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Make provisions for your future

FRS 12 may have a big impact, but SSAP 25 may override it; property valuations under the microscope; Hampel recommendations find favour.

Provisions are facing an uncertain future, as tighter recognition and measurement rules are introduced by FRS 12: ‘Provisions, contingent liabilities and contingent assets’.

The impact of the new regime is felt by First Leisure, which removes provisions of almost #2m from its balance sheet following the early adoption of the standard. The company releases, by way of a prior year adjustment, a #0.9m provision raised in previous years that fails to meet FRS 12’s recognition criteria. The remaining provisions balance of #1m is reclassified as a reduction in the carrying values of tangible fixed assets and investments. Only a handful of companies have adopted FRS 12 so far but, on this evidence, its effect on provisions may well be colossal.

Override dampens disclosure

There are still concerns that the SSAP 25: ‘Segmental reporting’ prejudicial override renders its requirements effectively optional. The publication of FRS 12 has given analysts a new prejudicial override to contend with – albeit one that is to be used only in ‘extremely rare cases’.

Speciality chemicals company Reflec is defending a legal action concerning the alleged infringement of US patents. In its exceptional items note, the company discloses a #750,000 provision for expected legal costs. It explains, however, that to avoid prejudicing the outcome of the litigation, not all of the information required by FRS 12 is disclosed. This new prejudicial override clause is a recognition of the aversion that companies have to disclosing an estimate of the financial effect of unsettled lawsuits.

Valuations go unrecognised

The Accounting Standards Board takes a dim view of companies carrying ‘revalued’ assets at out-of-date valuations, which is one reason behind its publication of FRS 15: ‘Tangible fixed assets’.

Once FRS 15 becomes effective, companies wishing to recognise revalued assets will have to do so at their current values.

FRS 15, which is effective for accounting periods ending on or after 23 March 2000, seeks to end practices such as that adopted this year by Scottish Highland Hotels. The company discloses that a property valuation was undertaken on 31 October 1998, but that the directors are of the opinion that recognising the resultant #7.4m surplus over book values would be inappropriate given future development plans and the present state of the economy. Accordingly, the properties remain at their 1995 valuation.

While this practice runs contrary to FRS 15, the standard is aimed more at companies failing to recognise valuation deficits, rather than those holding back from recognising surpluses.

Equity accounting avoided

The publication of FRS 9: ‘Associates and joint ventures’ has led to much reclassification between investments, associates and joint ventures.

There is, however, one circumstance where FRS 9 permits companies to override its requirements and treat associates as standard investments.

Under the definitions of both FRS 9 and the Companies Act 1985, Electra Investment Trust holds investments that should be equity accounted for as associates. This is due to Electra having the right (directly or indirectly) to influence the policy decisions of some of the investments that it holds purely for capital appreciation purposes.

Electra’s board is of the opinion that to equity account for investments in which it has no day-to-day involvement would be misleading and the company takes advantage of the FRS 9 option to account for all of its investment fund in the same manner. While this allows Electra to avoid equity accounting and comply with accounting standards, the practice goes against the Companies Act 1985 (Sch 4A para 22(1)), so the true and fair override is invoked. In addition, the company provides pro forma accounts to illustrate how the balance sheet would have looked under equity accounting.

Non-depreciation loses favour

Apart from the occasional blip, the move away from non-depreciation of property continues apace. First Leisure is the latest company to drop the practice, following a comprehensive review of its depreciation and capitalisation policies in the light of the proposals of FRED 17: ‘Measurement of tangible fixed assets’ (since superseded by FRS 15).

First Leisure now depreciates freehold and long leasehold properties but, unlike Slug and Lettuce, does not treat this as a change in its accounting policy. As changes in accounting estimates require no prior year adjustments, the company provides pro forma comparatives to show analysts how the p&l account would have looked had depreciation been charged last year also.

Warming to Hampel

Corporate governance reporting is in a transitional period at present, with the recommendations of Cadbury and Greenbury being succeeded by the combined code of Hampel. While companies still tend to report in terms of the older guidelines, references to the Hampel combined code are becoming more common.

Leisure equipment manufacturer Hawtin states that it supports most of the reforms contained in the Hampel report. The company discloses that a new director has been appointed under a one-year rolling contract, meeting the Hampel recommendation that notice periods be set at no longer than 12 months.

While Greenbury recommended this also, Hampel does not repeat its proviso that periods of up to two years can be acceptable in certain circumstances.

Discounting rears its head

Although FRS 11: ‘Impairment of fixed assets and goodwill’ grabbed the headlines for introducing an unprecedented level of discounting into financial reporting; the use of present values is not restricted to impairment reviews.

Daily Mail and General Trust made several acquisitions this year, with over #90m of the consideration being deferred and contingent on future trading results. Following FRS 7: ‘Fair values in acquisition accounting’, the company discounts the deferred element to present value, giving rise to a finance charge which is spread over the period of deferral. The most crucial aspect of discounting is the selection of the discount rate, as even small differences in the discount factor can lead to material differences in outcome.

Daily Mail and General Trust uses a discount factor that approximates to market rates, in keeping with the FRS 7 requirement to use a discount rate that equates to that at which similar borrowings can be obtained.

Paying the price

Pensions mis-selling in the financial sector has been criticised by many, and the companies involved are beginning to suffer for their actions.

Insurance broker Bradstock provides #3.3m to cover the cost of reviewing cases of possible mis-selling and compensating those who have suffered financial loss as a result. The company points out that this estimate may be exceeded due to factors out of its control, such as movements in long-term interest rates. Financial services company SEC discloses a #1.6m ‘pension review’ charge to profits that comprises costs plus provisions, net of amounts recoverable.

This feature is an edited version of the review published in Company Reporting magazine, a monthly title monitoring financial reporting practices in the UK Details from: 0131 558 1400

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