurd literal interpretation in favour of an interpretation that made sense of the paragraph as a whole.