Statement of Recommended Practice. Financial Statements of Authorised Funds

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1 Statement of Recommended Practice Financial Statements of Authorised Funds

2 Contents Statement by the Accounting Standards Board 2 1 Introduction 3 Status 3 Definitions 4 General accounting requirements 6 Approach 6 Other regulations and rules 6 Future changes 7 Date from which effective 7 Transitional provisions 7 2 Contents of financial statements 8 Contents 8 Statement of total return 13 Statement of change in shareholders net assets 20 Portfolio statement and balance sheet 21 Summary of material portfolio changes 24 Notes to the financial statements 25 Annex A: Pro forma annual report and financial statements 28 Annex B: Pro forma short form accounts 43 Annex C: Derivatives examples 48 Annex D: FSA rules 53 Annex E: FSA rules on TER calculation 71 SORP for authorised funds 1

3 Statement by the Accounting Standards Board The aims of the Accounting Standards Board (the ASB) are to establish and improve standards of financial accounting and reporting, for the benefit of users, preparers, and auditors of financial information. To this end, the ASB issues accounting standards that are primarily applicable to general purpose company financial statements. In particular industries or sectors, further guidance may be required in order to implement accounting standards effectively. This guidance is issued, in the form of Statements of Recommended Practice (SORPs), by bodies recognised for the purpose by the ASB. The Investment Management Association () has confirmed that it shares the ASB s aims of advancing and maintaining standards of financial reporting in the public interest and has been recognised by the ASB for the purpose of issuing SORPs. As a condition of recognition, the has agreed to follow the ASB s code of practice for bodies recognised for issuing SORPs. The code of practice sets out procedures to be followed in the development of SORPs. These procedures do not include a comprehensive review of the proposed SORP by the ASB, but a review of limited scope is performed. On the basis of its review, the ASB has concluded that the SORP has been developed in accordance with the ASB s code of practice and does not appear to contain any fundamental points of principle that are unacceptable in the context of present accounting practice or to conflict with an accounting standard or the ASB s plans for future standards. December 2005 SORP for authorised funds 2

4 1 Introduction Status 1.1 This SORP, issued by, supersedes the previous SORP for authorised funds (authorised unit trusts (AUT) and open ended investment companies (OEIC)), setting out recommendations for the preparation of financial statements for unitholders of all authorised funds. Notwithstanding that a SORP describes recommended practice, compliance with this SORP is required by the Financial Services Authority s (FSA s) Collective Investment Schemes (CIS) Sourcebook and New Collective Investment Schemes (COLL) Sourcebook The Accounting Standards Board ("the ASB") has approved for the purposes of issuing recognised SORPs for authorised funds. This arrangement requires to follow the ASB's code of practice for the production and issuing of SORPs. 1.3 This code of practice provides the framework to be followed by for the development of SORPs, but does not entail a detailed examination of the proposed SORP by the ASB. However, a review of limited scope is performed. 1.4 Under Part III of the OEIC Regulations the directors of an investment company with variable capital (ICVC) are responsible for the preparation of the company's annual and half-yearly reports. In addition, under Chapter 10 of the CIS Sourcebook or Chapter 4 of the COLL Sourcebook, the authorised corporate director (ACD) of the company is responsible for ensuring that the contents of each report comply with FSA rules. 1.5 Under Chapter 10 of the CIS Sourcebook or under Chapters 4 and 8 of the COLL Sourcebook, the manager of an AUT is responsible for the preparation of the AUT s annual and half-yearly reports. 1.6 The recommendations of this SORP have been arrived at after consideration of the Statements of Standard Accounting Practice ( SSAPs ) and Financial Reporting Standards ( FRSs ) issued before 31 March This SORP complies with International Financial Reporting Standards (IFRS) only to the extent that UK GAAP has converged with IFRS through FRSs and only to the extent that those FRSs are a requirement for authorised funds. The presentation aspects of FRS 25 became a requirement for authorised funds at 1 January However, the disclosure requirements of FRS 25 will have to be complied with only when 1 The CIS Sourcebook in 10.3 and the COLL Sourcebook which has been in effect since 1 April 2004 refers to the SORP in and By 12 February 2007 all authorised funds must comply with the COLL Sourcebook. SORP for authorised funds 3

5 FRS 26 is adopted by the SORP or becomes a requirement for authorised funds. Whilst to be consistent with FRS 26, this SORP introduces the use of bid valuations instead of mid, the SORP does not adopt FRS 26 as there are concerns relating to the impact of FRS 23 which must also be complied with when FRS 26 is adopted. Currently, the ASB is proposing that FRS 26 should apply to authorised funds from 1 January Definitions 1.7 The following definitions shall apply in this SORP. Authorised Corporate Director (ACD) The director of an ICVC that is the authorised corporate director of the ICVC in accordance with CIS Sourcebook 7.2.1R (The directors) and COLL Sourcebook 6.5.3R (Appointment of an ACD). Authorised fund An Investment Company with Variable Capital (ICVC) or an Authorised Unit Trust scheme (AUT). Authorised Unit Trust (AUT) As defined in section 237(3) of the Financial Services and Markets Act 2000 (Other definitions), a unit trust scheme which is authorised for the purposes of the Act by an authorisation order. CIS Sourcebook and COLL Sourcebook FSA rules relating to authorised funds. See Annex D for relevant extracts. Depositary The person to whom is entrusted the safekeeping of all of the scheme property of an ICVC and who has been appointed for this purpose in accordance with Regulation 5 (Safekeeping of scheme property by depositary) of and Schedule 1 (Depositaries) to the OEIC Regulations. Derivative financial instrument ( Derivative ) A derivative is a financial instrument or other contract with all three of the following characteristics: (a) (b) its value changes in response to the change in a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index, or other variable, provided in the case of a non-financial variable that the variable is not specific to a party to the contract (sometimes called the underlying ); it requires no initial net investment or an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors; and SORP for authorised funds 4

6 (c) it is settled at a future date. Typical examples of derivatives are futures, forwards swap and option contracts. More comprehensive guidance is contained in FRS 26 paragraphs AG 9 AG 12. Effective yield Effective yield is an income calculation that takes account of amortisation of any discount or premium on the purchase price over the remaining life of the security. The calculation uses the effective interest method as defined in FRS 26, paragraph 9 with guidance in paragraphs AG 5 AG 8. Instrument constituting the scheme (a) In relation to an ICVC, the instrument of incorporation; (b) In relation to an AUT, the trust deed. Investment Company with Variable Capital (ICVC) A body incorporated under the OEIC Regulations. Manager The firm that is the manager of an AUT in accordance with the trust deed. Market value For non-derivative securities, it is the fair value which generally is the bid market value. For futures, it is the unrealised gain or loss at the balance sheet date as this represents the cost of closing out the contract at that date. For call or put option purchased or written on any short position, it is the price to close out the contract at the balance sheet date. OEIC Regulations The Open Ended Investment Companies Regulations 2001 (SI 2001/1228). Trustee In accordance with section 237(2) of the Financial Services and Markets Act 2000 (Other definitions), the person holding the property in question on trust for the participants of a unit trust scheme. Unit a) In relation to an AUT, a unit representing the rights or interests of the unitholders in the AUT. b) In relation to an ICVC, a share in the ICVC. The term unit, and derivations thereof, have been used throughout this SORP for SORP for authorised funds 5

7 the sake of simplicity. This should not preclude an ICVC from using the term share or shareholder in situations where it is more appropriate. Unitholder The holder of a unit in an AUT or a share in an ICVC. Value at Risk (VAR) VAR is the expected loss of portfolio over a specified time period for a set level of probability. Zero dividend preference shares Preference shares which carry no entitlement to dividends but the right, on a fixed date or on any earlier redemption, to the repayment of capital and a premium in priority to any capital payment to the holders of ordinary shares. General accounting requirements 1.8 Financial statements should comply with SSAPs, FRSs and Urgent Issue Task Force (UITF) Abstracts. Appropriate disclosure of the accounting policies should be made in the notes to the financial statements. Examples of the accounting policies required are covered in Part II of this SORP. Taken together, these should ensure that the financial statements provide a true and fair view. Approach 1.9 Explanatory background has been included within the text and all the information about an individual topic can be found in one place. The whole of this statement including the annexes is therefore recommended practice. Other regulations and rules 1.10 The recommendations of this SORP should be read in conjunction with ASB s Explanatory Foreword to SORPs, any rules and regulations relating to authorised funds that are in force, and the law relating to these matters. Again, compliance with this SORP is required by FSA rules 2. In accordance with FRS 18 Accounting policies paragraphs 58 to 61, an authorised fund s financial statements should state the title of this SORP and whether its financial statements have been prepared in accordance with it. In the event of a departure from the SORP, the authorised fund should give a brief description of how the treatment adopted departs from the recommended practice set out in the SORP, which should include: (a) the reasons why the director(s) or manager judge the treatment adopted to be more appropriate to the particular circumstances of the authorised fund; and 2 See footnote to paragraph 1.1. SORP for authorised funds 6

8 (b) details of any disclosures recommended by the SORP that have not been provided, and the reasons why they have not been provided For the sake of completeness, this SORP includes the requirements of the OEIC Regulations and FSA rules covering the contents of annual and half-yearly reports to unitholders. The director(s) or the manager are responsible for preparing the reports, and for ensuring that the full financial statements give a true and fair view of the position at the end of the period, and the net income for the period. Future changes 1.12 Where requirements change as a result of changed regulations, legislation, product changes or the publication of FRSs, the implications for this SORP may be dealt with by guidance until such time as the SORP itself is revised. The will keep this SORP under regular review, in accordance with the ASB s code for SORPs, and will amend it from time to time in the light of developments, for example when it becomes clearer how IFRS will affect authorised funds. Pending such changes being issued, accounts must be prepared on the basis of accounting standards and UITF Abstracts issued after publication of this SORP, from their effective date. Date from which effective 1.13 Apart from paragraph 2.32 relating to bond income on an effective yield basis, the recommendations of this SORP will be applicable for accounting periods beginning on or after 1 January However, it should be noted that the FRS 25 presentation requirements became effective for accounting periods beginning on or after 1 January In order to allow sufficient preparation time, the requirements of paragraph 2.32 relating to bond yields will be expected for accounting periods beginning on or after 1 January Earlier compliance is encouraged. Transitional provisions 1.15 Restatement of prior year comparatives is not required in respect of changes required by the SORP relating to bid valuations and effective yield. If comparatives are not restated, preparers of reports should: a) apply the existing accounting policies to the comparative information; b) disclose this fact together with the basis used to prepare this information; and c) disclose the nature of the main adjustments that would make the information comply with the new requirements, but these adjustments need not be quantified. SORP for authorised funds 7

9 2 Contents of financial statements Contents Annual reports and accounts of the fund 2.1 The annual report to unitholders should contain the audited financial statements, a statement of net asset value per unit, the number of units of each class in issue, a comparative table and the information required to be disclosed by Chapter 10 of the CIS Sourcebook or Chapters 4 and 8 of the COLL Sourcebook. It should also contain the investment report together with reports of the auditor and depositary or trustee. Statements of responsibilities of each of the auditor, ACD or manager, and depositary or trustee should also be included. Special requirements relating to umbrella funds are also set out in Chapter 10 of the CIS Sourcebook and Chapter 4 of the COLL Sourcebook, which require each report of the fund to be signed by the ACD or manager (see paragraph 2.10). 2.2 In relation to ICVCs, if there are other directors, the ACD and at least one other director must sign the report on behalf of the Board. Regulation 66(3) of the OEIC Regulations requires the director(s) to lay copies of the annual report before the company in general meeting where the companies hold general meetings. Content of the financial statements 2.3 The audited annual financial statements should contain appropriate information on the transactions of the fund during the accounting period, and on the amount and disposition of the fund s assets and liabilities at the end of the period. 2.4 This information should be presented in the form of: a statement of total return a statement of change in shareholders net assets a portfolio statement a balance sheet a summary of material portfolio changes a statement of the material accounting policies used in preparing the financial statements further details in notes to the financial statements SORP for authorised funds 8

10 a distribution table Comparative figures should be given for the previous period for all items in the statement of total return, statement of change in shareholders net assets, balance sheet, and the notes to each, and for sector percentage totals in the portfolio statement. In the portfolio statement, comparatives at security level would be unhelpful, and FRS 28 paragraph 11 allows non-disclosure of these details. 2.5 If a fund meets the criteria of the special exemptions in the revised FRS 1, a cash flow statement is not required. Paragraph 5(d) of the revised FRS 1 is most likely to apply. This grants exemption to open ended investment funds that meet all the following conditions: i) substantially all of the entity s investments are highly liquid; ii) substantially all of the entity s investments are carried at market value; iii) the entity provides a statement of change in net assets. When funds use derivatives extensively, consideration should be given to whether the liquidity condition continues to be met. 2.6 Pro forma financial statements that meet the recommendations set out above are included in Annex A. The pro forma is a minimum recommendation and, although the order of the statements is not prescribed, it is recommended that the headings used within the statements be adhered to in the order shown. Additional disclosure is recommended to reflect any special circumstances and to ensure that the financial statements show a true and fair view. Half-yearly reports and accounts of the fund 2.7 The half-yearly report to unitholders should contain the half-yearly financial statements, a statement of the net asset value per unit, and the number of units of each class in issue. It should also contain the investment report and the information required to be disclosed by Chapter 10 of the CIS Sourcebook or Chapter 4 of the COLL Sourcebook. The report should be signed by the director or manager in accordance with Chapter 10 of the CIS Sourcebook or Chapter 4 of the COLL Sourcebook. The half-yearly financial statements, which are not required to be audited, should be prepared using the same accounting policies and format as the annual financial statements (although this does not preclude preparers from making a change of accounting policy in the half-yearly financial statements) and include the following items: a statement of total return a statement of change in shareholders net assets SORP for authorised funds 9

11 a portfolio statement a balance sheet a summary of material portfolio changes a statement of the material accounting policies used in preparing the financial statements further details in notes to the financial statements a distribution table (if appropriate) 2.8 Comparative figures should be given for all items in the statement of total return, statement of change in shareholders net assets and balance sheet, and the notes to each, and for sector percentage totals in the portfolio statement. They should be the equivalent figures for the same half-yearly period in the previous year for the statement of total return, but the last audited figures (i.e. at the end of the last full accounting period) for the other statements. Comparative figures are not required at security level in the portfolio statement. Short form accounts in reports of the fund 2.9 If using the CIS sourcebook, at the discretion of the director(s) or manager, short form accounts may be sent or supplied to unitholders for any period instead of the full accounts specified in paragraphs 2.1 and 2.7. If so, it must be made clear when such accounts are sent or supplied that unitholders are entitled to apply for and receive the full accounts. The information shown in short form accounts may be limited to give unitholders a clear and simple picture of the performance of their investment over the period. The short form accounts should be designed to give the average unitholder a clear simplified picture of first the total return and amount distributed or accumulated, and the amount taken out by way of expenses and, second, of where his funds were invested Every annual and half-yearly report to unitholders containing short form accounts should include a statement of the net asset value per unit and the information required to be disclosed by Chapter 10 of the CIS Sourcebook, in a form appropriate for short form accounts. The director s or manager s report included in a report containing short form accounts should cover everything required by Chapter 10 of the CIS Sourcebook, though not necessarily in the same amount of detail. In addition, a report that relates to an annual accounting period should include a comparative table, giving the same information as required by Chapter 10 of the CIS Sourcebook for reports containing the full accounts. It should also contain the report of the depositary or trustee, and a copy of the auditor s statement on the short form accounts. The reports, including the short form accounts should be signed by the director(s) or manager, as set out in SORP for authorised funds 10

12 paragraphs 2.1 and 2.2. Statements of responsibilities of each of the ACD or manager, auditor and depositary or trustee should also be included as appropriate Reports to unitholders containing short form accounts must form a separate stand-alone document that does not include any extraneous material. Short form accounts should contain the following items (with comparatives on the same basis as for the full accounts): a statement of total return a statement of change in shareholders net assets a statement of investments and other assets a distribution table 2.12 Pro forma short form accounts that meet the recommendations set out above are included in Annex B. The pro forma is a recommendation and although the order of statements is not prescribed, headings used within the statements should be adhered to in the order shown. It is not intended that notes to the financial statements will be included but additional disclosure is recommended where there is a need to reflect any special circumstances There are no provisions within the COLL Sourcebook for short form accounts. Short reports 2.14 The COLL Sourcebook Chapter 4 introduces Short Reports as the default reporting. This is a consumer focused six monthly document and should not be confused with short form accounts. Where Short Reports are issued following the COLL Sourcebook reporting requirements, short form accounts must not be produced. For funds operating under the CIS Sourcebook, where the manager or the director(s) do not elect to produce Short Reports, short form accounts may still be produced and made available until 12 February Short report requirements are detailed in Chapter 4 of the COLL Sourcebook. The information provided in the Short Reports must be consistent with long reports All retail funds operating under the COLL Sourcebook must produce short reports, which must be provided to investors. The long form reports and accounts must be provided to investors upon request Qualified Investment Schemes (QIS) operating under the COLL Sourcebook do not have to produce Short Reports but must produce long form report and accounts which must be provided upon request (COLL chapter 8.3.5). SORP for authorised funds 11

13 Reports and accounts of umbrella funds 2.17 The annual and half yearly report to unitholders of an umbrella fund should contain reports and accounts relating to each of its sub-funds, prepared in the reporting currency of the fund, together with the other information set out in paragraphs 2.3 and 2.7, as appropriate. The reports should also contain the other information specifically required by Chapter 10 of the CIS Sourcebook or Chapter 4 of the COLL Sourcebook for sub-funds. An aggregation of the accounts of each sub-fund must also be prepared, together with the additional information specifically required by Chapter 10 of the CIS Sourcebook or Chapter 4 of the COLL Sourcebook for an umbrella fund. The aggregated financial statements should comprise: a statement of total return a statement of change in shareholders net assets a balance sheet a statement of the material accounting policies used in preparing the financial statements appropriate notes to the aggregated financial statements 2.18 If the fund is operating under the CIS Sourcebook, the director(s) or manager can elect to send to unitholders a report on the relevant sub-fund only. This is currently not an option under the COLL Sourcebook. Where only sub-fund reports are provided, a report on the umbrella fund as a whole must be made available to unitholders on request. Chapter 10 of the CIS Sourcebook also permits the director(s) or manager to elect to produce short form accounts in reports sent to unitholders of umbrella funds. Where this is the case, copies of the report containing the full accounts of the umbrella fund as a whole (which include the full accounts for each sub-fund) must be made available to unitholders on request. Funds or sub-funds with different unit classes 2.19 Where there are different unit classes, the investments of the fund or sub-fund remain as one pool, and are not separately allocated to unit classes. Where there is a different charging structure for each class, such differences will be reflected in the price of each unit class and the proportion of the pool of investments attributable to each class. The prices will determine the amount receivable or payable by the fund or sub-fund in respect of issues and cancellations of units, but these amounts need not be analysed by class in the statement of change in shareholders net assets. The share of the fund s or sub-fund s net assets, the net asset value of each unit in each class (at the SORP for authorised funds 12

14 beginning and end of the period) and the distributions attributable to each class should be included in the accounts. The different rights and terms attaching to each unit class, including the rights on winding-up and the policy for allocating taxation and distributable income, should be summarised in the notes to the accounts. Statement of total return 2.20 A statement of total return should be prepared. This will set out the total return, comprising net investment gains or losses together with net income after tax, and will then identify that part of the total return that is to be distributed in accordance with FSA rules The statement of total return should show, with corresponding figures for the preceding equivalent period: Net gains/losses on investments during the period Other gains/losses Net income/expense after taxation for the period showing separately income, total expenses, interest costs and the tax charge Total return for the period before distributions Distributions Change in net assets attributable to unitholders 2.22 As Annex A shows, the statement of total return incorporates investment gains/losses and income after tax, showing the various components separately and distributions The headings used in paragraph 2.21 are summary components only, to keep the principal statement clear and simple. The main components should be analysed in more detail in notes to the financial statements, in particular, the net gains/losses on investments, other gains/losses, and net income/expense after taxation, examples of which are also at Annex A. Net gains/losses on investments 2.24 The investment gains/losses should be analysed in the notes to show the gains from derivatives, FX contracts and other investments. Any special dividends regarded as capital in nature (see paragraph 2.39) should be included within gains. Any movement on zero dividend preference shares, which are generally issued at a discount to compensate the investor for the lack of dividend, should SORP for authorised funds 13

15 be included within net gains/losses on investments. Other gains/losses 2.25 Other gains/losses should be explained (in the notes if not on the face of the statement) and may include such items as gains/losses on back-to-back loans, gains/losses on forward foreign exchange contracts, and other currency movements relating to capital items other than investments. Gains/losses on forward foreign exchange contracts relating to investments are included within net gains/losses on investments (see paragraph 2.24). Net income/expense after taxation 2.26 The net income/expense after taxation should show income, total expenses and taxation, with details of these individual components given in the notes. An example of recommended disclosure is at Annex A. Total return for the period 2.27 Where there is a material difference between net income after taxation shown in the statement of total return and the amount distributed, an explanation of the difference should be included in the notes. It is expected that the director s or manager s report will explain the investment strategy, the result of which has led to this material difference. Derivatives 2.28 The treatment of derivatives in the balance sheet is dealt with under portfolio statement, paragraphs 2.71 to For the purposes of the statement of total return, the inclusion of gains or losses from derivative products in net gains or losses on investments or in net income before taxation will depend upon the nature of the transaction. Where positions are undertaken to protect or enhance capital return, the gains or losses should be dealt with in gains or losses on investments; where they are for generating or protecting income, the costs or income should be dealt with in net income before taxation. Therefore, both motives and circumstances in the use of derivatives are important in determining whether items should be treated as income or capital. If, for example, the direct impact of entering a derivative transaction is to decrease the value of the existing income of the fund, the costs and revenues and any other impact associated with that transaction should be matched and therefore be taken against income. If appropriate, other indicators of motive should be considered in order to establish what the motive was. Examples of accounting for different derivatives are given at Annex C. Income from equities SORP for authorised funds 14

16 2.29 Income from equities should be accounted for when it is earned. In the case of quoted equity investments, and non-equity shares, the income should be regarded as earned when the security is quoted ex-dividend (i.e. when the price quoted falls to reflect the value of the dividend concerned). In the case of unquoted equity investments, income should be regarded as earned when the dividend is declared, and the amount at which the investments are shown in the portfolio statement will need to reflect any such income. Dividends received should be stated net of irrecoverable tax credits Application of the accruals concept means that a return (whether in respect of dividends, in respect of redemption, or otherwise) on a non-equity share (such as a preference share) should, in principle, be recognised as income and accrued on a time-apportionment basis. However, because of the practical difficulties arising from the requirement to undertake daily valuations for pricing purposes (such as the lack of availability of pricing information that achieves an accurate allocation between capital and income for these shares), this is impractical for authorised funds. Therefore, income from non-equity shares should be recognised on the same basis as equities. This paragraph does not apply to zero dividend preference shares, the treatment for which is stated in paragraph Interest and income on other securities 2.31 Interest and income on other securities should be recognised as earned. To achieve this, accrued interest purchased and sold on interest-bearing securities should be excluded from the capital cost of these securities and dealt with as part of the income of the scheme For accounting periods beginning on or after 1 January 2007, income should be accounted for on an effective yield basis, irrespective of the level of discount or premium, and it should be calculated with reference to the purchase price. Any movement in the fair value at balance sheet date not accounted for through amortisation of the discount or premium must be shown as a capital gain/loss When this requirement is first being implemented, in the possible event that amortised purchase prices cannot be obtained without undue cost and effort, a suitable alternative basis of calculation should be agreed and appropriately disclosed. Debt securities issued at a discount or premium 2.34 For accounting periods beginning before 1 January 2007, in the case of investments in debt securities issued at a significant discount or premium to the maturity value, the total income arising on such securities, taking into account the amortisation of such a discount or premium, should be spread over the life of the security on an appropriate basis, having regard to applicable accounting standards. A discount or premium is significant if greater than the lower of: SORP for authorised funds 15

17 x% of the redemption price, where x is equal to half the number of years of the issue term; 15% of the redemption price. Income recognition 2.35 If it is expected that income receivable at the balance sheet date will not be received, a provision should be made for the relevant amount. Deduction of tax 2.36 In cases where income is received after the deduction of withholding tax, the income should be shown gross of taxation, and the tax consequences should be shown within the tax charge. Scrip dividends 2.37 For certain securities, the holder may elect to receive a dividend in the form of shares rather than cash. In most cases, the value of the shares to be received will approximate to the amount of the cash dividend (an ordinary scrip dividend), any small difference being attributable to the movement of the share price between the dividend declaration and the shares being quoted ex dividend. In a few cases, an enhancement may be offered such that the value of the shares significantly exceeds the cash dividend (an enhanced scrip dividend) In the case of an ordinary scrip dividend, the whole amount should be recognised as income, on the basis of the market value of the shares on the date they are quoted ex dividend. In the case of an enhanced scrip dividend, the value of the enhancement, calculated as the amount by which the total market value of the shares on the date they are quoted ex dividend exceeds the cash dividend, should be treated as capital. Scrip dividends may not need to form part of the distribution, and the fund s distribution policy for this item should be stated, i.e. that the ordinary element of scrip dividends is treated as income but does/does not form part of the distribution. If the ordinary element of scrip dividends does not form part of the distribution, a statement that the distribution is in accordance with the CIS sourcebook should be disclosed. Special dividends, share buy-backs and additional share issues 2.39 Whether a special dividend, share buy-back or additional share issue is income or capital by nature depends very much on the facts of each particular case. For example, it is likely that where the receipt of a special dividend results in a significant reduction in the capital value of the holding, then the special dividend should be regarded as capital in nature so as to ensure that the matching principle is applied to gains and losses. Otherwise, the special dividends should SORP for authorised funds 16

18 be regarded as income. Underwriting commission 2.40 Underwriting commission should be taken to income and be recognised when the issue takes place, except where the fund is required to take up all or some of the shares underwritten, in which case an appropriate proportion of the commission received should be deducted from the cost of those shares. Stock lending 2.41 Any fees arising from stock lending should be recognised as income on an accruals basis Unless disclosed elsewhere within the report, there should be a note in the accounts disclosing the gross amount and any fees that have been paid to arrive at the net stock lending income amount. Expenses 2.43 To facilitate comparability between funds, all expenses, including interest on borrowing (other than the direct costs of purchase and sale of investments, for example commission, and stamp duty reserve tax arising on sales and repurchases of units in the company), should be charged against income, regardless of any alternative treatment that may be permitted in determining the distribution. To the extent that such expenses can be borne ultimately by capital, the distribution will reflect this, and be higher than the net income as disclosed in the financial statements. Expenses should be analysed to show those payable to the ACD or manager, the depositary or trustee, related parties and third parties Where there is directly or indirectly any fee sharing between the manager, the depositary or an affiliate of either, this must be disclosed with the relevant details. Performance fees 2.45 Where performance fees are charged, the basis of the charge should be disclosed Performance fees should be accrued in accordance with accounting standards and, in the first instance, charged against income. Where all or part is offset against capital for distribution purposes, the basis for the determination of such amounts should be disclosed Where there are known circumstances that may affect future performance fees, for instance a high water mark, this information should be disclosed. SORP for authorised funds 17

19 Guaranteed funds 2.48 Where a premium is paid to a third party(ies) for a guarantee, the accounting treatment follows the nature of the transaction. Where a third party(ies) guarantee to protect investments, the gains or losses should be dealt with in gains or losses on investments; where it guarantees to protect income, the costs or income should be dealt with in net income before taxation. Where the nature of the guarantee is to limit or cap the expenses of the fund, any receipt from the third party(ies) should be shown as a deduction against expenses rather than income. Any such deduction should be disclosed in the notes. The cost of the premium should be recognised in the statement of total return over the period to which the guarantee relates. The treatment of any recoveries from third parties follows the treatment of the premium. Because there will be instances where professional judgement will be required and other factors might have to be taken into account (for example the ability of third parties to honour their guarantees), there should be sufficient narrative disclosure to enable the user properly to understand the nature of the receipt. Taxation 2.49 The following items should be separately identified within the notes to the financial statements together with any other material components of the tax charge: UK corporation tax Overseas taxation Double tax relief Overseas tax credits Deferred tax Adjustments in respect of previous periods 2.50 In general, the tax accounting treatment should follow that of the principal amount, with charges or reliefs allocated using the marginal basis. Under the marginal basis, tax charges or reliefs are allocated to capital or income to the extent that there remains a liability to corporation tax after relief has been made for all expenses attributed directly to the income and capital accounts. In calculating how much tax relief should be allocated, revenue expenses are matched first against taxable income arising in the revenue account, and tax deductible capital expenses are matched first against taxable income arising in the capital account. Tax relief should be allocated to the capital account only to the extent that expenses in the capital account (if any remain after offsetting these expenses against taxable income in the capital account) are required to reduce or eliminate taxable profits. Similarly, tax relief should be allocated only to the revenue account to the extent that expenses in the revenue account (if any SORP for authorised funds 18

20 remain after offsetting these expenses against taxable income in the revenue account) are required to eliminate taxable profits. The fact that a fund is not in an overall taxpaying position is not, in itself, a reason not to allocate tax relief on expenses For example, a fund with 100 of taxable income and 120 of relievable expenses, 50 of which are offset to capital, would take full relief for the 70 of expenses borne by income before allocating relief of 6 (being 100 less 70 = 30 at 20%) to the capital account. Overseas taxation 2.52 Overseas withholding tax suffered net of expected recoveries under any relevant double tax treaty, to the extent that a valid claim is or is expected to be made, should be separately disclosed in the financial statements. In addition, there may be a large amount of overseas taxation recoverable under double tax treaties. There may often be a significant time lag between the receipt of the overseas dividend net of taxation and the receipt of the tax refund. Whether the distribution should assume that all tax claims would be recovered in full will depend on the circumstances and recovery experience in respect of the investments and territories involved. If provision is considered necessary, owing to significant uncertainty as to receipt, this should be deducted from the amount receivable and disclosed as part of overseas taxation. The estimated expense of recovering the taxation should also be provided for and included within expenses. Interest distributions 2.53 Where an authorised fund opts to pay an interest distribution, the amount paid out or invested in respect of accumulation units is allowed as a deduction against the fund s taxable profit for the period. In effect, where all such income is paid out or invested in respect of accumulation units, there should be no charge to tax within the fund in respect of that income. However, except where an interest distribution is paid gross to unitholders, it will nevertheless be a responsibility of the fund to deduct income tax at source at the appropriate rate on payment of the interest distribution to the unitholder. Withholding tax on interest distributions should be shown within other creditors and not as part of the fund s liability to corporation tax, since it will be settled from amounts transferred to the distribution account. Deferred taxation 2.54 There may be timing differences between the accounting treatment of certain items and their taxation. Because it is important to maintain equity in entitlements between accounting periods, deferred taxation should be provided on all temporary timing differences (that are not specifically exempted by FRS 19 paragraphs 9-33) that have originated but not reversed by the balance sheet date. Details of any deferred tax assets and liabilities should be given in the SORP for authorised funds 19

21 notes to the financial statements in accordance with FRS 19 Deferred tax. Value added tax (VAT) 2.55 The VAT recovery position will vary from fund to fund. As for all other items in the financial statements, the recovery of VAT should be accounted for on an accruals basis. Irrecoverable VAT should be included as part of the relevant cost. Distributions 2.56 Details of the type of distribution being paid should be given in the notes to the accounts. Irrespective of the type of distribution, under FRS 25, units in a trust or shares in an OEIC are not treated as equity. Therefore, all distributions made are shown in the statement of total return under the heading of finance costs. Statement of change in shareholders net assets 2.57 The statement of change in shareholders net assets should summarise the movements in the total value of the fund This statement reconciles the changes in net assets during the period in summary form. It draws on the statement of total return for the net increase/decrease in assets attributable to the investment activities and shows the extent to which the fund has grown or contracted as a result of the issue or cancellation of units. An example of this statement is given at Annex A The statement of change in shareholders net assets should be presented on the same page of the financial statements as the statement of total return, thereby providing unitholders, on one page, with a summary of the principal features of the fund s results for the period. Dilution levy 2.60 Any dilution levy charged (in the case of issue and sale of units) or deducted (in the case of redemption and cancellation) should be shown separately. Stamp Duty Reserve Tax (SDRT) 2.61 SDRT arising as a result of redemptions of units in the fund should be shown separately where the cost is borne by the fund. Portfolio statement and balance sheet 2.62 The reports to unitholders must include a balance sheet, which includes all assets and liabilities, and a portfolio statement, which shows the disposition of a fund s investment portfolio. SORP for authorised funds 20

22 Portfolio statement Investments in securities valuation 2.63 Investments of the fund should be stated at market value at the balance sheet date Investments should always be valued to exclude any element of accrued income. The value of overseas securities should be translated into the reporting currency at exchange rates prevailing at the balance sheet date. Where, in view of exceptional circumstances, for example the suspension of the market, the last quoted price is not used, the notes should describe clearly the basis of valuation and the reasoning behind it The accounting system used for valuing the investments for financial statements purposes at the period end will normally be the same as that used for valuation purposes. Where daily valuations are produced for the purposes of pricing, it is acceptable to use that valuation of the property of the fund for the purposes of the financial statements, rather than perform an additional valuation, provided that the valuation point is sufficiently near to the close of business on the balance sheet date, such that any distortion arising from price movements or as a result of subsequent deals is clearly immaterial. The precise valuation point should be disclosed in the notes to the financial statements For most funds, the determination of the market value of the portfolio should be reasonably straightforward, since the values are readily available through published sources. However, in certain situations, the value of a security may not be readily determinable, as will often be the case where the investment is not an approved security within the meaning of FSA rules. Where the value cannot be readily determined, the securities should be stated at the director s or manager s valuation, arrived at in accordance with the fund s instrument constituting the scheme. The notes to the financial statements should include adequate details about the basis of the valuation, including the identity of those who carried out the valuation and a statement on how the valuation was reached. This statement should make it clear that the intention of the valuation was to estimate market value. Investment in securities presentation 2.67 For each holding in the portfolio, the percentage of the value of the fund or subfund property that the holding represents should be shown. The percentage should also be shown for each category of holding in the property of the fund or sub-fund, in addition to the individual holdings. These categories should be the most appropriate in the light of the investment policy of the fund, for example economic, geographical or by currency. A suggested format for the portfolio SORP for authorised funds 21

23 statement is set out at Annex A In addition, if a fund invests in more than one class of asset (for example, bonds and equities) and asset class is not a category used in presenting the portfolio statement, the split between each asset class must be made clear at the foot of the portfolio statement. Such an analysis is not recommended for an asset class if that asset class represents less than 5% of the fund s value. For example: Market value % 000s Bonds 25, Equities 9, Portfolio of investments 35, For bond funds, where credit rating is not a category used in presenting the portfolio statement, the listing of bonds should be in sectoral categories, similar to the way that the analysis is performed for equities. Where this is the case, there should also be an analysis at the foot of the portfolio statement showing the investments in bonds in credit rating blocks unless licence agreements with credit rating agencies do not permit publication of this information in reports. For example: Rating block Market value 000s AAA 5,987 AAB 10,000 CCC 7,000 Unrated 3,000 Total bonds 25,987 Equities 9,865 Portfolio of investments 35, The portfolio statement should distinguish between those securities admitted to official stock exchange listing, and traded on or under the rules of an eligible securities market, and those that are unapproved. Derivatives 2.71 This statement sets out the general principles that should be followed. As a principle, derivatives should be accounted for in the same way as any other investment (see paragraph 2.28) Interest received or paid relating to margin deposits must be separately disclosed. SORP for authorised funds 22

24 2.73 Derivatives should be included in the balance sheet and portfolio statement at market value. The portfolio statement should not net positive market values against negative market values. However, aggregation of derivatives of the same asset type and terms is permitted Recommended disclosures for the notes to the accounts are described in sections 2.93 to Investment in units in another collective investment scheme 2.75 Where a fund invests in another collective investment scheme, the following valuation bases should apply: For collective investment schemes managed or operated by the ACD or manager or an associate of the ACD or manager, holdings should be valued at cancellation price for dual priced funds and at the single price for single priced funds. For collective investment schemes operated by other management groups, holdings should be valued at bid price for dual priced funds and at the single price for single priced funds. Valuation should take into account any agreed rate of redemption charge Where the units are held in an accumulation form, the accumulation of income relating to the holding should be recognised in the income account, including any withholding taxes but excluding tax credits In accordance with FSA rules, equalisation on distributions received may be passed through to unitholders in their distribution rather than being deducted from the cost of the investment. The equalisation policy adopted should be disclosed within the accounting policies. Immovable property 2.78 Immovable property should be valued at open market value An open market value for each immovable property in the fund should be commissioned from the Standing Independent Valuer of the fund to support the balance sheet carrying values (COLL 5 sets out the valuation rules) The value of each individual property need not be shown in the portfolio statement. Rather, properties may be aggregated in bands, each of which represents not more than 5% of the total value of immovable properties. Details of individual properties should be given within each band, but the actual valuation figure for each property need not be shown. SORP for authorised funds 23