Accounting policies - FRS 18

FRS 18 - Accounting policies (In force for year ends ending after 22 June 2001)

Although this standard is written in highly technical terms and has its roots deep in the ASB's conceptual framework, the subject matter is straightforward and familiar. The key enhancements to existing guidance are requirements that:

Accounting policies must be reviewed regularly and changed if necessary.
Where there is a choice of permissible accounting policy, directors should adopt that which is considered most appropriate to the entity's particular circumstances.
Similarly, where any accounting entry has to be estimated, directors must adopt the most appropriate available technique to do so.
Where applicable, the following extra disclosures are required in the financial statements:

A statement of compliance with or departures from any Statement of Recommended Practice (SORP) for the type of entity concerned
Any material uncertainties relating to the adoption of the going concern basis
A description of any estimation techniques used where the range of monetary values that could result from using a particular technique and set of assumptions, as opposed to others, is significant.

At first glance this is a fairly anodyne Standard that merely codified extant practice. FRS 18 requires disclosure of accounting policies, any significant uncertainty relating to the going concern assumption and any use of the true and fair override. More substantially, however FRS 18 also contains two key obligations that have sent a number of companies back to their financial statement drawing boards:

Accounting policies should be reviewed regularly to ensure that those adopted remain the most appropriate to the company
Estimation techniques (used in preparing financial statements) should also be those that are most appropriate in the particular circumstances.

Aggressive accounting - testing the limits of permissible cost capitalisation and deferral and permissible income anticipation - was already under genteel attack prior to Enron. Now, a concern about accounting practices is enough to move a share price. Whilst the requirements of FRS 18 are nothing like having the Review Panel on the doorstep, they do make the adoption of the most appropriate accounting methods a matter of routine, self determined adjustment.

These reviews and reassessments have typically led to the voluntary adoption of more conservative accounting treatments, for example:

Writing off development costs as incurred, rather than capitalising and amortising them (both presently permitted by SSAP 13)
Writing off pre-contract bid costs as incurred (unless recovery is provided for in the contract) rather than capitalising them and then assessing them for recoverability
Recognising income on delivery of goods rather than on an earlier receipt of a customer's payment (there is no general standard in the UK on income recognition)
Recognising income at project completion rather than over the duration of the contract (SSAP 9 requires that income and costs relating to long term contracts are spread)
Recognising property sales on completion rather than on exchange of contracts
Identifying and deferring income relating to the ongoing service or maintenance elements within an overall sales contract
Deferring initial subscriptions such as connection charges over the estimated lengths of the customer relationships
Substantially increased warranty provisions
The consolidation of special purpose vehicles previously carried off balance sheet.

The examples above show companies taking the initiative and amending policies and treatments that appear not to have been under any overt attack and that they and their auditors have previously found acceptable. I think these companies are recognising that accounts prepared using prudent accounting policies not only "tell it like it is" but also set more sustainable trend lines for profit and turnover, and this is true whether a company is preparing its accounts for the city or for its bank manager.

As Disraeli said "Change is inevitable in a progressive country. Change is constant." So don't forget to review your accounting policies this year.

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