The chair of the Local Authority Pension Fund Forum (LAPFF) has written to the UK Financial Reporting Council (FRC) to warn that the position set out in the audit watchdog’s comment letter on a pivotal accounting standard is wrong in law.

LAPFF chair Doug McMurdo wrote: “The [FRC] draft response is fundamentally incorrect in law, and in a way that is especially harmful to the parties affected, in particular our member funds as large holders of UK shares in companies as well as the wider public.”

He concluded: “It is not acceptable to have the law requiring one thing and the FRC knowingly agreeing to something that is so obviously different.”

At the heart of the row is a project launched by the International Accounting Standards Board (IASB) to update International Accounting Standard 1 (IAS 1). The standard sets out the necessary requirements for a set of financial statements and can be seen as the gateway to preparing accounts under international standards.

The board launched the effort in 2017 as part of its Primary Financial Statements project with the aim of improving how information is communicated through an entity’s financial statements.

The board has since published proposals that make a series of changes to the income statement, together with more limited refinements to the balance sheet and the cashflow statement.

The question of endorsing the new standard for use in the UK would normally have been handled by the European Union. However, once the UK leaves EU institutions at the end of this year, the question of accounting standards will be handled by a new UK endorsement body.

The LAPFF letter argued that not only does IAS 1 deliver the wrong accounting numbers, it also fails to deal correctly with the purpose or function of statutory accounts under the Companies Act 2006.

It goes on to remind the FRC that recent political and legal developments in the UK in recent months should have put the watchdog on notice of these issues.

Those developments are:

  • recent findings from the BEIS Select Committee into the future of audit;
  • the Asset Co v. Grant Thornton case, where the Court of Appeal ruled that auditors could be held liable for their negligent failure to detect management’s attempts to conceal fraud; and
  • the position of the Competition and Markets Authority (CMA) that audited accounts prepared under IFRSs can fail to satisfy the requirements of the Companies Act.

UK audit firms have countered, however, that the real issue is one of an expectation gap in that the public has misunderstood the true purpose of audit.

The question of the purpose of statutory accounts has emerged in recent months as a pivotal issue among some investors along with capital maintenance and going concern.

On capital maintenance, some argue that failing to follow the UK statutory accounting framework puts companies at risk of paying out dividends from illusory profits, which, in turn, erodes a company’s capital base to the detriment of shareholders and creditors.

Second, the current crisis has reignited long-standing concerns that auditors have failed to address the going concern assessment – the idea that a company is able to continue trading on the basis of its financial position – with sufficient rigour.

A LAPPF spokesperson told IPE: “The letter says the revised standard can’t be aligned with the UK’s legal framework for company law because it’s so defective.”

However, the spokesperson said, ”many people end up sitting on the UK’s new endorsement body, they can only operate within the law. They will need watertight transparent legal advice.”

The spokesperson added: “This means that they cannot do what we have seen in the past in the setting of accounting standards which is to push a decision through by securing a majority in support of a particular position. The default is always obeying UK company law.”

The FRC published its draft comment letter for public consultation on 17 July.

The LAPFF has already submitted its own comment letter in which it warned that without “further substantial changes” the new IFRS “as it stands is un-endorseable” in the UK.

FRC has declined to comment.

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