For 30 years, Statement of Standard Accounting Policies 2 Disclosure of accounting policies was the nearest thing that most FDs got to thinking about the theoretical nature of their work. Even then, as the ASB points out, the authors of SSAP2 were keen to emphasise that their descriptions of fundamental accounting concepts were not intended to stand for all time, but simply reflected “present generally-accepted meanings”. In other words, they were practical rules, not theoretical ideas. Nevertheless, SSAP2 named going concern, accruals, consistency and prudence as “fundamental accounting concepts”. But life has moved on since SSAP2 arrived in 1971 and, although the four ideas are still important, they have lost that “fundamental” tag in the new exposure draft, FRED21 Accounting policies, published in December. For instance, going concern and accruals are now described by the ASB as “part of the bedrock of accounting” and vital to the selection of accounting policies. But the proposals on accruals deal with only part of how the concept is used. As every FD knows, SSAP2 requires revenue and expenses to be matched where possible – in contrast, FRED21 discusses the accruals concept simply as meaning that the effects of transactions and other events should be reflected, as far as possible, in the period in which they occur rather than in the period when cash passes. The long-awaited Statement of Principles, issued at the same time as FRED21, sets out the qualities of useful financial information that should be included in financial statements. According to the ASB, what makes financial information useful is whether it is material, relevant, reliable, comparable (which implies consistency) and understandable. It is against the background of those characteristics that companies need to frame accounting policies. After all the controversy surrounding the finalisation of the SoP, the ASB is keen to portray the update of SSAP2 as little more than a makeover – the financial equivalent of getting rid of flares and tanktops. However, FRED21 is in reality more far-reaching than that. For example, the new exposure draft sets out the circumstances in which an entity should also disclose the “estimation techniques” used in applying accounting policies. The standard-writers of the 1960s and 1970s hadn’t bothered with estimation techniques but these have grown up higgledy piggledy over the past few years, so the revision of SSAP2 provides the opportunity to set them out tidily. According to the ASB, accounting policies are “the specific principles, bases, conventions, rules and practices applied by an entity in order to reflect the effects of transactions and other events” through recognising and selecting measurements bases. Estimation techniques are the methods and estimates which companies use to arrive at monetary values for their assets and liabilities, gains and losses. For instance, an estimation technique could be a method of depreciation used to estimate the economic benefit of a tangible fixed asset consumed in a period. Setting these policies is clearly a matter of judgement, which FDs must exercise and which auditors must then ensure are sound. As we all know, the results published in an annual report are the outcome of many finely-balanced decisions. The ASB acknowledges that companies have to balance the (sometimes conflicting) demands of relevance, reliability, comparability and understandability. For instance, sometimes the accounting policy that is most relevant to a particular company’s circumstances is not the most reliable, and vice versa. The ASB sets out very clearly how FDs should resolve this tension: in such circumstances, the most appropriate accounting policy will be that which is “the most relevant of those that are reliable”. Perhaps more important than relevance or reliability is the contrast between two aspects of reliability – neutrality and prudence. The FRED says: “Whilst neutrality involves freedom from deliberate or systematic bias, prudence is a potentially biased concept that seeks to ensure that, under conditions of uncertainty, gains and assets are not overstated and losses and liabilities are not understated. In the selection of accounting polices, the competing demands of neutrality and prudence are reconciled by finding a balance that ensures that the deliberate and systematic understatement of assets and gains and overstatement of liabilities and losses do not occur.” This paragraph is calling for a fundamental shift in the psyche of the accountancy profession. For decades, the FD has been respected – and mocked – for his or her cautious approach to presenting and representing the fortunes of a business in terms of numbers. This revision of SSAP2 is striking because it is clearly telling FDs that prudence should be dropped down the order. It will be interesting to see how that switch of emphasis worked out in practice by FDs. Peter Williams is a chartered accountant and freelance journalist.
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