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Introduction

International Financial Reporting Standards (IFRS) are established by the International Accounting Standards Board (IASB). These standards facilitate in communicating the financial results of a company to its stakeholders so that they can analyse the information and take appropriate decisions regarding entering into a financial transaction with it. These standards also facilitate in comparing the financial results of two and more companies that prepare their financial statements by complying with the IFRS (IFRS 2013).

The local Generally Accepted Accounting Principles (GAAP) is standards set by the local regulatory authority of that country, which is adopted by companies that are based in the concerned country. The selected country for this paper is the UK. This paper focuses on the difference between UK GAAP and IFRS. The three significant differences between UK GAAP and IFRS are illustrated by representing them in the form of financial statements. These differences are related to intangible assets, provisions and government grants. There will also be a discussion of problems faced by the entity in adoption of IFRS for the first time in a chosen country. Besides this, the impact of adoption of IFRS on the financial performance and position of a company is also discussed in this paper (Ernst & Young 2012).

 

Differences between IFRS and UK GAAP

There is an existence of significant differences between IFRS and UK GAAP. Under IFRS, the statement of changes in equity includes the statement of recognised gains and incomes. The cash flow statement includes both cash, as well as, cash equivalents and there is a classification of interest and dividends on the basis of their nature into three categories i.e. operating, investing and financing. Under certain circumstances, there is an involvement of bank overdraft in cash and cash equivalents. In contrast the UK GAAP states that there is a separate presentation of recognised gains and loses and changes in the shareholder’s fund. There is no consideration given to cash equivalents under these standards in the cash flow statement and there is also an inclusion of bank overdrafts in cash. The interest, dividends and taxes are classified into different categories of an item (KPMG 2003).

The cost of inventory is calculated by using LIFO method, whereas in UK GAAP, LIFO method is rarely used by companies for the evaluation of inventory in their financial statements. The cost of agricultural produce is recorded at cost or net realisable value, whichever is less, but in IFRS, the cost of agricultural produce is recorded at the value attained by subtracting point of sale cost from the fair value. Under IFRS, some of the equity shares are classified as liabilities. In addition to this, the dividend earned on these shares are treated as interest on the accrual basis in income statement, whereas there is a requirement to record all shares under shareholder’s funds and the shares that are owned by employees under ESOP scheme are treated as assets of a company under UK GAAP (World GAAP Info 2008).

In addition to this, the distribution of dividend is recognised in the year to which it relates. There is a requirement to differentiate the amount of dividend and shareholder’s fund with regard to the equity and non equity. The revaluation of financial statements under IFRS is done either on the mandatory basis or on the option basis. Despite this, the adjustments are made on the basis of current purchasing power if the currency of an enterprise is hyperinflationary. On the other hand, under UK GAAP, there is a rare possibility of revaluation of assets, except property; along with this, there is no additional requirement to be fulfilled by the company under the hyperinflationary nature of currency (Ernst & Young 2011).

Under IFRS, power to control is the foundation of consolidation and subsidiaries are treated as financial assets if they are excluded from the consolidation. The computation of minority interests is done either on the basis of carrying amounts of subsidiaries or on consolidation; while in UK GAAP, there is a requirement of consolidation only if dominant influence is exercised regardless of the existence of formal power. The treatment of subsidiaries is done as equity if these are excluded from consolidation and have a significant influence on the business of the company (World GAAP Info 2008). In addition to this, the evaluation of minority interest is done on the basis of carrying amounts on consolidation. Under IFRS, there is an exclusion of those acquired assets and liabilities, which do not adhere with the requirements of recognition under other standards. In addition to this, the income statement recognises negative goodwill. There is a capitalisation of transaction cost and the cost of acquisition includes expenses related to the registration and issue of equity securities. On the other hand, UK GAAP recognises those acquired assets and liabilities which do not meet the requirements of recognition under other standards. There is no capitalisation of transaction costs and it involves deduction of cost of issuing shares from gross proceeds and it has been credited to equity shareholder’s funds (KPMG 2003).

 

There is an exclusion of property under operating lease from investment property and it is recorded at the fair value along with changes in the income statement under IFRS. The dual use investment property is classified only if the separate parts can be sold separately. On the other hand, the investments held under operating leases are considered under investment property and only that part is classified under investment property which can be let out not necessarily to be disposed off separately under UK GAAP. Besides this, there is recognition of investment property at the open market value in the financial statements and the record of changes is to be treated under reserves in this system (World GAAP Info 2008).

The impairment is calculated annually for those tangible fixed assets that have a life span of 50 years and the monitoring of cash flows is to be done for five years after a value in use in UK GAAP, whereas impairment is not calculated annually for property, plant and equipment under IFRS and there is no requirement of monitoring after a specified time period. Under UK GAAP, there is an inclusion of provisions in financial statements regarding the sale and termination of an operation. This type of provision includes estimated operating losses for the future period. On the other hand, there is no requirement to make provisions for future operating losses under IFRS. Under UK GAAP, there is no deduction of government grants from the cost of fixed assets to which these grants relate, whereas government grants related to the fixed assets are deducted from the cost of that particular asset (KPMG 2003).

The main difference for the treatment of intangible assets between UK GAAP and IFRS is that the intangibles, such as development costs are capitalised and amortised under IFRS, but it is not either capitalised or amortised under UK GAAP. In the IFRS system, it is recorded only if there is a possibility of recovering of the deferred taxes, whereas under UK GAAP, the amount which is not likely to be recovered related to deferred tax assets is recorded. When deferred taxes are related to intra-group transactions, the tax rate of selling entity is applicable under UK GAAP while the tax rate of buying entity is applicable on the deferred taxes associated with the intra-group transactions in IFRS (Ernst & Young 2011).

There is an adjustment of goodwill only if the recovery of deferred tax assets exceeds the original estimate in IFRS. In addition to this, it is provided from the perspective of the re-evaluation of a financial statement of hyperinflationary subsidiaries; while there is no recognition of deferred taxes under these conditions, as well as, there is no recognition of adjustment of goodwill when the amount of acquisition of deferred tax assets exceeds the estimated value under UKGAAP. Under IFRS, deferred tax assets are not discounted, whereas in UK GAAP, deferred taxes can be discounted (World GAAP Info 2008).

Under IFRS, the profits and losses from the repurchase or settlement of debt are not considered as extraordinary items, whereas it is treated under interest in UK GAAP. There is a separate accounting standard for hedging under IFRS while no detailed information is provided under UK GAAP. The financial instruments that are not classified under derivatives can be used for hedging the exposure of risk related to currency fluctuations in IFRS but these instruments cannot be used for hedging the risk related to the foreign currency fluctuations under UK GAAP.

 

No mandatory format related to the income statement is given under IFRS but companies that follow UK GAAP have to present their income statement in a format given under these standards. The treatment of contingent assets and liabilities under UK GAAP guide that companies have to provide full information to stakeholders as per the rules and regulations of Companies Act 1985, even if this results in serious bias. On the other hand, only some information can be disclosed rather than full disclosure under IFRS. The recognition of unrealised profits in the income statement is allowed under IFRS, whereas it is allowed to recognise the unrealised profits in income statement under UK GAAP. There are no guidelines given for share based payments under IFRS, whereas expenses related to shares are recorded on the basis of intrinsic value under UK GAAP. Under UK GAAP, extra ordinary items are removed effectively and specific rules are mentioned under these standards for the treatment of these items. In contrast, IFRS do not provide any disclosure regarding extraordinary items and these are present in certain special circumstances.

There is a need to disclose detailed information related to the credit risk, currency risk, and interest rate risks before the effect of hedging under IFRS, whereas the information related to these risks is provided in the financial statements after the effect of hedging in case of UK GAAP.

Preparation and Translation of Financial Statements

The PR Solutions was established in 2012. PR Solutions started its business with cash of £500000. The entity started its business in London and was setup to provide the consultancy service in the United Kingdom. PR Solutions follows the accounting standards of the United Kingdom (UK GAAP). Before starting the company, the promoters conducted some research and development for £50000.

Following are the some basic accounting treatment in the United Kingdom

  • Development Cost (Intangible asset) is not capitalised and it is deducted from the income statement when it is incurred.
  • Provisions for future losses are recognised using estimated future operating losses.
  • Government Grants are not deducted from the cost of fixed assets.
  • Prepaid Expenses are recognised in the balance sheet.

Transactions in Year 2012

  1. Company has purchased a land for £ 200000 in the year 2012.
  2. Company has incurred a development cost of £ 20000 related to the business work. As per UK GAAP, development costs are intangible assets and it is the part of administrative cost.
  3. PR Solutions has created the provision for future losses of £ 20000. These losses are expected to be incurred due to the close down of the unit 2 in the year 2014. Expected total from the sale of unit 2 is about £ 40000, which is divided in two years i.e. £ 20000 in 2012 and £ 20000 in 2013.
  4. Company has received grants from the government for building its infrastructure. The gross amount of the grant is £ 80000 to be used in two years i.e. £ 40000 in the year 2012 and £ 40000 in the year 2013. This grant is to be utilised for construction of the building. The cost incurred in the building construction is £ 150000.
  5. Rent paid for office building is £ 2000 per month.
  6. Rent for Building Paid in Advance for 2 months is £ 4000.
  7. Salary paid to Employees is £ 30000.
  8. The Revenue from the operation received in cash is £ 100000.
  9. The tax rate on the entity is 30 % of the taxable income.

 Balance sheet

 Translation Table

 

 

Transactions for Year 2013

  1. Entity has recognised the provision for future losses relating to the demolishment of unit 2, which amounts to £ 20000.
  2. The Entity has used its remaining government grants of £ 40000
  3. Cost incurred for construction of building amounts to £ 100000 from which £ 40000 is utilised from the government grant.
  4. Rent paid for office building is £ 2000 per month.
  5. Rent for Building Paid in Advance for 2 months of £ 4000.
  6. Salary paid to Employees is £ 50000.
  7. The Revenue from the operation received in cash is £ 180000.
  8. The tax rate on the entity is 30 % of the taxable income.
  9. Prepaid rent recognised in this year.
  10. Entity has paid its previous year Tax of £ 13,800.

 Income Statement for Year 2013 (According to UK GAAP)

 Particulars

 Amount in £

 Total Revenue From operations

 180000

 Add: Government Grant

 40000

 Less: Administrative Cost(Rent)

 24000

 Less: Other Operating expenses ( provision)

 20000

 Less: Salary Paid

 50000

 Profit before Tax

 126000

 Less: Tax Expense @ 30%

 37800

 Profit

 88200

 

 Balance Sheet as on 31st December, 2013

 Particulars

 Opening balance

     A

     B

      C

     D

    E

     F

     G

     H

        J

  Closing  balance

 Fixed assets

 

 

 

 

 

 

 

 

 

 

 

 Building

 150,000

 

 

 100,000

 

 

 

 

 

 

 250,000

 Land

 200,000

 

 

 

 

 

 

 

 

 

 200,000

 Current assets

 

 

 

 

 

 

 

 

 

 

 

 Cash

 252,000

 

 

 -100,000

 -20,000

 -4,000

 -50,000

 180,000

 

 -13,800

 244,200

 Prepaid Rent

 4,000

 

 

 

 -4,000

 4,000

 

 

 

 

 4,000

 Total assets

 

 

 

 

 

 

 

 

 

 

 698,200

 

 

 

 

 

 

 

 

 

 

 

 

 Equity

 

 

 

 

 

 

 

 

 

 

 

 Share capital

 500,000

 

 

 

 

 

 

 

 

 

 500,000

 Profit

 32,200

 -20,000

 40,000

 

-24,000

 

 -50,000

 180,000

 -37,800

 

 120,400

 Current liabilities

 

 

 

 

 

 

 

 

 

 

 

 Government Grants

 40,000

 

 -40,000

 

 

 

 

 

 

 

 0

 Provision

 20,000

 20000

 

 

 

 

 

 

 

 

 40,000

 Current tax liability

 13,800

 

 

 

 

 

 

 

 37,800

 -13,800

 37,800

 Total equity and liabilities

 

 

 

 

 

 

 

 

 

 

 698200

 

Translation table for IFRS Opening Statement of Financial Position at December, 31st, 2013

Particulars

UK GAAP

Govt. Grant

Development Cost

Provision for Future Losses

Deferred tax

IFRS

Fixed assets

 

 

 

 

 

 

Building

250,000

-40,000

 

 

 

210000

Land

200,000

 

 

 

 

200000

Intangible assets

0

 

12,000

 

 

12000

Current assets

 

 

 

 

 

 

Cash

244,200

40,000

 

 

 

284200

Deferred Tax Asset

 

 

 

 

7200

7200

Prepaid Rent

4,000

 

 

 

 

4,000

Total assets

698,200

 

 

 

 

717400

 

 

 

 

 

 

 

Equity

 

 

 

 

 

 

Share capital

500,000

 

 

 

 

500,000

Profit

120,400

 

12,000

40000

7200

179600

Current liabilities

 

 

 

 

 

 

Government Grants

0

 

 

 

 

0

Provision

40,000

 

 

-40000

 

0

Current tax liability

37,800

 

 

 

 

37800

Total equity and liabilities

698,200

 

 

 

 

717400

 

Income statement – translation table

Particulars

UK GAAP

Government Grant

Development Cost

Provision

Deferred tax

IFRS

Revenue

180000

 

 

 

 

180000

Government Grant

40000

0

 

 

 

40000

Development Cost

0

 

12000

 

 

12000

Administrative Cost

-24000

 

 

 

 

-24000

Provision

-20000

 

 

20000

 

0

Salary Paid

-50000

 

 

 

 

-50000

Tax Paid

-37800

 

 

 

7200

-30600

Profit

88200

 

 

 

 

127400

 

Working Notes

  1. Calculation of Deferred Tax –

Adjustment for:

UK GAAP

IFRS

Difference

Deferred tax (30%)

A for asset,

L or liability

Intangible assets

0

12000

-12000

-3600

L

Provision

40000

0

40000

12000

A

Deferred tax Asset – Opening Statement of Financial Position

8400

Less: previously created

1200

Total

7200

IFRS financial statements for Year 2013

Statement of Financial Position at December, 31st

Particulars

2012

2013

Fixed assets

 

 

Building

110000

210000

Land

200000

200000

Intangible assets

16,000

12000

Current assets

 

 

Cash

292000

284200

Deferred Tax Asset

1200

7200

Prepaid Rent

4,000

4,000

Total assets

623200

717400

 

 

 

Equity

 

 

Share capital

500,000

500,000

Profit

69400

179600

Current liabilities

 

 

Government Grants

40,000

0

Provision

0

0

Current tax liability

13,800

37800

Total equity and liabilities

623200

717400

 

Statement of Comprehensive Income for 2013

Particulars

Amount

Revenue

180000

Government Grant

40000

Development Cost

12000

Administrative Cost

-24000

Provision

0

Salary Paid

-50000

Tax Paid

-30600

Profit

127400

 

 

Statement of Changes in Equity for the year ended December, 31st, 2013

Particulars

Share Capital

Profit

Total

Balance at Jan, 1, 2013

500,000

69,400

569,400

Total Comprehensive Income for 2013

 

127,400

127,400

Balance at Dec, 31, 2013

500,000

196,800

696,800

 

 

 

Cash Flow Statements for the year 2013

Particulars

Amount in

Cash flow from operating activities

 

Profit before tax provision

144,000

Amortization of intangible asset

-4,000

Cash   generated (used) from operations

140,000

Working Capital changes

 

Deferred Tax Assets

-6,000

Government Grants

-40,000

Income tax paid

-13,800

Net cash from operating activities

92,200

 

 

Cash flow from investing activities

Investment in Building

-100,000

Net cash from Investing activities

-100,000

 

 

Cash flow from financing activities

 

 

 

 

Net increase in cash and cash equivalents

-7,800

Cash and cash equivalents at beginning of period

292000

Cash and cash equivalents at end of period

284200

 

 

The impact of the first adoption of IFRS on the entity’s financial position and performance

Opening Statement of Financial Position – reconciliation

Particulars

UK GAAP

Note

Difference

IFRS

Fixed assets

 

 

 

 

Building

150,000

 

40000

110000

Land

200,000

 

 

200000

Intangible assets

0

2

16,000

16,000

Current assets

 

 

 

 

Cash

252,000

 

40,000

292000

Deferred Tax Asset

0

4

1,200

1200

Prepaid Rent

4,000

 

0

4,000

Total assets

606,000

 

 

623,200

 

 

 

 

 

Equity

 

 

 

 

Share capital

500,000

 

0

500,000

Profit

32,200

3

37200

69,400

Current liabilities

 

 

 

 

Government Grants

40,000

1

0

40,000

Provision

20,000

5

20000

0

Current tax liability

13,800

 

0

13,800

Total equity and liabilities

606,000

 

 

623200

 

Notes

  1. The government grants are not deducted from the cost of building as per UK GAAP as government grants are related to the fixed asset i.e. building. These grants are deducted from the cost of building at the date of the opening statement of financial position i.e. balance sheet under IFRS.
  2. The development cost for the company is £20,000. As per UK GAAP, the development costs are not capitalised and £4000 will be deducted from the profit and loss account for 5 years, instead of presenting in the opening statement of financial position, whereas development costs are capitalised and £4000 is amortised each year for 5 years as per IFRS and is included in the opening balance sheet.
  3. The opening balance of retained earnings has changed due to the difference in the accounting treatment, such as government grants, inclusion of intangible assets, and non recognition of provisions and the effect of taxes applicable in the opening statement of the financial position.
  4. The changes in the deferred taxes have occurred due to three significant adjustments that have been taken in account during the translation process. These adjustments relates to provision, intangible assets and government grants.
  5. The provisions related to future losses are permitted under UK GAAP, but are restricted under IFRS due to which these are not included in the opening statement of the financial position.

The first adoption of IFRS by PR Solutions has impacted its financial position in a significant manner due to the above differences in the accounting treatments under two different standards, namely IFRS and UK GAAP.

Closing Statement of Financial Position – reconciliation

Particulars

UK GAAP

Note

Difference

IFRS

Fixed assets

 

 

 

 

Building

250,000

1

40000

210000

Land

200,000

 

0

200000

Intangible assets

0

2

16,000

12,000

Current assets

 

 

 

 

Cash

244,200

 

40,000

284200

  Deferred Tax Asset

  0

  4

  1,200

  7200

  Prepaid Rent

  4,000

 

  0

  4,000

  Total assets

  698,200

 

 

  717,400

 

 

 

 

 

  Equity

 

 

 

 

  Share capital

  500,000

 

  0

  500,000

  Profit

  120,400

 

  59200

  179,600

  Current liabilities

 

 

 

 

  Provision

  40,000

  3

  20000

  0

  Current tax liability

  37,800

 

  0

  37,800

  Total equity and liabilities

  698200

 

 

  717400

 

Notes

  1. The UK GAAP recognises non deduction of government grants from the cost of building and the amount of government grants is subtracted from the cost of building in the opening statement under IFRS, which states that same treatment is done in the closing statement of the financial position as well.
  2. Under UK GAAP the development cost is not capitalised and not included in the closing balance sheet, but as per IFRS, the development costs are capitalised and included in the balance sheet.
  3. The provisions related to future losses are not included in the year 2013 in the closing statement of the financial position under IFRS as compared to UK GAAP, which affects the financial position of the company.
  4. The adjustments in the year 2013 related to the changes in the accounting treatment of different items, such as development costs, provisions, and government grants and taxes affect the deferred taxes for the given year.

Notes

  1. There is an inclusion of development cost under IFRS, whereas there is no inclusion of development cost under UK GAAP due to which there is a positive impact on profit under IFRS.
  2. Provisions are not included in the IFRS and it is charged under the income statement in UK GAAP which has a positive impact on the profit of the company under IFRS.
  3.  There is an inclusion of deferred taxes in the IFRS as compared to UK GAAP which reduces the tax liability of the company and increases its profit.

Problems faced by entities in the UK by the adoption of IFRS for the first time

Entities based in the UK that have adopted UK GAAP face problems at the time of implementing IFRS for the first time for preparing its financial statements. In order to change the financial statements, as per the IFRS, entities have to do analysis of those items and activities that have an impact on their financial statements. Besides this, the collection of the data which is required to make changes in the existing figures due to the changes in the procedure of accounting treatment of different items is also done by the entity. The company have to reassess the accounting policies and standards as these have a great influence on the format of financial statements. It is a very long process and requires huge amount of cost and time. Businesses also face issues related to the audit procedure of the financial position as there is a requirement to audit the financial statements fully from UK GAAP to IFRS (KPMG 2013).

There is a requirement to do detailed analysis of adjustments as IFRS requires inclusion of additional adjustments related to different items that are included in the statements. The adoption of IFRS requires disclosing more information as compared to UK GAAP. Company also finds difficulty in engaging with Audit Committees before a prescribed time so as to spread awareness among them about the procedure, as well as, the impact of adoption of IFRS (KPMG 2013).

 

At the time of adoption of IFRS for first time, company has to follow a set of procedure issued by the IASB, if these entities are adopting it after 1 January 2009 (Deloitte 2013). The treatment of deferred tax is an additional requirement under IFRS that makes the process complex and difficult. The adoption of IFRS forces entity to prepare financial statements of the year in which it is adopted, in addition to a year prior to the adopted year. It also faces difficulty with regard to treatment of taxes. This is because taxes greatly influence the amount of profit earned by the company. The company, in order to reduce its tax liabilities so as to reduce the negative impact on its profitability, has to adopt different measures (Moore Stephens). Besides this, a firm has to classify its assets and liabilities as per the accounting standards of IFRS due to the absence of recognition of some assets and liabilities under UK GAAP. There is also a need to reclassify the opening balances of assets and liabilities of a firm as per the guidelines of IFRS (Deloitte 2013).

References

Deloitte. 2013. IFRS 1 — First-time Adoption of International Financial Reporting Standards. [Ernst & Young. 2011. UK GAAP vs. IFRS. [Online]. Available at: Ernst & Young. 2012. International GAAP 2012 - Generally Accepted Accounting Practice Under International Financial Reporting Standards. John Wiley & Sons

IFRS. 2013. About us. KPMG. 2003. IAS compared with US GAAP and UK GAAP. KPMG. 2013. IFRS Practice Issues. World GAAP Info. 2008. UK FRS.

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