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  • Page extent: 226 pages
  • Size: 228 x 152 mm
  • Weight: 0.493 kg
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 (ISBN-13: 9780521607223 | ISBN-10: 0521607221)

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Accounting Principles for Lawyers




Many lawyers, especially those dealing with commercial matters, need to understand accounting yet feel on shaky ground in the area. This book is written specifically for them. It breaks down and makes clear basic concepts (such as the difference between profit and cash flow), and explains the accounting profession and the legal and regulatory framework within which accounting operates. The relevant provisions of the Companies Act 1985 are discussed at some length. Holgate explains generally accepted accounting principles (GAAP) in the UK, the trend towards global harmonisation and the role of international accounting standards. He then deals with specific areas such as group accounts, acquisitions, tax, leases, pensions, financial instruments, and realised profits, focusing in each case on those aspects that are likely to confront lawyers in their work. This book will appeal to the general practitioner as well as to lawyers working in corporate, commercial, and tax law.

PETER HOLGATE is Senior Accounting Technical Partner at PricewaterhouseCoopers LLP in the UK.







Law Practitioner Series




The Law Practitioner Series offers practical guidance in corporate and commercial law for the practitioner. It offers high-quality comment and analysis rather than simply restating the legislation, providing a critical framework as well as exploring the fundamental concepts which shape the law. Books in the series cover carefully chosen subjects of direct relevance and use to the practitioner.

   The series will appeal to experienced specialists in each field, but is also accesssible to more junior practitioners looking to develop their understanding of particular fields of practice.

   The Consultant Editors and Editorial Board have outstanding expertise in the UK corporate and commercial arena, ensuring academic rigour with a practical approach.

Consultant editors
Charles Allen-Jones, retired senior partner of Linklaters
Mr. Justice David Richards, Judge of the High Court of Justice, Chancery Division

Editors
Chris Ashworth – Ashurst Morris Crisp
Professor Eilis Ferran – University of Cambridge
Nick Gibbon – Allen & Overy
Stephen Hancock – Herbert Smith
Judith Hanratty – BP Corporate Lawyer, retired
Keith Hyman – Clifford Chance
Keith Johnston – Addleshaw Goddard
Vanessa Knapp – Freshfields
Charles Mayo – Simmons & Simmons
Andrew Peck – Linklaters
Richard Snowden QC – Erskine Chambers
Richard Sykes QC
William Underhill – Slaughter & May
Sandra Walker – Rio Tinto

Other books in the Series
Stamp Duty Land Tax
Michael Thomas, with contributions from KPMG Stamp Taxes Group; Consultant Editor David Goy QC

The European Company: Volume I General editors Dirk Van Gervan and Paul Storm







Accounting Principles for Lawyers




PETER HOLGATE
PricewaterhouseCoopers LLP







CAMBRIDGE UNIVERSITY PRESS
Cambridge, New York, Melbourne, Madrid, Cape Town, Singapore, São Paulo

Cambridge University Press
The Edinburgh Building, Cambridge CB2 2RU, UK

Published in the United States of America by Cambridge University Press, New York

www.cambridge.org
Information on this title: www.cambridge.org/9780521607223

© Cambridge University Press 2006

This book is in copyright. Subject to statutory exception
and to the provisions of relevant collective licensing agreements,
no reproduction of any part may take place without
the written permission of Cambridge University Press.

First published 2006

Printed in the United Kingdom at the University Press, Cambridge

A catalogue record for this book is available from the British Library

Library of Congress Cataloguing in Publication data
Holgate, Peter, 1953–
Accounting principles for lawyers / Peter Holgate. – 1st ed.
p. cm. – (Law practitioner series)
Includes bibliographical references and index.
ISBN-13: 978-0-521-60722-3 (hardback)
ISBN-10: 0-521-60722-1 (hardback)
1. Accounting – Great Britain. 2. Accounting – Standards – Great Britain. 3. Accounting –
Wales. 4. Accounting – Law and legislation – England. 5. Accounting – Law and
legislation – Wales. I. Title. II. Series.
HF5616.G7H65 2006
657′.02′434 – dc22 2005020132

ISBN-13 978-0-521-60722-3 hardback
ISBN-10 0-521-60722-1 hardback




Cambridge University Press has no responsibility for the persistence or accuracy of URLs for external or third-party internet websites referred to in this book, and does not guarantee that any content on such websites is, or will remain, accurate or appropriate.







Contents




  Acknowledgements page ix
  Glossary of terms x
 
Part I   The accounting environment
 
1   Introduction 3
  Aim of this book 3
  What is accounting? 3
  The components of a company’s annual report 4
  The meaning of accounting terms 6
  The use of accounting terms in legal agreements 8
  What is GAAP? 9
  Selecting and disclosing accounting policies 10
 
2   UK GAAP and international harmonisation 12
  The UK Accounting Standards Board 12
  International harmonisation 14
  The International Accounting Standards Board 15
  The EU Regulation for harmonisation within Europe 17
  Convergence with US GAAP 19
  Implications for the UK 20
 
3   The legal framework for accounting 22
  The Companies Act 1985 22
  Application of the Companies Act to UK GAAP companies and to IFRS companies 23
  Accounting provisions of the Act – Part VII 24
  Accounting provisions of the Act – Schedule 4 29
  Accounting provisions of the Act – Schedule 4A 43
 
4   Substance over form 48
  Form v. substance 48
  Early examples 48
  Emergence of the off balance sheet industry 49
  FRS 5 ‘Reporting the substance of transactions’ 49
  Examples of FRS 5 in practice 52
  The future of FRS 5 55
 
5   The accounting profession and the regulatory framework for accounting and auditing 56
  The accounting profession 56
  The Financial Reporting Council 57
  Audit reporting 61
  The role of accountants in transactions 62
 
6   Communicating accounting information 64
  Background 64
  The corporate reporting supply chain 64
  The reality of the ‘earnings game’ 65
  Adjusted earnings numbers 67
  Users and analysis of accounting information 68
 
7   Current trends in accounting 69
  Why all the change? 69
  Current trends in thinking 71
 
Part II   Some specifics
 
8   Individual entity accounts and consolidated accounts 77
  The distinction between entity accounts and consolidated accounts 77
  When to consolidate 79
  What to consolidate 80
  Techniques of consolidation 87
  Associates and joint ventures 88
 
9   Mergers and acquisitions 91
  Introduction 91
  Companies Act 1985 requirements 91
  The current UK standards in overview 98
  Merger accounting in the UK 98
  Acquisition accounting in the UK 102
  Goodwill and other intangibles under UK GAAP 106
  Application of IFRS 3 107
  Reform of IFRS and UK GAAP 109
 
10   Interaction of accounting with tax 110
  Introduction 110
  Accounting profit and its adjustment 110
  Accounting for current and deferred tax 111
  HM Revenue and Customs and the move to IFRS 114
 
11   Assets 117
  Introduction 117
  Recognition of assets 117
  Measurement of assets 117
  Impairment of assets 118
  Classification and presentation of assets 119
  Depreciation 120
  Disclosure 121
 
12   Liabilities 122
  Introduction 122
  Definition of liabilities 122
  Recognition of liabilities 123
  Measurement of liabilities 125
  Presentation of liabilities on balance sheets 125
  Disclosure, including contingent liabilities 126
  Liabilities under IFRS 127
 
13   Leases 128
  Introduction 128
  Leases under UK GAAP 129
  Leases under IFRS 136
  The way forward 137
 
14   Pensions 138
  Introduction 138
  Defined contribution and defined benefit 138
  Accounting for defined benefit schemes 139
  FRS 17 140
  IAS 19 142
  The effect of pensions on realised profits 143
 
15   Financial instruments, including capital instruments 144
  Introduction 144
  Background 144
  Definitions 145
  Basic classification rule 146
  Shares 147
  Equity instruments – accounting treatment 151
  Financial liabilities – accounting treatment 152
  Disclosure 155
  Treasury shares 156
  Repurchase and cancellation of shares 157
  Financial instruments other than capital instruments 157
  Accounting under IFRS 159
 
16   Realised and distributable profits 160
  Introduction 160
  ‘Realised’ and ‘distributable’ 160
  General rules on distributions 161
  Relevant accounts 163
  Relationship with reporting of performance 163
  Tech 7/03 165
  Effects of Tech 7/03 169
 
17   Disclosures in published accounts 174
  Introduction 174
  Corporate governance disclosures 174
  Operating and financial review 177
  Directors’ report 180
  Directors’ emoluments 180
  Related party relationships and transactions 182
  Segment disclosure 183
 
18   Use of financial information in contracts and agreements 185
  Introduction 185
  Case study 1 – borrowing covenants 186
  Case study 2 – sale and purchase of a subsidiary 189
 
  Appendices
  Appendix 1: List of UK accounting standards (SSAPs and FRSs), Statements and UITF Abstracts 195
  Appendix 2: List of international accounting standards (IASs and IFRSs) and IFRIC interpretations 198
 
  Index 201






Acknowledgements




My thanks are due to a number of people, without whom this book would not have appeared. First to Professor John Tiley of Cambridge University who did not so much plant a seed thought but watered a seed that had lain unattended for some years. Second, to Kim Hughes of Cambridge University Press for guiding me through the publishing process.

   Thanks are also due to many colleagues at PricewaterhouseCoopers LLP. To the whole Accounting Technical department, for providing me with a learning environment and a stock of knowledge, much of which appears in these pages. In particular, to Barry Johnson and Helen McCann for their excellent work on the ‘PwC inform’ database and the two PwC Manuals of Accounting: the ‘Manual of Accounting: UK GAAP’ and the ‘Manual of Accounting: IFRS for the UK’. Readers who need more detail than is found in this slim volume are referred to those works.

   I thank Elizabeth Buckley for her extensive help in detailed review of the entire text and for drafting assistance on some sections. Thanks also to Chris Nobes for his helpful review comments.

   Finally, I thank my wife, Nelda, and my son, Andrew. This book was for many months my Sunday morning job, and the need for the Holgate alarm clock to sound early on a Sunday morning was a point of some discussion on certain occasions. I thank them for their forbearance and dedicate this book to them.

   The law as stated in this book is correct as at 31 March 2005.







Glossary of terms




ACCA. Association of Chartered Certified Accountants.

Accruals accounting. The method of accounting that underpins the profit and loss account and balance sheet, namely recognising transactions in the period to which they relate, rather than in the period in which the cash is received or paid. Hence (a) the charge in the profit and loss account for an expense is not (except by chance) the same as the amount of cash paid; (b) the amount recognised as revenue (or turnover, or sales) for the year, is not (except by chance) the same as the cash received from customers.

Act (or ‘The Act’). Unless specified to the contrary, ‘Act’ or ‘The Act’ refers to the Companies Act 1985.

AIDB. Accountancy Investigation and Discipline Board. Part of the FRC.

AIM. Alternative Investment Market.

APB. The UK Auditing Practices Board. Part of the FRC.

ARC. Accounting Regulatory Committee (of the EU).

ASB. The UK Accounting Standards Board. Part of the FRC.

ASC. The UK Accounting Standards Committee, which set standards from 1970 to 1990, when the ASB took over the activity.

Asset. In a formal sense, the UK Statement of principles (para. 4.6) defines assets as: ‘rights or other access to future economic benefits controlled by an entity as a result of past transactions or events’. Less formally, an asset is something of value that a company has; it is recognised as an asset on the balance sheet if it meets certain recognition criteria, such as whether it can be measured reliably.

Associated undertaking. An entity (other than a subsidiary or joint venture) in which another entity (the investor) has a participating interest and over whose operating and financial policies the investor exercises a significant influence. [FRS 9, para. 4]

CA 1985. The Companies Act 1985.

CCAB. The Consultative Committee of Accountancy Bodies in the UK and Ireland, which comprises:

  • The Institute of Chartered Accountants in England and Wales (ICAEW)
  • The Institute of Chartered Accountants of Scotland (ICAS)
  • The Institute of Chartered Accountants in Ireland (ICAI)
  • The Association of Chartered Certified Accountants (ACCA)
  • The Chartered Institute of Management Accountants (CIMA)
  • The Chartered Institute of Public Finance and Accountancy (CIPFA)

CESR. Committee of European Securities Regulators.

CIMA. Chartered Institute of Management Accountants.

CIPFA. Chartered Institute of Public Finance and Accountancy.

Combined Code. The UK code of corporate governance, the latest version of which (2003) is published by the Financial Reporting Council.

DB. Defined benefit (pension scheme).

DC. Defined contribution (pension scheme).

Debit/credit. These are bookkeeping terms. A debit entry represents either an expense or an asset (or a reduction of a liability). A credit entry represents either income or a liability (or a reduction of an asset). The application of accounting principles in drawing up financial statements involves determining which debits are to be treated as assets and which are to be treated as expenses; and determining which credits are to be treated as liabilities and which are to be treated as equity or income. As an example, a payment of cash of £100 to acquire stock is represented as: Dr Stock £100 (an increase in the asset ‘stock’); Cr Cash £100 (a decrease in the asset ‘cash’).

Deferred tax. Estimated future tax consequences of transactions and events recognised in the financial statements of the current and previous periods. [FRS 19, para. 2]

DTI. The UK Department of Trade and Industry.

Earnings. An undefined term, broadly equivalent to profits. Generally refers to profit after tax and minority interest. More accurately, it refers to profit after tax, minority interest and preference dividend, this being the definition of earnings used in the calculation of EPS (see below).

EBITDA. Earnings before interest, tax, depreciation and amortisation. This is a measure of earnings favoured by some analysts and some companies. Depreciation and amortisation are added back because they are non-cash items. Hence EBITDA is sometimes called ‘cash earnings’ though this is something of a misnomer, as it still includes many items calculated on an accruals basis.

EFRAG. The European Financial Reporting Advisory Group, part of the mechanism used by Brussels to help it to consider endorsement of International Financial Reporting Standards for use in the EU.

Entity accounts. The accounts of an entity itself – for example the accounts of a single company – as opposed to consolidated accounts. See chapter 8.

EPS. Earnings per share. Broadly, earnings (profit after tax, minority interest and preference dividend) divided by the number of equity shares in issue during the year. The details are set out in FRS 22.

Equity. (1) The IASB’s term for shareholders’ funds. (2) An equity share, defined in section 744 of the Act as ‘in relation to a company, its issued share capital excluding any part of that capital which, neither as respects dividends nor as respects capital, carried any right to participate beyond a specified amount in a distribution’. Note that FRS 4 ‘Capital instruments’ defines non-equity shares in a way that gives equity shares for FRS 4 purposes a different meaning from that in the Act.

Equity accounting. This is also known as ‘the equity method’. It is the method of accounting adopted for associated companies and in certain cases for joint ventures, as explained in chapter 8.

ESOP. Employee Share Ownership Plan.

Expense. A reduction in assets, charged in the profit and loss account. This includes non-cash items such as depreciation of fixed assets.

FASB. The US Financial Accounting Standards Board.

Financial statements. A company’s annual financial statements, which comprise the profit and loss account, the statement of total recognised gains and losses, the balance sheet, the cash flow statement and various supplementary notes. They form the major part of the company’s annual report; this is sent to shareholders and placed on the public record at Companies House. Can also refer to other contexts, such as interim financial statements.

FLA. Finance and Leasing Association.

FRC. The UK Financial Reporting Council, the body that oversees the regulation of corporate reporting and audit, including the UK ASB and the FRRP.

FRRP. The UK Financial Reporting Review Panel. Part of the FRC.

FRS. A UK Financial Reporting Standard, an accounting standard developed by the ASB. See also SSAP.

FRSSE. Financial Reporting Standard for Smaller Entities.

FSA. The UK Financial Services Authority.

GAAP. Generally accepted accounting principles, discussed in chapter 1.

Gearing. The relationship between debt and equity. Gearing can be calculated in a number of ways. See chapter 18 for details.

Gross profit. This is profit measured as revenue less cost of sales, that is, profit before deducting overhead expenses, interest and tax.

IAS. An international accounting standard issued by the IASC.

IASB. The International Accounting Standards Board, the global standard-setter from 2001.

IASC. The International Accounting Standards Committee, the global standard-setter until 2001.

ICAEW, ICAS, ICAI. See CCAB.

IFRIC. The International Financial Reporting Interpretations Committee, a subsidiary of the IASB.

IFRS. An international financial reporting standard issued by the IASB.

Income. An undefined term, used rather loosely. Can be used as a synonym for profit (e.g. in US parlance ‘net income’ means profit after tax). Sometimes also, confusingly, used to mean revenue.

Interest cover. The ratio of interest cost to profit before interest. So if profit before interest is 100 and interest cost is 25, interest cover is 4. That is, interest is covered 4 times by profits.

Interims. Interim reports published by listed companies, required by the FSA as Listing Authority.

Joint venture. An entity in which the reporting entity holds an interest on a long-term basis and is jointly controlled by the reporting entity and one or more other venturers under a contractual arrangement. [FRS 9, para. 4]

JV. Joint venture.

KPI. Key performance indicators.

Liability. In a formal sense, the ASB’s Statement of principles (para. 4.23) defines liabilities as: ‘obligations of an entity to transfer economic benefits as a result of past transactions or events’. Less formally, a liability is something that a company owes to a third party; it is recognised as a liability on the balance sheet if it meets certain recognition criteria, such as whether it can be measured reliably.

Listing Rules. The rules issued by the Financial Services Authority that apply to companies listed on the London Stock Exchange.

LTIP. Long-term incentive plan.

Minority interest. The interest of an outside shareholder in a partially-held subsidiary.

NASDAQ. National Association of Securities Dealers Automated Quotation system).

NRV. Net realisable value.

OFR. The Operating and Financial Review. This was for some time recommended by the ASB as a supplementary report to be given by listed companies, mainly in narrative form. It is now becoming a statutory requirement for listed companies.

Operating profit. A measure of profit after deducting all operating expenses but before adding share of results of associates and joint ventures, and before deducting interest and tax. In UK GAAP, certain exceptional items (non-operating exceptionals, or ‘super-exceptionals’) are also added/deducted after operating profit.

P & L. Profit and loss.

Participating interest. An interest held by an undertaking in the shares of another undertaking which it holds on a long-term basis for the purposes of securing a contribution to its activities by the exercise of control or influence arising from or related to that interest. [CA1985, section 260]

POBA. The UK Professional Oversight Board for Accountancy. Part of the FRC.

Prelims. Preliminary announcements of results by listed companies as required by the Listing rules.

Profit. A measure of the results of a business on the basis of accruals accounting (see above). (See also Gross profit, Operating profit, Profit before tax, Profit after tax.)

Profit after tax. A measure of profit after deducting all expenses including tax.

Profit before tax. A measure of profit after deducting all expenses apart from tax.

Revenue. The amount earned by an entity from selling goods and services. The terms ‘sales’ and ‘turnover’ are broadly synonymous with revenue.

Sales. See Revenue.

SAS. Statement of Auditing Standards.

SEC. Securities and Exchange Commission.

Shareholders’ funds. The aggregate of a company’s share capital and its reserves. Called ‘equity’ in IFRS.

SIC. Standing Interpretations Committee of the IASC.

SoP. Statement of principles.

SORP. Statement of Recommended Practice.

SPE. Special purpose entity.

SSAP. A UK Statement of Standard Accounting Practice, an accounting standard developed by the ASC. See also FRS.

STRGL. The statement of total recognised gains and losses. This is a statement required by UK GAAP as a continuation of the profit and loss account. Together the two statements give a more comprehensive picture of economic performance than does the profit and loss account alone. Broadly, the distinction is that the STRGL includes value changes, such as gains and losses on revaluing a property, whereas the profit and loss account deals with transactions.

Subsidiary/Subsidiary undertaking. Under IFRS, a subsidiary is ‘an entity, including an unincorporated entity such as a partnership, that is controlled by another entity (known as the parent)’. For UK GAAP and UK law purposes, there is a distinction between ‘subsidiary’ and ‘subsidiary undertaking’. Section of the Act defines a ‘subsidiary’ for the general purposes of the Act but not for accounting purposes. Section 258 of the Act defines a ‘subsidiary undertaking’ for accounting purposes, chiefly in connection with consolidation.

Turnover. See Revenue.

UITF. The UK Urgent Issues Task Force. This is a subsidiary of the ASB.

XBRL. Extensible Business Reporting Language.


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