The impact of FRS 12: ‘Provisions, contingent liabilities contingent assets’ is being felt this month, as companies eliminate infrastructure renewal provisions, provide in full for site restoration costs and scale down or eliminate ‘big bath’ provisions.
Renewal accounting reworked
It is long-standing practice for companies not to depreciate infrastructure assets and to provide evenly for related renewal costs. FRS 12 abolishes this as such provisions fail to meet its recognition criteria. Fortunately for the companies concerned, FRS 15: ‘Tangible fixed assets’ introduces a new approach which minimises the impact of this change.
Both Hyder and Scottish Power eliminate their renewals provisions on adoption of FRS 12. Following FRS 15, renewal expenditure is now capitalised as an addition to fixed assets and subjected to a depreciation charge equivalent to the annual expenditure required to maintain the assets operating capability.
As disclosed by both companies, the effect on profit is nil as the old renewals provision charges are simply reclassified as depreciation.
The effect on net assets is also nil, representing a direct transfer from provisions to fixed assets. The interaction of the two standards ensures companies can continue to spread renewal costs evenly over the lives of infrastructure assets.
Site restoration costs
Provisions raised for site restoration costs do meet FRS 12’s recognition criteria, but must now be recognised in full immediately an obligation arises, rather than evenly over the life of the site. Fortunately FRS 12 contains a clause that enables companies to continue to spread restoration costs over the life of the site.
After adopting FRS 12, waste-management company Shanks Group provides in full for the present value of site restoration costs, which it used to spread evenly over the lives of the sites concerned.
The resulting increase in provisions of £7.5m does not, however, impact immediately upon the profit-and-loss account as fixed assets, but are instead increased by an equivalent amount. The company discloses that the effect on profit is minimal; replacing the old annual provisions with new depreciation charges of a similar size. FRS 12 permits an asset to be recognised in tandem with a provision in specific circumstances. Thus, the essence of a long-standing practice is maintained.
Emptying the big bath
One of the main motivating factors behind FRS 12 was the Accounting Standards Board’s perception that companies were over-providing for the costs of major events then using the provision against unrelated expenses. FRS 12’s attempt to pull the plug on these ‘big bath’ provisions by setting tight recognition criteria, this appears to be having the desired effect.
For example, this month EMI reduces disposal and reorganisation provisions by £27m and acquisition and integration provisions by £4m. Similarly, J Sainsbury uses a prior-year adjustment to reverse an £89m provision set up to cover integration costs connected with Texas Homecare.
It is the stated objective of FRS 15 that companies choosing to revalue fixed assets should keep their revaluations up to date. It is hard to reconcile this with its transitional option that permits companies to carry assets at frozen revaluations for an unlimited length of time.
Marks & Spencer and Scottish Power adopt FRS 15 and disclose that they do not intend to revalue assets in future. Rather than restate all revalued assets back to historical cost, both companies carry them forward at existing valuations, disclosing that they will not be updated.
This option, available to companies on initial adoption of FRS 15, overrides the standard’s primary objective and means outdated valuations may still be a feature of balance sheets for many years to come.
Merger accounting headaches
Merger accounting remains available for use in limited circumstances.
This month, it is used by Invensys, formed by the merger of BTR and Siebe, and by Seton Scholl Healthcare, formed by the merger of Seton Healthcare and Scholl. In both cases, substantial adjustments are made to the carrying values of intangible assets carried forward into the merged companies by the combining entities.
Pre-merger Siebe recognised intangible assets arising on acquisition whereas BTR subsumed them within goodwill. Post-merger Invensys adopts BTR’s policy as it would be impractical to value intangibles that arose on previous acquisitions. As a result, £278m of intangibles carried in the accounts of Siebe are written off as a merger adjustment. Invensys adds that it will follow the recognition criteria of FRS 10 from the date of the merger. Similarly, Seton Scholl Healthcare does more than simply combine the intangible assets of Seton Healthcare and Scholl. Scholl’s intangibles are amalgamated into one Scholl brand and all #8m of Seton Healthcare’s intangibles are written off in full. The company says it wanted to ‘tidy up’ the balance sheet so only the Scholl brand was recognised.
Adopting foreign standards
UK shareholders of British Steel and British Telecommunications need not worry about receiving less segmental information than their US counterparts, as both companies have adopted the relevant US standard for their UK accounts.
US SFAS 131: ‘Disclosures about segments of an enterprise and related information’ differs from its UK equivalent, SSAP25: ‘Segmental reporting’, by taking a management approach to defining business segments. As a result, British Telecommunications provides additional segmental information to that required under UK GAAP. In contrast, adopting SFAS 131 has had no effect on the segmental disclosures of British Steel, which states that it operates in one reportable segment under the provisions of both standards.
The above analysis is drawn from the new issue of Company Reporting, a monthly title monitoring financial reporting practices in the UK. For subscription details, telephone 0131 558 1400.
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