Question

What is the differences between UK and US balance sheet?

Answer 1

Following are the differences between the UK and US GAAP that materially affected the companies’ financial statements:

Goodwill and Intangible Assets: US GAAP required, Accounting Principles Board (APB) Opinion No. 17, that the excess of acquisition price over net assets acquired (goodwill) be amortized over its useful life, not exceeding forty years. US GAAP required similar treatment for other intangible assets such as brand names, licenses, trademarks and patents, etc. However, Financial Accounting Standards Board (FASB) Statement No. 142 superseded APB Opinion. According to the Statement, goodwill and intangible assets will not be amortized but tested for impairment and appropriate adjustments will be made.

UK companies were allowed to write off goodwill and intangible assets to reserves in the related financial period. However, since 1998, goodwill should be capitalized and amortized over its estimated useful economic life.

Income Taxes and Deferred Income Taxes: British companies are allowed to use the new tax rates as soon as they are proposed in the government budget. American companies are not permitted such treatment of tax rates until the enactment of proposed rates into law.

UK companies account for deferred income taxes only to the extent of management’s judgment of probable liabilities or benefits that may materialize in the foreseeable future. US accounting standards require a detailed accounting for deferred income taxes.

Revaluation of Assets/Properties: UK accounting standards allow a revaluation of properties based upon their current market value. The US GAAP require that the properties be recorded in the financial statements on a historical cost basis, and allow any permanent decrease in the value to be expenses.

Several British companies in the sample revalued their properties. Any surplus resulting from revaluation was shown in the carrying value of assets and was taken directly to shareholders’equity or a revaluation reserve which was a part of shareholders’ equity. Any deficit, in addition to the reflection in the carrying value of assets, was charged to the income statement.

Most of the companies’ properties were carried on a higher value in comparison the historical cost basis required by the US GAAP. The properties’ value, in most cases, had to be adjusted downward to bring them in compliance with the US GAAP.

A diversity in carrying value of properties also resulted in a different amount of depreciation charged to the income statement. Therefore, depreciation charges were modified, usually reduced, in order to reconcile the differences.

Some companies in the sample did not charge depreciation on properties such as freehold and leasehold properties because, they believed, it was insignificant. In the US, all fixed assets, with the exception of land, should be amortized over their estimated useful lives.

The gain or loss on sale of properties was also affected because of the different methods used to value properties. UK companies recorded a gain or loss based on revalued carrying amounts and took it to the income statement. Any revaluation surplus was then realized and reclassified to retained earnings. The gain or loss on sale of properties was adjusted to reflect difference between sale proceeds and net carrying value based upon historical cost in order to bring it in conformity with US GAAP.

Dividends: UK companies provide for dividends, including proposed dividends awaiting shareholders’ approval, in the related year. On the other hand, US companies provide for dividends in the year in which they are declared.

Convertible Capital Bonds: UK companies charged the costs incurred for issuance of convertible capital bonds to additional paid in capital. US GAAP require that such costs be deferred and amortized over the life of the bonds.

Employee Share Ownership Plan and Compensation Expenses: UK accounting standards allow recording of advances/loans granted to employees under employee share ownership plans as contingent liabilities. US GAAP require that such transactions be shown as a deduction from shareholders’ equity.

In addition, US accounting standards require that compensation expenses should be recorded in case of issuance of share options or warrants to employees at cost. UK GAAP do not require such treatment. UK companies recorded compensation expenses in order to reconcile their financial statements to US GAAP.

Pension Costs: Several UK companies adjusted their pension costs in order to bring them in compliance with US GAAP. UK GAAP allow the measurement of pension plan assets at discounted present value of expected future income. US GAAP require that such assets be valued at their fair market values.

The US GAAP require that plan assets and obligations be measured as of the date of the financial statements or within three months before the financial statements date. UK GAAP allow the valuation based upon the latest actuarial assessment.

Extraordinary Items: Some costs, such as restructuring and disposal of operations, that qualified as “exceptional items” and “extraordinary items” under UK accounting standards did not meet the criteria for extraordinary items, as outlined by the US GAAP. According to the US GAAP, a transaction must be unusual in nature and infrequent in occurrence in order to qualify as an extraordinary item.

Capitalization of Interest Costs: US accounting standards require that interest costs incurred for certain qualifying assets be capitalized and amortized over the estimated useful life of assets. Assets that require some time to prepare them for use qualify for capitalization of interest. Example of such assets would include construction of property and making of a ship according to a company’s specifications. UK companies are not required to capitalize such interest costs. Some of the selected UK companies expensed the interest incurred in respect of construction of property and plan and equipment.

Earnings Per Share: UK companies computed their earnings per share by dividing net income by weighted average number of shares outstanding during the year. The computations under US GAAP are rather complex because of assumption of maximum dilution. The American practice is to divide income available to common stockholders by weighted average number of common shares assuming dilution from all dilutive securities.

Discontinued Operations: Under UK GAAP, discontinued operations/activities refer to a material activity whose sale or disposal causes a change in the nature and focus of an entity. US accounting standards prescribe that, in order to qualify as discontinued operations, the assets, the results of the operations, and activities of a segment of a business must be clearly distinguishable, physically, and operationally from the other assets, results of operations, and activities of the entity.

Moreover, UK accounting standards allow exclusion of disposal of business as of the contract date. On the other hand, US GAAP permit such exclusion from the completion of transaction date. This may result in gains or losses on disposal of business to be accounted for in different financial periods.

Debt Restructuring: Under US GAAP, settlement of a debt by issuance of equity may result in recognition of extraordinary gain or loss. It is equal to the difference between the carrying value of debt and the market value of equity issued. In the UK, such difference is treated as premium or discount on the equity issued.

Research and Development Costs: Under UK GAAP, Research and Development (R&D) costs may be capitalized and amortized over their estimated useful life. US accounting standards require that R&D costs be expensed with the exception of purchases of assets from outside that may be utilized for other purposes in future.

Under the UK accounting standards, software research and development costs may be expensed in the period they were accrued. US GAAP prescribe that such costs be expensed until technological feasibility is established, and then these costs should be capitalized and amortized in the current and future periods.

Foreign Exchange Contracts: Under US GAAP, gain or loss from translation of certain foreign currency forward exchange contracts, at the prevailing rates on each balance sheet date, is recorded as a notional gain or loss. UK accounting standards do not require such a treatment for gain or loss from translation of foreign exchange contracts.

Foreign Currency Translation: UK companies adjusted the cost of assets financed wholly or in part in foreign currency to take account of the repayments and translation of outstanding liabilities. Under US GAAP, such adjustments are accounted for as exchange gains or losses and taken to the income statement. The assets are carried at original translation rate on the acquisition date.

Translation of Overseas Subsidiaries: In the UK, revenues, expenses, liabilities, and assets of overseas subsidiaries are translated into the reporting currency rate prevailing on the financial statements date. US accounting standards prescribe that revenues and expenses be translated at average exchange rates during the fiscal period, and liabilities and assets be translated at the exchange rate ruling at the end of fiscal period.

Foreign Currency Hedging: Some British companies in the sample entered into forward exchange contracts and used other financial instruments to hedge against foreign currency translation risk. They accounted for these transactions as hedges of future income under UK accounting standards. In the US, such transactions should be valued at market rates at the end of each financial reporting period and a loss or gain should be recognized.

Sale of a Foreign Subsidiary: Under UK GAAP, gain or loss on sales of subsidiary may be recorded as the difference between sales proceeds and net assets of the subsidiary at the date of disposal. US GAAP require that all exchange differences since the inception of subsidiary, if taken directly to reserves, should be taken into consideration in determining gain or loss on sale of a foreign subsidiary.

Property Leases: In the UK, annual rental payments for leased properties may be charged to the income statement. In the US, such expenses are recognized on a straight line basis over the lease period.

Gain on Sale and Leaseback Transactions: UK companies included gains on sale and leaseback transactions in their income statements to the extent of the difference between sales revenue and fair market value of the asset. Any excessive gains were deferred and amortized over the minimum lease terms. US accounting standards require that all gains should be deferred and amortized over the minimum lease term.

Cash Flow Statement: The fundamental difference between cash flow statement prepared in accordance with UK and US accounting is in the classification of items. Under UK GAAP, the statement is classified into operating activities, returns on investments and servicing of finance, taxation, investing activities, and financing. In the US, it is classified into operating, investing, and financing activities.

Depletion of Natural Resources: Under UK GAAP, depletion of natural resources may be adjusted against the estimated growth. US accounting standards require that depletion be charged to the income statement. Additional costs incurred over natural resources may be taken to the income statement in UK. The US GAAPrequire that such assets be capitalized.

Recapitalization: UK GAAP allow the gain or loss on restructuring of capital be included in net income. US accounting standards require that such gain or loss be taken directly to shareholders’ equity and share capital.

Real Assets Sales: Under UK GAAP, profit or loss on the sale of real estate may be recognized if a contract exists between the parties, and consideration is not contingent upon a future event. Under US GAAP, full profit may be recognized if the sale is consummated, the buyer’s initial and continuing investments demonstrate a commitment to pay for the property, the seller’s receivable is not subject to future subordination, and risk and rewards of ownership have been transferred. If this criteria is not met, the full accrual method can not be used, which may result in deferment of all or part of the profit.

Conclusion:

Differences between the UK and US GAAP included accounting for goodwill and tangible assets, income taxes, revaluation of assets/properties, pension costs, extraordinary items, and discontinued operations. Besides, capitalization of interest, debt restructuring, and research and developments costs were adjusted to comply with the US GAAP. Furthermore, diversity in accounting for foreign exchange, leases, depletion of natural resources, and real estate sales caused modification of financial data. The financial information was moderately affected as a result of reconciliation to US GAAP.