Every company has a legal obligation to publish its financial statements and related information.
How much, and how often, depends on how large the organisation is, whether it is listed on stock markets, which regulatory regimes, such as financial services affect it, whether it has obligations to major customers or financial funders to report (even if only to them) to specified standards and in which jurisdictions it operates. While you won’t need to be a financial expert, you will, as an in-house lawyer, have a stake in ensuring your organisation meets this legal commitment.
How businesses must prepare their accounts
The statute that governs how organisations prepare their financial statements is known as Generally Accepted Accounting Principles (GAAP).
In most countries, GAAP comprises the accounting standards laid down by the national accounting regulator and relevant local company law.
As an in-house lawyer, you won’t need to have the same depth of knowledge about these matters as the finance and accounts functions. However, you may find it helpful to understand the overall financial reporting framework that applies to your organisation and know when and how it’s obliged to submit and publish its financial statements.
This is can be particularly important when looking at contractual delivery, acceptance, payment, revenue recognition and claw-back terms, dispute and litigation costs, claims, prospects of success, intra group and cross border contracting arrangements, and other areas where legal and accounting standards may touch the same areas of business activity but not necessarily have the same needs out of them.
Historically, every country had its own version of GAAP, with slight nuances on how to treat various accounting matters. However, the last two decades have seen a major international effort to create common standards. As a consequence, there are now just two versions of GAAP globally:
- US GAAP, which is overseen by the US Financial Accounting Standards Board (FASB) under the authority of the US Congress; and
- International Financial Reporting Standards (IFRS), overseen by the International Accounting Standards Board (IASB), based in London. IFRS has been adopted by more than 70 countries, including those in the European Union.
US GAAP and IFRS overlap to the point where, for most accounting issues, they’re identical. Even so, a long-term project is underway to align the two approaches into a single global standard. Unfortunately, broader issues arising from the global financial crisis of 2008 have slowed this work down.
Most multinational companies, and all those listed on both US and non-US stock exchanges, prepare and file accounts under both standards.
US financial reporting
In the US, the Securities & Exchange Commission (SEC) requires all publicly listed companies to prepare an annual report and financial statements once a year. As well as core financial statements (known as the 10-K), these companies must also include substantial commentary and disclosure. Typical submissions are between 200 and 300 pages long.
Then, in each of the other three quarters of the year, publicly listed companies must also file a full set of financial statements (known as 10-Qs). These require significantly less in the way of general disclosure than the annual report.
If a significant event, such as the withdrawal from a major market, occurs between quarter ends, companies must file an additional, separate report. It doesn’t need to include financials, just information about that event.
Things aren’t quite as onerous for privately held companies in the US. Their annual reports are more abbreviated than those for publicly listed businesses. And smaller companies need only publish a set of annual statements.
However, if a privately held company has major creditors, such as banks or bondholders, it’ll be expected to provide semi-annual or quarterly reporting. This is to enable the creditors to monitor the company’s health on an ongoing basis.
UK financial reporting
Effective from 1 January 2015, UK GAAP comprises Financial Reporting Standards (FRS) 100, 101, 102 and 103, which were published by the UK Financial Reporting Council (FRC).
Furthermore, UK companies must prepare their accounts in accordance with Statements of Recommended Practice (SORPs). These are specialist standards for particular industries or sectors. The FRC recognises the power of other bodies to develop SORPs and provide guidance on the application of UK GAAP to specific industries or sectors. SORPs are issued by, and available from, appropriate bodies for those industries or sectors. For example, the Charity SORP is issued by the UK Charity Commission.
As in the US, all UK companies must publish a set of financial accounts once a year, with publicly listed companies having to provide substantial additional disclosure in the form of a broader annual report. While UK authorities don’t require quarterly account filings as in the US, most large companies will voluntarily provide quarterly or semi-annual trading updates to keep investors informed.
Types of accounts
Different users of a company’s accounts require different types of financial information. For this reason, most companies prepare at least three sets of accounts:
- Financial accounts: the standardised document prepared for external users such as investors, creditors and customers;
- Tax accounts: books complied in accordance with tax legislation, which can be significantly different to the GAAP framework. Tax accounts are used to compute the amount of tax a company has to pay in relevant jurisdictions; and
- Management accounts: bespoke figures calculated only to support internal decision-making. Most organisations prepare management accounts monthly using internally defined specific to the organisation’s strategy. Management accounts are not governed by any standards or regulations, however most organisations prepare them using their appropriate GAAP framework to avoid misalignment between internal and external perspectives.
It is really important that in-house lawyers have a good working understanding of the different types of accounting practices, standards and reports that affect their businesses. These things have such an all pervasive effect on how the businesses whose needs we service operate, that we almost certainly will be misunderstanding, and therefore failing properly to support, our businesses if we do not.
Following a concerted international effort, there are now just two global accounting frameworks, and work continues to unify these into a single set of GAAP. Though identical in many ways, there are subtle differences between US GAAP and IFRS. How the frameworks apply to your organisation will depend on which jurisdictions it operates in, whether it’s publicly listed or privately held and whether it has any major creditors.
It is very hard to be a good senior in-house lawyer and to service your business properly without having a good understanding of how the different types of accounting practices, standards and reports apply in your business and shape the way that it is run.