Several weeks ago, the UK voted to leave the European Union. The political and economic implications are the subject of much speculation. But what about financial reporting? What follows is a brief personal view on what might lie ahead, drawing on a number discussions in recent weeks with standard setters, members of the Institute of Chartered Accountants of England and Wales (ICAEW), and colleagues in institutes outside of the UK.
In the short term, no aspect of the UK or EU financial reporting regime will change. It may be unwise to assume that the looming Brexit will not affect the way that UK regulators, policy makers, and businesses regard, respond, and react to EU laws and legislative initiatives, or the way their EU counterparts deal with the UK. But the fact remains that the UK is still a full member of the EU right now, with the rights and obligations associated with membership. The UK regulatory framework continues to apply, as do existing EU laws and regulations, and the UK will need to continue to work toward implementing new EU requirements on schedule. For example, EU law requires the Non-Financial Reporting Directive be transposed into UK law by December 2016. Plans to achieve this in the UK are well advanced, and the process of implementation will continue.
Nothing is likely to change either on the face of it when the UK government decides to invoke Article 50 of the Lisbon Treaty and officially notifies the EU of the UK’s intention to leave. This official notification may not happen for some time, as indicated by the new Prime Minister, Theresa May. In the meantime, the UK will remain a member state and will continue to be so for up to two years after the date that the notice is served—or even longer is all EU member states agree.
Although any changes to how UK organizations report won’t take effect for some time, in many cases the vote to leave the EU and its immediate economic impacts will affect what is reported by individual businesses and other reporting entities in their half-yearly and annual financial reports. Boards will need to think carefully about what Brexit means for their organizations when they come to consider the disclosure of uncertainties and operational and financial risks. They’ll also need to consider the implications of leaving for the strategy and prospects of the business in the context of forward-looking commentary, disclosures about accounting judgements and estimates, assessments of going concern and viability, and consideration of whether assets have suffered impairment in the wake of the referendum result.
Similar issues will no doubt arise when companies in the EU with significant business or finance links to the UK prepare their financial reports.
But what about the medium to long term? This time the answer is less straightforward. We simply do not know what is going to happen.
Much will depend on the arrangements eventually negotiated in Brussels. It is possible that the outcome will mean that UK accounting law remains aligned with EU law and that the opportunities for UK policy makers to effect change are small. On the other hand, if no longer subject to EU legislation and regulation, the UK would be free to undertake a radical overhaul of its financial reporting regime.
Does this mean that the UK would, if it could, abandon its use of international standards? Abandoning IFRS—used by alternative investment market companies as well as companies on the main market—seems unlikely, especially at a time when the International Accounting Standards Board’s standards are increasing regarded as the benchmark for reporting by listed companies around the world. For many years, the UK government has been a strong supporter of IFRS, and there is evidence that the mandatory adoption of IFRS in the EU has brought with it economic benefits. As a major global financial center, the UK will probably wish to continue to adhere to internationally-accepted standards. The equivalence rules on financial reporting in the Transparency and Prospectus directives will also make this critical for any UK company wishing to list on an EU-regulated market.
The question of if the UK’s departure from the EU could mean the EU abandons its use of international standards over time is, perhaps, as much of a concern, regardless of what the UK decides to do. The UK has tended to be a strong voice in favor of IFRS adoption, without modification. The dynamics of the discussion will surely change once the UK voice falls silent. Similarly, the influence of the UK-less EU and the EU-less UK on the development of IFRS may be affected, albeit in unpredictable ways. The UK might, in any case, need to consider whether to replace with EU’s complicated IFRS endorsement mechanism with a home-grown alternative and, if so, with what. Various solutions would be possible.
If the UK is no longer subject to EU law, it will also be possible to review other aspects of the financial reporting regime that find their origin in EU directives. How much change would result in practice is difficult to say; the UK has had a significant influence in shaping the EU accounting directives and radical changes would not be the inevitable outcome. In any case, Financial Reporting Standard (FRS) 102 is a UK invention, based on international standards. The decision to abandon the Financial Reporting Standard for Smaller Entities owes nothing to the edicts of Brussels. And it seems unlikely that another round of significant changes to private company accounting any time soon would be widely welcomed. So in terms of the transition to FRS 102, it’s likely to be business as usual. Nonetheless, there may be scope over time to remove much of the detail on the content of financial statements from UK company law. We could, perhaps, aim for the law to consist of a high-level legal framework, with the detail left to accounting standards, facilitating a more flexible and, perhaps, lighter regulatory regime.
In practice, any such overhaul seems highly unlikely for a substantial period of time. The legislative program of a UK government adjusting to a new Brexit world will inevitably be very crowded for years to come, whatever happens. Reform of company law is unlikely to be anywhere near the top of the government’s to-do list, although some accounting matters at least would require early attention if the UK no longer has to follow EU law. For example, the UK would no longer be bound by the International Accounting Standards Regulation, which requires listed groups to use IFRS in their consolidated financial statements. However, the requirements and choices in relation to the Regulation are built into the Companies Act, so some early change there may be necessary.
In the long run everything may change. Or very little. In due course, withdrawal from the EU may present the UK with a once in a lifetime opportunity to think again about some of its financial reporting requirements. But there are risks aplenty too, and scope for all manner of unintended consequences for the UK and, perhaps, the EU and IFRS Foundation. It is unlikely in any case that the UK government will be in a hurry to make changes to UK accounting. Measured consideration over time of the case for change is more likely to be the name of the game, and ICAEW’s Financial Reporting Faculty will stay very close to the debate over the coming months and years.