Why IFRS matters to lawyers

International Financial Reporting Standards (IFRS) have arrived in local government. Paul Mason from the Chartered Institute of Public Finance and Accountancy (CIPFA) explains why this accounting change is of interest to lawyers as well as accountants.

International Financial Reporting Standards (IFRS) are being adopted in many countries, replacing the previous national accounting standards. This is intended to provide greater consistency across national boundaries, and allows multi-national companies to apply the same accounting standards to all their activities. In the European Union, the use of IFRS has been a requirement for listed companies since 2005 following the incorporation of IFRS into European law in Regulation (EC) No 1606/2002.

Gordon Brown announced in the 2007 Budget that the UK public sector would adopt IFRS, “to improve consistency and comparability” and “to follow private sector best practice”. Central government and the health service adopted IFRS in 2009/10. Local government is completing its transition to IFRS in 2010/11, although some aspects were introduced earlier. Whilst this might seem initially to be purely a finance issue, this is not the case.

Which organisations will be affected?

Regulation (EC) No 1606/2002 does not apply to local government. Instead, the Local Government Act 2003 allows the Secretary of State or Welsh Ministers to identify the proper practices for accounting. Similar arrangements apply in Scotland and Northern Ireland. Across the UK, the CIPFA/LASAAC Code of Practice on Local Authority Accounting in the United Kingdom (the Code) has been identified as proper practice.  CIPFA/LASAAC is a joint board of CIPFA and the Local Authority (Scotland) Accounts Advisory Committee.

The Code applies to principal councils, police authorities, fire and rescue authorities, and the Greater London Authority and its functional bodies (England and Wales); councils, the Strathclyde Partnership for Transport, and those bodies to which section 106(1) of the Local Government (Scotland) Act 1973 applies (Scotland); and district councils (Northern Ireland).

Implementation

The Code’s status as proper practice under the relevant legislation makes it a legal requirement for local authorities to implement IFRS. The first IFRS-based accounts need to be produced by June 2011. Whilst this may seem a long time away, a significant amount of work is required at a time when authorities are facing other pressures. However, the experience of implementing IFRS in other sectors shows that investing internal resources early makes for a smoother implementation. External resources are also less likely to be required.

Implementing IFRS is not without risk for local authorities. The additional work may make it more difficult for authorities to meet the legal deadlines for publishing their accounts. Auditors may also give a qualified opinion if authorities have failed to implement IFRS correctly, which would damage an authority’s reputation.

In England and Wales, publication of the accounts in accordance with proper practice is a requirement of the Accounts and Audit Regulations. Contravention of the provisions of the Regulations could be a criminal offence, so the Chief Financial Officer has an incentive to implement IFRS successfully – even if prosecution is unlikely.

Local authorities should already be well advanced with their plans to move to IFRS. However, much work remains to be done.

Many of the requirements under IFRS remain the same as under UK accounting standards. But where there are differences, accounts will normally have to be restated as if the IFRS requirements had always been in place. This restatement exercise cannot be undertaken solely by finance staff. Some properties may need to be revalued, and estates staff will need to be involved. Accounting for payroll items such as holiday pay is changing, and here HR staff will have a key role. And leases and other contracts need to be reassessed, which is where lawyers will need to be involved.

Contracts need to be identified – not always an easy task, especially for contracts going back many years. Contract terms need to be reviewed, with legal advice sought as part of the process. In reassessing leases, one approach is to review a sample of leases with the same standard terms to determine whether a more detailed review is needed. Identifying which leases have the same terms will be an important stage in this process.

The lawyers’ role doesn’t end once the move to IFRS has been completed. Many of the contracts that local authorities enter into are complex, and IFRS reflects this complexity. For example, IFRS requires authorities to separately account for any leases that are embedded in other contracts. These contracts may have the legal form of a service contract, but if the ‘economic substance’ (to use IFRS terminology) is that there is a lease within the contract, this has to be accounted for as a lease.

As a result, authorities need more information about some contracts than they currently collect to enable them to get the accounting right. Lawyers, accountants and procurement staff will all have a role in identifying these contracts before they are signed, to ensure that the necessary information is available. Getting information after the contract has been signed is proving difficult in other sectors.

IFRS brings different accounting standards, but the legal framework remains unchanged. Queries about the interpretation of regulations won’t go away – although the proper practice referred to in some regulations may be changing.

Benefits

So what benefits does IFRS bring? Ultimately, that’s up to each authority. IFRS should provide better information in key of areas – information about how much untaken annual leave has built up, about the use of assets, and about lease commitments. The challenge is for authorities to make use of that information to manage their resources (staff, finances and property) more effectively.

That means asking some difficult questions. If untaken annual leave is being built up, what are the implications? Could the authority still deliver its services if everyone took their leave? What would it cost to buy out the leave?

IFRS presents opportunities to streamline processes, especially in finance. With all the public sector moving to IFRS, CIPFA/LASAAC has taken the opportunity to minimise the differences between local government and central government accounting. Careful development of year-end procedures could simplify the collection of information for government returns such as the Whole of Government Accounts.

One final benefit of IFRS is that it allows a little more flexibility when presenting financial information. This, coupled with the better information that IFRS provides, should enable authorities to better explain their (admittedly complex) financial statements.

Paul Mason works in the policy and technical directorate at CIPFA (www.cipfa.org.uk).