Financial Reporting Updates
FRC consults on revisions to the UK Corporate Governance Code
New FRC proposals are set to expand the role of audit committees and provide users of annual reports with greater transparency as to how the audit committee discharges its responsibilities. The proposals also introduce an expectation that FTSE 350 companies put their external audit out to tender at least every ten years, albeit on a ‘comply or explain’ basis.
The Financial Reporting Council (FRC) is proposing revisions to the UK Corporate Governance Code and to the accompanying Guidance on Audit Committees to give effect to the policies set out in its paper Effective Company Stewardship: Next Steps that was issued in September 2011. It is also consulting on related revisions to auditing standards and on updates to the Stewardship Code. The changes to the Stewardship Code apply primarily to investors and clarify the respective roles of asset owners and managers.
As a result of these new proposals:
- FTSE 350 companies would be expected to put the external audit contract out to tender at least every ten years (subject to certain transitional arrangements);
- The board would need to explain in the annual report why it believes the annual report is fair, balanced and understandable; and
- The audit committee would be encouraged to provide more meaningful reporting, for example, by reporting to the board and in the annual report on the significant issues it considered in relation to the financial statements and how it addressed those issues.
The UK Corporate Governance Code will also be updated to include the provisions announced in October 2011 requiring boards to report on their diversity policies (including gender). The regime will continue to be that of ‘comply or explain’ and the FRC’s guidance on what makes an explanation informative will be incorporated into the Preface to the UK Corporate Governance Code.
The Next Steps paper also highlighted a call for the contribution by auditors to be more transparent. To this end, the FRC is also proposing revisions to International Standards on Auditing (UK and Ireland) governing reporting by auditors to audit committees and in audit reports.
For entities that are required, or choose voluntarily, to report on how they have applied the UK Corporate Governance Code, the auditor would report to the audit committee on its view of the effectiveness of the entity’s internal control system. This would be based on procedures performed as part of the audit of the financial statements and would include a view on the effectiveness of the internal control system in addressing risks arising from the entity’s business model. Furthermore, the auditor would be required to report in the audit report, by exception:
- if the board’s statement of why the annual report is fair, balanced and understandable is inconsistent with the knowledge acquired by the auditor in the course of performing the audit, and/or
- if the matters disclosed in the report from the audit committee do not appropriately address matters communicated by the auditor to the committee.
The FRC is also proposing to require the auditor explicitly to read the other information in the annual report to identify any information that is apparently incorrect based on, or materially inconsistent with, the knowledge acquired by the auditor in the course of performing the audit. This revision would apply for the audit of all entities, not just for those that apply (or choose to apply) the UK Corporate Governance Code.
The proposed changes are open for comment until 13 July 2012 and would apply for financial years beginning on or after 1 October 2012. The FRC’s press release with links to the relevant consultation documents is available here.
Accounting for the tax changes announced in the 2012 Budget
As part of the phased reduction to 22 per cent, the UK corporation tax rate fell to 24 per cent with effect from 1 April 2012. As substantive enactment of the rate change occurred on 26 March 2012, for March interim and full year ends, deferred tax balances should be re-measured based on 24 per cent.
The Budget on 21 March 2012 revised again the previously announced phased reduction in the main UK corporation tax rate. The rates are now as follows:
||Date substantively enacted|
||1 April 2012
||5 July 2011|
24% (supersedes the 25%)
|1 April 2012
||26 March 2012|
||1 April 2013
||1 April 2014
The reduction to 23 per cent from 1 April 2013 will be included in the 2012 Finance Bill, which is expected to be substantively enacted* for the purposes of IFRS and UK GAAP (i.e. having completed its Commons stages) by the end of July 2012. The remaining 1 per cent reduction is expected to be included in the 2013 Finance Bill.
Note that for companies with other than a 31 March accounting period end, the tax rate applicable to the accounting period crossing 1 April will be a time-apportioned rate. For example, the applicable rate for a 31 December 2012 year end will be 24.5 per cent, being 3 months at 26 per cent and 9 months at 24 per cent.
Accounting requirements for measurement of tax assets and liabilities
Paragraph 47 of IAS 12 Income taxes (and paragraph 37 of FRS 19 Deferred tax) requires that deferred tax assets and liabilities are measured at the tax rates that are expected to apply to the period when the asset is realised or the liability settled, based on rates that have been enacted or substantively enacted by the balance sheet date. For interim reporting, paragraph B13 of IAS 34 Interim financial reporting also requires the use of tax rates that have been enacted or substantively enacted by the interim balance sheet date.
In other words, no account is taken of the expected reductions to 23 per cent and 22 per cent until substantive enactment of those changes. Those changes are, until that time, relevant only for disclosure.
The effect of the re-measurement will be taken to the income statement, to other comprehensive income (OCI), or directly to equity depending on where the original entry to recognise the deferred tax was recorded. For example, the effect of re-measuring the deferred tax liability under IAS 12 in relation to an upwards revaluation of own-use property (above cost) will be recognised in other comprehensive income.
IAS 12.84 (and FRS 19.64) effectively requires disclosure of significant factors that could affect the future relationship between tax expense and accounting profit. Therefore, in advance of substantive enactment, if the anticipated effect of the announced changes is significant, disclosure should be made.
Where the announcement or enactment of the change takes place after the balance sheet date but prior to the approval of the financial statements, IAS 12.88 specifically requires disclosure to be made of any significant effect of a change in tax rates. For interim reporting, IAS 34.16A(h) also requires disclosure of material events subsequent to the end of the interim period that have not been reflected in the financial statements of the interim period.
This means that:
- For December 2011 year ends, deferred tax balances continue to be measured based on a rate of 25 per cent.
- For 31 March 2012 interims and full year ends, deferred tax balances should be re-measured based on a rate of 24 per cent (as this rate was substantively enacted on 26 March 2012).
- For balance sheets, whether in interim or year-end accounts, prepared to a date after substantive enactment of the 2012 Finance Bill (expected by the end of July 2012), deferred tax balances should be re-measured based on a rate of 24 or 23 per cent (or relevant blended rate), depending on the expected timing of reversal of the related timing or temporary difference.
- The effect of any re-measurement of deferred tax – e.g., a 31 March 2012 year end company remeasuring deferred tax from 25 per cent down to the new 24 per cent – will be taken to the income statement, to OCI, or directly to equity depending on where the original entry to recognise the deferred tax was recorded. See below for further commentary on this attribution process.
- In all cases, disclosure should be made of the significant effect on future current tax and on deferred tax balances of the rate decrease – i.e., those that have not yet been substantively enacted and hence not brought into the accounting itself – together with a general indication of the likely effect of the expected further reduction in tax rates.
In some circumstances IAS 12.63 (and FRS 19.36) acknowledges that it may be difficult to determine the precise amount of the re-measurement that relates to an item recognised outside profit or loss. For example, take the situation where a company has recognised a pension plan deficit and recorded a deferred tax asset thereon. The deficit may have arisen as a result of both actuarial losses (that have been recognised in OCI) and under-funding of the current service cost (that has been recognised in profit or loss). In this case, where should the re-measurement of the deferred tax asset be recognised? In our view, a company should if practicable "back trace" the movements in its pension plan deficit to identify the source of that deficit, with the re-measurement of the deferred tax asset allocated accordingly. However, this may prove difficult for long-standing plans. In cases of difficulty, IAS 12.63 (FRS 19.36) requires that a reasonable pro rata allocation should be made. In some cases no reasonable pro rata basis of allocation may exist; then another method that achieves a more appropriate allocation in the circumstances should be used. In this case, if it is reasonable to presume that the deficit has arisen from actuarial losses (which will generally be the case), then the re-measurement should be deemed to relate to, and should be allocated to, OCI.
* A UK tax rate can be regarded as “substantively enacted” under IFRS and UK GAAP if it is included in either a Bill that has been passed by the House of Commons and is awaiting only passage through the House of Lords and Royal Assent; or a resolution having statutory effect that has been passed under the Provisional Collection of Taxes Act 1968 (PCTA 1968).
FRRP publishes revised Operating Procedures
In a revision to its operating procedures from 1 April 2012, the Financial Reporting Review Panel (FRRP) may opt to share more company-confidential information with the Audit Inspection Unit. Further, its ability to issue announcements about companies' reports and accounts under review is extended: it is no longer restricted to issuing announcements only when the directors of the company under review had agreed that the annual report was defective.
The Financial Reporting Review Panel (FRRP) has now published its revised operating procedures which reflect, without significant change, the proposals it consulted on in autumn 2011. The changes relate to:
- sharing otherwise company-confidential information with the Audit Inspection Unit* (AIU);
- extending the circumstances in which it can issue a press release to cases where a company makes a significant change, whether corrective or for clarification, to its corporate reporting following FRRP intervention. Previously the possibility of issuing a press release was limited to situations where the directors of the company had agreed that the annual report under review was defective; and
- allowing the FRRP to release its own announcement where the existence of an FRRP enquiry has become public.
The FRRP provided separate feedback on the responses to the consultation and indicated that:
- information will be shared between the FRRP and AIU only to the extent necessary to enable an FRRP or AIU inspection to be completed effectively;
- the FRRP remains committed to a consensual approach when it engages with a company;
- it envisages issuing additional press releases only where significant changes to a company’s corporate reporting are made following FRRP intervention, but the directors decline to acknowledge this; and
- the press release power will be exercised only where it would be obvious to an informed reader that the accounts are defective.
The Panel will continue to work to improve financial reporting by the issue of generic press notices and its annual activity report.
The revised operating procedures apply to all cases where the FRRP’s initial letter is sent to the company on or after 1 April 2012. The FRRP’s press release is available here.
* The AIU is part of the Professional Oversight Board and is responsible for monitoring the audits of all listed and othe major public interest entities.
IFRS newsletters and other publications
KPMG in the UK publishes Financial Reporting Matters, a short newsletter to alert you to key changes in UK and International Financial Reporting Standards and UK company law. It is available for download here. Alternatively, you may subscribe by sending an email to Financial Reporting Matters.
KPMG IFRG Limited has published the following since the January/February 2012 Update, which are available on its web site at www.kpmgifrg.com:
New on the Horizon: Revenue recognition for technology companies (March 2012)
New on the Horizon: Revenue recognition for aerospace and defence companies (March 2012)
IFRS Practice Issues: Applying the consolidation model to fund managers (March 2012)
KPMG IFRG Limited also publishes In the Headlines, which provide information in relation to new exposure drafts and standards issued by the IASB, as well as any other relevant developments affecting current and future IFRS reporters, including summaries of IASB meetings on a monthly basis.
In the Headlines Issue 3 – Government loans: Amendments to IFRS 1
In the Headlines Issue 4 – Reminder: effective dates of IFRS
In the Headlines Issue 5 – Public consultation on MG governance review and PIOB work programme