As if they did not have enough to worry about with the introduction of the euro, finance directors must ensure that the accounting treatment is up to speed. Thankfully, those nice men and women who make up the Urgent Issues Task Force (UITF) have done a boat-load of thinking about the double-entry implications, thus saving the average FD time and stress.
The original premise of the UITF – a sub-committee of the Accounting Standards Board – was as one half of a financial reporting trouble-shooting duo. Partnering the Financial Reporting Review Panel, it was set up to kill off accounting wheezes before FDs and their advisers got too fond of them. However, in the case of the euro (and its constant companion the year 2000), the UITF appears to have turned from the financial reporting equivalent of a terrier into an accounting agony aunt dispensing admittedly strict but worthy advice.
When the UITF was first set up, many of us were revelling in the prospect of financial reporting experts grumpily blasting creative accounting treatments. We must now contain our disappointment that the UITF is working so constructively, helping the preparers of accounts to solve up-and-coming problems – another sign, no doubt, of the improvement in the culture of financial reporting in the UK. In any case, the advent of stage three of Emu will mean that every business will have to spend significant sums to adapt operations and information systems to enable them to deal with the euro.
While politicians may hesitate, such prevarication is not a luxury open to FDs. They need to get their organisations ready for the change regardless of whether their country is involved in the first wave. All those trading in, or with, participating member states will be affected. Even FDs of non-exporting small companies, who would like to believe themselves initially immune, may find multinational suppliers or customers, eager to account in euros.
As a result, the UITF describes three specific accounting issues which, in reverse order of difficulty, are: the treatment of costs incurred in connection with the introduction of the euro, along with the appropriate disclosure; the impact of cumulative foreign exchange differences that become permanent; and, the impact on anticipatory hedging instrument existing at the date of introduction of the euro.
The first question is whether the associated costs of dealing with the euro can be capitalised. This is a hoary old issue and no FD can be surprised that the UITF has stopped that one. Costs can only be capitalised if they give rise to assets and the consensus from the great and the good is that costs such as staff training, modifying software and giving information to customers will not create future economic benefits and therefore they should be written off to the profit & loss account.
The UITF has left open a tiny window: if by spending the cash there is an enhancement of economic benefit by extending the service potential of the asset then that can go on the balance sheet. But FDs will have to work hard to get that one past a half-decent auditor. This is one problem that can largely be solved by disclosure. The abstract encourages companies to spell out the cost in detail and suggests that there may be circumstances where the cost is defined as “exceptional”. The final point on accounting for the costs is that the UITF is insisting that, to be consistent with FRED 14: Accounting for provisions and contingencies, the costs should be recognised in the year in which the work is carried out and no provision should be made for estimated future costs. In other words, no opportunity for a little smoothing.
Nor can FDs use the euro as an opportunity to clean up their reserves. Over the years, most companies will have recognised cumulative foreign exchange translation differences. Locking national currencies will mean those differences are also locked. Translation differences arise when different rates are used at different balance sheet dates to translate the financial statements of foreign entities. These translation differences are taken to reserves and reported in the statement of total recognised gains and losses. And there, says the UITF, they will stay. FRS 3 is clear that the same gains and losses cannot be recognised twice therefore exchange differences must remain in reserves and must not be recycled through the profit & loss account.
The most arcane element of the abstract is the treatment of anticipatory hedges when the euro comes into being. In a way, the hedging question is the mirror image of the foreign currency problem. Foreign exchange contracts – and other financial instruments – are often used to hedge the currency risk. Of course, a major reason for the euro is to kill this exchange risk but in the run-up to, and early years of, the euro these contracts will be in use and unwinding. The UITF advice is simple: carry on as normal. In the absence of an accounting standard for anticipatory hedges, most companies with such instruments have an accounting policy of deferring gains and losses and recognising them in the profit & loss account in the same period as the related income or expense being hedged. The euro has no impact on such an accounting treatment and so gains and losses should continue to be deferred.
It is perhaps not surprising that the abstract published in March is in line with the approach adopted by the International Accounting Standards Committee. Its Standing Interpretations Committee echoes the thinking of the ASB’s UITF – bad news for any FD who thought there might be room for a little standards interpretation arbitrage.
While FDs in some sectors, notably retail, have made great strides in making sure their companies are fit to deal with the euro, many others have not accomplished nearly so much. The impact of the change will be massive, psychologically as well as financially. Whether the information is published in sterling or euros, FDs now have the advice they need to ensure the costs are clearly and consistently accounted for.