UK: Changes To Accounting Requirements

The Regulations have effect with regard to companies’ financial years beginning on or after 1 January 2005. The resulting changes to accounting and auditing requirements will affect all companies required to prepare accounts by the Companies Act 1985. They implement EU legislation - the IAS Regulation, the Accounts Modernisation Directive and the Fair Value Directive. Some are minor, but others, particularly in the IAS Regulation, are more fundamental.

International Accounting Standards (IAS) are standards inherited by the International Accounting Standards Board (IASB). The IASB issues International Financial Reporting Standards (IFRS). The terms IAS and IFRS are used interchangeably. The European Commission (EC) has adopted all standards and interpretations of the IASB with certain exceptions - full details can be found on: www.europa.eu.int/comm/internal_market/a ccounting/ias_en.htm#adopted-commission

Companies governed by the law of an EU Member State whose securities (debt securities and/or shares) are traded on a regulated market in any EU Member State are required to prepare their consolidated accounts on the basis of the accounting standards of the IASB adopted by the EC. In the UK the regulated markets currently include the markets of the London Stock Exchange (LSE), other than AIM which is to be included with effect from 1 January 2007. If a parent company is obliged (or opts) to use IAS then each of its subsidiary undertakings must do so as well (unless there are good reasons for not doing so).

Additionally, publicly traded companies can choose to use IAS in their individual accounts. Non-publicly traded companies can use IAS in their individual and consolidated accounts. The only exceptions are charities which cannot use IAS at all. In general, once a company has used IAS, it cannot subsequently use UK GAAP.

IAS deal with the form and content of accounts (for example primary financial statements and supporting notes will replace a profit and loss account and a balance sheet). There is some press speculation as to whether the new IAS requirements on disclosing and valuing derivatives will alter companies’ hedging tactics.

Certain changes in the Regulations apply to accounts prepared in accordance with the Act (not IAS), many of which are being reflected in new UK FRS. Those on presentation align these accounts more closely with IAS. Information on derivatives and dividends has to be disclosed. Fair value accounting can be used for some financial instruments, investment property and/or living plants and animals.

Changes have been made to the rules on parent/subsidiary relationships and the exemption of some subsidiary undertakings from inclusion in consolidated accounts. Some changes have been made to the audit report requirements. Accounts under the Act are to give a "true and fair view" whilst accounts under IAS are to "present fairly".

The changes mean that the FSA is making urgent adjustments to its regulatory rules with effect from 1 July 2005. Further changes will be made when the accounting has settled down and the Capital Requirements Directive implementing the revised Basel Framework is in place. These may well have an effect on facilities, such as securitisations, and the costs of providing them to borrowers and issuers.

The Loan Market Association (LMA) and the Association of Corporate Treasurers (ACT) have issued a Joint Statement on IFRS highlighting the need to consider differences between IFRS and other accounting standards. Provisions in facility agreements might need to be amended. Similar issues may arise from some of the other accounting changes effected by the Regulations. The ACT has also published a Briefing Note on communications with lenders.

Many facility agreements contain a "frozen GAAP" provision requiring a borrower to deliver financial statements prepared using GAAP and accounting practices consistent with those originally provided. Where changes have occurred, the financial statements have to be accompanied by sufficient information to enable the lenders to accurately compare the latest financial statements and the original ones. If such a frozen GAAP provision exists, there may be no need to make immediate amendments. However, complying with these requirements may be burdensome.

Lenders and borrowers need to consider the terms of existing facility agreements and bond documents in view of the mandatory changes effected by the Regulations and any options which companies exercise under them. Amendments or waivers may be required.

Some relevant provisions will be easily identifiable, e.g. those specifying form and content of financial statements, audit reports and compliance certificates, accounting principles to be used, definitions for financial covenants and loan to value covenants and financial triggers for margin adjustments or prepayments. There may be changes in the way in which property valuations are determined.

Other provisions may not be so obviously affected, e.g. the term "Subsidiary" can be defined as a subsidiary undertaking within the meaning of section 258 of the Act (which has been amended by the Regulations). This could mean that entities which did not previously fall within the defined term of Subsidiary, now do so with unforeseen results in representations, covenants and events of default.

Given the ongoing development of UK FRS and IAS/IFRS and other international initiatives, the LMA and the ACT have suggested that "frozen GAAP" provisions should be included in syndicated facility agreements within a clause allowing the borrower and the agent to agree amendments dealing with future changes which would be binding on all parties. Similar provisions might usefully be considered for other documents as well.