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(232)-REPORTING FINANCIAL PERFORMANCE

Reporting Financial Performance

The main abuse of SSAP related to the treatment of extraordinary items, particularly redundancy, reorganization and restructuring costs. Any such costs classified as extraordinary were excluded from the earnings per share number under SSAP/.

The treatment of extraordinary items was thus often “EPS-driven”.


Main charges

The main charges introduced by financial reporting standards include:

• Presentation in the profit and loss account
  

Items such as turnover, cost of sales, gross profit, operating expenses and operating profit are to be analyzed between, continue operations, discontinuing operations and exceptional items.

• Presentation and measurement of profit on disposal of fixed assets
  

This is particularly important for companies who incorporate fixed asset revaluations into the accounts.

• Treatment of extraordinary items
• Additional statements and notes
  

Statement of total recognized gains and losses, note of historical cost profits and losses, reconciliation of movement in shareholders’ funds.

• A change in the definition of earnings per share.
  

Earnings per share will in future be based on earnings after taking account of extraordinary items if they exist in the future.

• Implementation
  

The accounting standard burrow encourages companies to adopt financial reporting standard at the earliest opportunity.


Split between continuing and discontinuing operations


Financial reporting standards set out detailed criteria to be followed in deciding whether particular business disposals and terminations are to be regarded as “discontinued”. The standard also specifics the extent to which provisions can be set up in the balance sheet relating to the year prior to discontinuance.


This area of the standard is particularly complex and will apply mostly to large quoted groups which are regularly involved in acquisitions, disposals and business closures. As this part of financial reporting standards are concerned particularly with consolidated accounts.

(231)-EXTRAORDINARY ITEMS AND PRIOR YEAR ADJUSTMENTS

Extraordinary Items and Prior Year Adjustments

Prior Year Adjustments


Prior year adjustments are those material adjustments applicable to prior year arising from changes in accounting policies or from the correction of fundamental errors. They do not include normal recurring corrections or adjustments of accounting estimates made in prior years.

• Changes in accounting policy
  

Examples could include policy changes by a company regarding depreciation of building, deferred tax, goodwill or finance leases.

• Correction of fundamental errors
  

This refers to errors which are of such fundamental importance as to affect the true and fair view. Had the errors been recognised at the time they occurred, the financial statements would have been withdrawn and subsequently amended.


Reserve movements


the term "reserve movements" refers to items which are taken direct to reserves rather than passed through the profit and loss account. One purpose of SSAP was to restrict the use of reserve movements.

Reserve movements may be required or permitted in the following circumstances:

• Changes in value of investment properties
• Certain exchange differences required to be taken direct to reserves by SSAP
• immediate write-off against reserves
• amounts required by law to be charged direct to the share premium account
• Sale of previously revalued assets
  

Disclosure requirements of SSAP


SSAP made it very clear that the following items should be separately disclosed in the profit and loss account and dealt with in the following order;

• Profit and loss on ordinary activities
• Extraordinary profit or loss
• Profit or loss for the financial year
• Dividends and other appropriations
  

(230)-EXTRAORDINARY ITEMS AND PRIOR YEAR ADJUSTMENTS

Extraordinary Items and Prior Year Adjustments

The all-inclusive concept

SSAP was based on the all-inclusive concept whereby the profit and loss account reflected all profits and losses including extraordinary items.


Extraordinary items

Two key definitions:

• Extraordinary items are material items which derive from events or transactions that are outside the ordinary activities of the company and which are therefore expected not to recur frequently or regularly. They do not include exceptional items nor do they include prior year items merely because they relate to prior year.
• Ordinary activities are any activities which are usually, frequently or regularly undertaken by the company and any related activities in which the company engages in furtherance of, incidental to, or arising from those activities. They include, but are not confined to, the trading activities of the company.
  

Exceptional items


Exceptional items are material items which derive from events or transactions that fall within the ordinary activities of the company, and which need to be disclosed separately by virtual of their size or incidence if the financial statements are to give a true and fair view.


Illustrations of usual treatments for exceptional items


Subject to the business and the circumstances of the transaction, the following are example of items which would normally be treated as exceptional:

• Redundancy costs relating to continuing business segment
• Reorganization costs unrelated to the discontinuance of a business segment
• Previously capitalized expenditure on intangible fixed assets written off other than as part of a process of amortisation
• Amounts transferred to employee share schemes
• Profits or losses on the disposal of fixed assets
• Abnormal charges for bad debts and write-offs of stock and work in progress
• Abnormal provisions for losses on long-term contracts
• Surpluses arising on the settlement of insurance claims
• Amounts received in settlement of insurance claims for consequential loss of profits
  

A business segment is a material and separately identifiable component of the business operations of a company or group whose activities, assets and results can be clearly distinguished from the reminder of the companies activities. A business segment will normally its own separate product lines or markets.


Illustrations of usual treatments for extraordinary items


Subject to the nature of the business and the circumstances of the transaction, the following are examples of items that would normally be treated as extraordinary.

• The discontinuance of a business segment, either thought termination or disposal
• The sale of an investment not accurate with the intention of resale, such as investments in subsidiary and associated companies
• Profits or losses on the disposal of fixed assets
• Provision made for the payment diminution in value of a fixed assets, because of extraordinary events during the period
• The expropriation of assets
• A charge in the basis of taxation or significant charge in government fiscal policy

(229)-A CONCEPTUAL FRAMEWORK OF ACCOUNTING

A Conceptual Framework of Accounting

Introduction

The standard-setting process has proceeded for almost two decades in the absence of a conceptual framework underlying the preparation of periodic financial statements.

This has resulted in illegalities and inconsistencies in several of the accounting standards which have been produced. One particular attempt at setting a framework was the international accounting standards committee's exposure draft. This is referred to below in brief terms.

Main elements

The main elements in the international accounting standards committee's framework for financial statements are shown in the diagram below. Each of these statements in referred to briefly.

Objective of financial statements


The principle objective is to provide information about the financial position, performance and changes in financial position of an enterprise that is useful to a wide range of potential users in making economic decisions.


Qualitative characteristics of financial statements


The two characteristics which are of particular importance are relevance and reliability. Additional characteristics include comparison and timeliness.

Relevance to information needs users

• Reliability confidence of users will be increased if information is independently verified
• Comparability, users should be able to compare results with those of previous periods and with similar entities
• Timeliness, date of publication of the report should be soon after the end of the period to which the report relates.
  

Elements of the financial statements

• Relating to financial position - asset, liability, equity
• Relating to performance - income and expenses
• Recognition - criteria for determining when an item may be incorporated in the balance sheet or profit and loss account
• Measurement - measurement attributes include historical cost, current cost, realisable value, present value.

Concepts of capital and capital maintenance and the determination of profit

The paper refers to financial capital maintenance and physical capital maintenance.

(228)-ACCOUNTING FOR SUBSTANCE

Accounting for Substance

Substance over form

The principle of substance over form was introduced in international accounting standards.
International accounting standards refers to three fundamental accounting assumptions:

1. Going concern
2. Consistency
3. Accrual

International accounting standards further refers to three considerations that should be accounted for and presented in accordance with their substance and financial reality and not merely with their legal form.

Substance over form is defined as follows: “transactions and other events should be accounted for and presented in accordance with their substance and financial reality and not merely with their legal form”.

Accounting for substance

The concept of substance over form has now been replaced by the concept of accounting for substance. The incidence of so-called “creative accounting” has added increased urgency to the need to develop this concept.

That can be defined as follows: “accounting for transaction in accordance with its substance requires that its accounting treatment should fairly reflect its commercial effect”.

Reporting the substance of transaction proposes that “a reporting entity’s financial statements should report the substance of the transactions into which it has entered”.

Examples of accounting for substance

• Goods sold subject to reservation of title: legal title does not pass to the purchaser until the goods have been paid for. Nevertheless accounts are drawn up including the goods in stock with a corresponding creditor, in accordance with the commercial substance of the transaction.
• Fixed assets acquired under hire purchase contracts: legal title does not pass until the final installment is paid. Nevertheless the fixed asset is included in the balance sheet right from the start together with a corresponding creditor. Again this reflects the commercial substance of the transaction.
• Finance leases: a lessee may obtain the use of a fixed asset over its useful economic life by means of a financial lease contract. Although the lessee never actual obtains legal title the lessee has rights and obligation similar to those of an outright purchaser.

Further considerations

One particular point about the types of transactions that are caught within the accounting for substance was also referred to as follows:

Many transactions are straightforward and embody a number of standard rights and obligations with the result that the commercial effect and consequent accounting treatment are well known.
Some transactions, on the other hand, combine or divide up rights and obligations in ways that make it difficult to discuss their effect on the enterprise’s assets and liabilities.

The following are common features of transactions that combine or divide up rights and obligations:

• Severance of legal title to an item from the ability to enjoy the principle benefits and exposure to the principle risks associated therewith;
• Linkage of a transaction with one or more others in such a way that the commercial effect cannot be understood without reference to the series as a whole;
• Inclusion in the terms of a transaction of one or more options or conditions whose terms make it reasonably probable that the option will be exercised or the condition fulfilled.

Some more examples for accounting for substance

• Sale of goods with a commitment to repurchase: at first sight, a sale of goods might appear to be a trading transaction, with stock replaced by cash. However, the commercial effect is that the transaction is a financing transaction. The cash received should be regarded as receipt of a loan, not as sale of goods.
• Sale and leaseback: a sale and leaseback which involves a finance lease is effectively a financing transaction and both the asset and liability should appear on the balance sheet.
• Consignment stock: consignment stock arrangements are particularly common in the motor trade. Consignment stock is held by one party but legally owned by another on terms which give the holder the right to sell the stock in the normal course of his business or, at his option, to return it unsold to the legal owner.

(227)-VARIATIONS IN ACCOUNTING PRACTICE

Variations in Accounting Practice

The accounting standards programmed has sought to eliminate the scope for variations in accounting practices, both within company annual reports and between one company and another. Nevertheless there remains significant scope for variations. Some of the more common areas are referred to below.

Impact of fixed asset revaluations

Depreciation charges may be based on either historical cost or revalued amount.

Long term contracts

Where a particular contract of less than 12 months’ duration is accounted for as long-term may well be a matter of fine judgment.

In addition, for long-term contracts which are expected to be profitable, there are several acceptable ways of allocating profit over the life of the contract.

Group accounts matters

Business combinations which satisfy the merger conditions may be consolidated either on a merger accounting basis or an acquisition accounting basis.

Where foreign subsidiaries are translated using the closing rate/net investment method, profit and loss accounts items may be translated at either average rate or loosing rate.

Under acquisition accounting, there is scope for determining the extend to which provisions for losses and reorganization costs may be taken into account under the fair value exercise. A future standard is likely to restrict this scope significantly.

Extraordinary and exceptional items

Until there has been considerable scope for deciding whether particular reorganization costs should be treated as exceptional or extraordinary. However, a financial reporting standard effectively abolish extraordinary items and introduces significant changes in both accounting disclosures.

Intangible fixed assets

Goodwill- purchased goodwill may be eliminated against reserves are as soon as it arises. Alternatively it may be carried forward as an intangible fixed asset amortized over useful life.
Development costs which satisfy the criteria may be written off to profit and loss account as they arise. Alternatively they may be capitalized as an intangible fixed asset amortized over a period.

Deferred revenue expenditure

Certain borrowing costs may be capitalized as part of the cost of a fixed asset or they may be charged to profit and loss as incurred.

Pre-opening expenses relating to new hotels or store may be carried forward in the balance sheet and expenses over a period. Alternatively they may be written off as incurred.

Pension costs

Companies were offered a choice of radically different traditional provisions. The effect of this choice will last many years.

Post balance sheet events

Certain post balance sheet events which would normally be classified as non-adjusting may be treated as adjusting in special circumstances.

The above examples are many and varied but the list is by no means comprehensive. The purpose of the above is underlining the scope for significant variations in accounting practice between different companies.