FINANCIAL REPORTING COUNCIL RULE 4, A CONFLICT WITH IFRS?

The FRCN is a Federal Government agency established by the Financial Reporting Council of Nigeria Act, No. 6, 2011.  It is a Federal Government parastatal under the supervision of the Federal Ministry of Industry, Trade and Investment. The FRC is responsible for, among other things, developing and publishing accounting and financial reporting standards to be observed in the preparation of financial statements of public entities in Nigeria; and for related matters. The FRCN replaced the Nigerian Accounting Standard Board (NASB) following the adoption of the International Financial Reporting Standards (IFRS), and has since been regulating the practice of accounting in Nigeria.  FRCN issues rules and guidelines from time to time, in carrying out its mandate to regulate accounting and financial reporting.  This is in observance of its powers under S 30 and S 53 (2) of its enabling Act.

The FRCN has issued nine (9) rules so far, one of which (and the most contentious) is the Rule 4 (Transactions requiring registration from statutory bodies such as the National Office for Technology Acquisition and Promotion). Rule 4 deals with the requirements that must be fulfilled before transactions governed by other statutory provisions can be recognised in the financial reporting process.  Specifically, it states that:

 

“Transactions and/or events of a financial nature that require approval and/or registration or any act to be performed by a statutory body in Nigeria and/or where a statute clearly provides for a particular act to be performed and/or registration to be obtained; such transactions or events shall be regarded as having financial reporting implication only when such act is performed and/or such registration is obtained…”

 

In simple language, FRCN via the above rule now requires that all transactions or activities that impacts the financial statements of companies can no longer be recognised in the financial statements, until any requirements for the certification or registration of such activities by any existing legislation have been met.

The specific transactions or activities that readily come to mind within the current economic framework in Nigeria are:

  1. NOTAP[1] Certification of technology related contracts and
  2. Federal Ministry of Industry Trade and Investment certification of qualifying capital expenditures – Plant & Machinery, Motor Vehicles, Furniture, etc.

The rule goes to further require that “…the details of the required act and/or registration obtained from such statutory body shall be disclosed by way of note in the financial statements if the transaction is recognised as part of the financial reporting of the entity.”  Therefore, details of the registration (such as registration certificate number, approved amount, approval basis, validity period and subject matter) should be disclosed in the notes to the financial statements.

The rule also requires the disclosure of the financial implications of intercompany transfer and technical management agreements between the company and its significant local and overseas suppliers (if any).

NOTAP is the statutory body established to approve and monitor the implementation of the technology transfer agreements to ensure that the transferred technology is adaptable to the local environment and reflect national interest, but mainly to guard against “dumping” and capital flight.  As guard against capital flight, no payment for technology related contracts are allowed through Nigerian financial system unless a NOTAP certificate is presented.

Similarly, the Industrial Inspectorate Act of 1970 requires companies to obtain certification for assets acquired for the purpose of carrying out their business.  The certificates are expected to be issued by the Industrial Inspectorate Division (IID) of the Federal Ministry of Industry Trade and Investment.  Currently, any acquisition(s) in excess of NGN500,000 (US$1,634) must be certified.  An extreme interpretation of FRC Rule 4 therefore indicates that this certificate must be produced before recognising the cost of property plant and equipment (PPE), acquired in any year, in the financial statements.

 

Rule 4 as a Child of Necessity

It is a generally held belief that FRC Rule 4 is a reaction by FRCN to a boardroom dispute into which it was initially drawn into by the minority shareholders of a major Nigerian bank in 2015. The minority shareholders of the bank had reported the bank to FRC alleging a deliberate erosion of their interest by the majority shareholder (a foreign entity) by the execution of a sale and lease back contract for the provision of the bank’s operating software.  The bank’s application for certification of the contract was declined by NOTAP, but the bank went ahead to make provision for the lease payments and recognise indebtedness to the foreign shareholder.  A situation that the minority shareholders viewed as a deliberate erosion of their share of the bank’s earnings and by extension the market value of their shares.

The FRC reacted to this allegation through a number of actions, including the imposition of sanctions against the bank’s statutory auditors and directors for signing the financial statements containing such provisions even after NOTAP had ruled the contract to be ineligible for payment. These sanctions were subsequently challenged at the Federal High Court and a number of suits and counter-suits have since been instituted by the various parties.  It is believed that FRC had quickly issued Rule 4 to ensure that the outcome of the suits do not set a detrimental precedent for recognition of such transactions in future.

 

What does IFRS Say?

The introduction of Rule 4 has generated quite a debate in the financial reporting circles in Nigeria, both by audit practitioners and finance managers/CFOs.  The debate has centred mainly on the issue of supremacy between the principles set out in the IFRS and the rules issued by FRCN.  Most commentators have opined that Rule 4 attempts to counter some clear principles of IFRS, whose standards Nigeria has fully adopted.

  1. Framework and Accrual basis of accounting

The Conceptual Framework for Financial Reporting “the Framework” recognises elements of financial statements. One of such elements are expenses. Recognition is the process of incorporating in the balance sheet or income statement an item that meets the definition of an element and satisfies the recognition criteria in the Conceptual Framework, which are

1. It is probable that any future economic benefit associated with the item will flow to or from the entity; and

2. The item’s cost or value can be measured with reliability.

Based on these general criteria, expenses are recognised when a decrease in future economic benefits related to a decrease in an asset or an increase of a liability has arisen that can be measured reliably. This means, in effect, that recognition of expenses occurs simultaneously with the recognition of an increase in liabilities or a decrease in assets (for example, in this case, the accrual for expenses based on technical agreements entered with vendors).  Also, paragraph 27 of IAS 1 (Presentation of financial statements) states that ‘an entity shall prepare its financial statements, except cash flow information using the accrual basis of accounting’. When the accrual basis of accounting is used, an entity recognises items as assets, liabilities, equity, income, and expenses (the elements of financial statements) when they satisfy the definitions and recognition criteria for those elements in the Framework.

The question then is – does the non-certification of a contract for the supply of technology by NOTAP vitiates the obligation/liability to pay the value set out in the contract?  If the answer to this is in the negative, then what is the implication for not recognising the cost and liabilities?

  1. IAS 16 – Property Plants & Equipment

Paragraph 7 of IAS 16 provides for recognition of property plants and equipment as provided by the Conceptual Framework as follows:

The cost of an item of property, plant and equipment shall be recognised as an asset if, and only if:

(a) it is probable that future economic benefits associated with the item will flow to the entity; and

(b) the cost of the item can be measured reliably.

Unfortunately, the IID and NOTAP are no different from other agencies of government whose activities are traditionally delayed and bogged down by unending bureaucracy and varied inefficiencies.  Because of this, most certificates or registrations take months and sometimes years to complete, by which time the financial statements would have been issued.

 

Conclusion

While waiting for the outcome of the court judgements, businesses will continue to invest in qualifying capital expenditures and enter into agreements requiring NOTAP approval, which will mean flaunting the Rule 4 of FRCN either purposely or inadvertently. The FRCN needs to revisit its rules for possible amendments or outright repeal to align with the IFRS which it has enforced entities in Nigeria to comply with. This will ensure compliance and will be beneficial to all parties.

However, the FRC Act being an Act of parliament adopts the provisions of the IFRS and its application in Nigeria is a superior provision to the FRC Rules. In the interpretation of laws and statutes, the FRC Act therefore takes pre-eminence in any court of competent jurisdiction.

[1] NOTAP (National Office for Technology Acquisition and Promotions

By Adebamiji Adelaja. August 2017

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