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FRS 102: Transition issues

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19th Jan 2015
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FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland becomes mandatory for accounting periods commencing on or after 1 January 2015 and accountants who are going to be affected by this new regime should now have a sound knowledge of the standard, explains Steve Collings.

Companies at the smaller end of the scale (which do not apply the micro-entities legislation) may also find that they are moved under the scope of FRS 102 for accounting periods starting on or after 1 January 2016 if the proposals announced by the Financial Reporting Council (FRC) are given the go ahead once the UK transposes the EU Accounting Directive into companies’ legislation. Hence it is advisable for all practitioners to gain a broad understanding of the new accounting methodologies contained within the FRS.

The latest version of FRS 102 to be issued by the FRS is the August 2014 edition.

As FRS 102 has now come into mandatory effect, this first article of a two-part series will examine some of the key provisions in Section 35 of FRS 102 Transition to this FRS. Section 35 is the first section that preparers need to understand in detail in order to enable a transition to go smoothly.

The rules in FRS 102 are retrospective – i.e. they have to be applied to the date of transition. Section 35 contains four mandatory exemptions from retrospective application (paragraph 35.9) and 18 optional exemptions from retrospective application (paragraph 35.10). In respect of the optional exemptions, an entity can choose to adopt all, some or none of them but practitioners are advised to look in detail at the optional exemptions to assess their applicability to affected clients as they are designed as a time-saving mechanism. All the exemptions are considered in this article.

Procedures for preparing the opening balance sheet

Paragraph 35.7 requires an entity transitioning to FRS 102 to prepare an opening balance sheet (statement of financial position) as at the date of transition. The date of transition is the start date of the earliest period reported in the financial statements (hence for a 31 December 2015 year-end, the date of transition will be 1 January 2014). Paragraph 35.7 requires an entity to:

  • Recognise all assets and liabilities that need to be recognised under FRS 102 (for example recognising deferred tax liabilities in respect of gains on the fair value of investment property)
  • Derecognise assets or liabilities that cannot be recognised under FRS 102
  • Reclassify items that were recognised as one type of asset, liability or component of equity under old GAAP but are considered a different type of asset, liability or component of equity under FRS 102 (for example moving revaluation surpluses relating to investment property to profit and loss account reserves)
  • Apply FRS 102 going forward in measuring all recognised assets and liabilities

Reporting entities will not need to present the opening balance sheet in the financial statements, but restatement is needed as far back as the date of transition so that all amounts reported in the accounts are FRS 102-compliant. Adjustments made to opening equity balances and prior year profit are disclosed in the transitional disclosure notes.

Example – transitional adjustments

Company A has run an opening trial balance as at 1 January 2014 (based on the 31 December 2013 closing trial balance). The opening trial balance shows a revaluation surplus in respect of its investment property of £120,000. The tax rate is 20%.

On transition to FRS 102, Company A should make the following transitional adjustments to its opening balances to arrive at an FRS 102-compliant set of opening balances:

DR revaluation reserve                 £120,000

CR accumulated P&L                   £120,000

Being reclassification of investment property revaluation surplus on transition

Under FRS 102 Company A will have to provide for the deferred tax in respect of the investment property’s fair value as follows:

DR accumulated P&L                    £24,000

CR deferred tax provision             £24,000

Being deferred tax on investment property revaluation

Once the transitional adjustment above is complete, the preparer should turn their attention to the comparative year (i.e. the 2014 financial statements).

Example – restatement of 2014 amounts

Continuing with the example above in respect of Company A’s investment property. Assume that in 2014 the investment property’s market value had increased by £5,000.

Originally the entries in the books would have been:

DR investment property                £5,000

CR revaluation reserve                 £5,000

The concept of the revaluation reserve no longer applies to investment property in FRS 102 and so transitional adjustments will have to be carried out in the 2014 financial year as follows:

DR revaluation reserve                £5,000

CR profit and loss                        £5,000

Being reclassification of investment property gain

DR profit and loss tax charge      £1,000

CR deferred tax provision            £1,000

Being deferred tax on investment property revaluation

From the above you can see that there will be an overall increase in previously reported profit of £4,000 (£5,000 gain on revaluation less the deferred tax charge of £1,000). The gains taken to profit and loss are not, however, distributable to shareholders as they are unrealised for dividend purposes.

Mandatory exemptions from retrospective application

As mentioned above, there are four mandatory exemptions from retrospective application which are as follows:

Derecognition of financial assets and financial liabilities

Entities cannot recognise financial assets and financial liabilities which were derecognised under previous UK GAAP. For those instruments that would have been derecognised under FRS 102 and arose in a transaction that took place before the date of transition but were not derecognised under old UK GAAP there is a choice – either derecognise them on adopting FRS 102 or continue recognising them until they are disposed of or settled.

Accounting estimates

Entities cannot use hindsight to change the value of accounting estimates recognised at the date of transition. Should additional information have come to light about the estimate, this should be treated as a non-adjusting event and accounted for in the current (not previous) accounting period unless there is clear evidence that the accounting estimate is incorrect.

Discontinued operations

On transition to FRS 102, a reporting entity cannot change the accounting it followed under previous GAAP in respect of its discontinued operations and hence there will not be any reclassification or remeasurement for discontinued operations that have been previously accounted for.

Non-controlling (minority) interests

Entities cannot retrospectively change the accounting that it followed for measuring non-controlling interests.

Optional exemptions from retrospective application

There are 18 optional exemptions from retrospective application (some of which might prove to be very useful to clients) as follows:

Business combinations, including group reconstructions

A first-time adopter does not have to apply Section 19 Business Combinations and Goodwill to those business combinations that took place before the date of transition. However, where the entity restates any combination so as to comply with Section 19, it must restate all later combinations.  Where the provisions in Section 19 are not applied retrospectively, all assets and liabilities acquired or assumed in a past business combination at the transition date will be recognised and measured in accordance with paragraphs 35.7 to 35.9 (or if applicable, paragraphs 35.10(b) to (r)). There are two exceptions to this requirement in respect of:

  • Intangible assets (other than goodwill): intangible assets subsumed within goodwill should not be separately recognised
  • Goodwill: no adjustment is made to the carrying value of goodwill

Share-based payment

For equity instruments granted before the date of transition, a first-time adopter does not have to apply Section 26 Share-based Payment. This exemption also applies to liabilities arising from share-based payment transactions which were settled before the date of transition. 

Where a first-time adopter has previously applied either FRS 20/IFRS 2 Share-based Payment to equity instruments granted BEFORE the date of transition, the entity must then apply either FRS 20/IFRS 2 (whichever applies) or Section 26 at the transition date.

Fair value as deemed cost

For items of property, plant and equipment (Section 17), investment property (Section 16) or intangible assets (not goodwill) (Section 18), the first-time adopter can use fair value as deemed cost on transition to FRS 102.  The term ‘deemed cost’ is defined in the glossary as:

“An amount used as a surrogate for cost or depreciated cost at a given date. Subsequent depreciation or amortisation assumes that the entity had initially recognised the asset or liability at the given date and that its cost was equal to the deemed cost.”

Revaluation as deemed cost

Again, for items of property, plant and equipment, investment property or intangible assets (not goodwill), a first-time adopter can use a revaluation amount as deemed cost. This might be of particular benefit to a client who wants to stop getting periodic revaluations and move back onto the depreciated historic cost model for measuring fixed assets (e.g. a building). Be careful, however, with this exemption. Valuations should be obtained at, or before, the date of transition but not after. 

Individual and separate financial statements

Paragraphs 9.26, 14.4 and 15.9 of FRS 102 require an entity to account for investments in subsidiaries, associates and jointly controlled entities at either cost less impairment or at fair value in the individual or separate financial statements. Where cost is used, the first-time adopter must use one of the following amounts in the individual/separate opening balance sheet:

  • Cost per Section 9 Consolidated and Separate Financial Statements, Section 14 Investments in Associates or Section 15 Investments in Joint Ventures
  • Deemed cost. In this respect, the deemed cost is the carrying amount at the transition date which has been determined under previous UK GAAP

Compound financial instruments

‘Split accounting’ is used for compound financial instruments (where the debt and equity components of the instrument are accounted for separately). A first-time adopter does not have to use split accounting if the liability portion of the instrument has been settled at the date of transition.

Service concession arrangements

A service concession arrangement is defined in the glossary as:

“An arrangement whereby a public sector body or a public benefit entity (the grantor) contracts with a private sector entity (the operator) to construct (or upgrade), operate and maintain infrastructure assets for a specified period of time (the concession period).”

For such arrangements, a first-time adopter does not have to apply the provisions in paragraphs 34.12I to 34.16A for service concession arrangements entered into before the date of transition as these arrangements will continue to be accounted for using the same accounting policies applied at the transition date.

Extractive industries

Where a first-time adopter has previously accounted for exploration and development costs for oil and gas properties which are in the development/production phases in cost centres that included all properties in a large geographical area, it can choose to measure oil and gas assets at the transition date on the following basis:

  • Exploration and evaluation assets at the amount determined under previous UK GAAP
  • Assets in the development/production phase at the amount determined for the cost centre under previous UK GAAP (this amount will be allocated to the cost centre’s underlying assets on a pro-rata basis using reserve volumes/values at the date of transition)

First-time adopters must test exploration and evaluation assets and assets in the development and production phases for impairment at the transition date in accordance with either Section 34 Specialised Activities or Section 27 Impairment of Assets

Arrangements containing a lease

First-time adopters can choose to determine whether an arrangement that exists at the transition date contains a lease on the basis of facts and circumstances existing at the date of transition rather than when the arrangement was originally entered into.

Decommissioning liabilities included in the cost of property, plant and equipment (PPE)

The cost of an item of PPE should include the initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located. A first-time adopter can choose to measure this portion of cost at the transition date rather than on the date(s) when the obligation initially arose.

Dormant companies

A company which is dormant (as defined in the Companies Act) can retain its accounting policies for reported assets, liabilities and equity at the transition date until such time that there is a change to those balances or the company enters into new transactions.

Deferred development costs as deemed cost

The carrying amount of development costs capitalised under previous SSAP 13 Accounting for research and development can be used as deemed cost on transition to FRS 102.

Borrowing costs

When a first-time adopter decides to capitalise borrowing costs as part of the cost of a qualifying asset, it can treat the transition date as the date on which capitalisation of such costs commences.

Lease incentives

A first-time adopter does not have to apply paragraphs 20.15A and 20.25A to lease incentives provided that the lease was entered into before the transition date. The first-time adopter can continue to recognise any remaining lease incentive (or cost associated with lease incentives) on the same basis as that applied at the transition to FRS 102.  

Public benefit entity combinations

A first-time adopter does not have to apply paragraphs PBE34.75 to PBE34.86 to public benefit combinations which had taken place before the transition date. However, if the first-time adopter restates any entity combination to comply with FRS 102, it must restate all later entity combinations.

Assets and liabilities of subsidiaries, associates and joint ventures

When a subsidiary becomes a first-time adopter later than its parent, the subsidiary measures it assets and liabilities at either:

1. The carrying values that would be included in the parent’s consolidated accounts. These values would be based on the parent’s date of transition to FRS 102 if no consolidation adjustments were made and for the effects of the business combination in which the parent acquired the subsidiary

2. The carrying values required by the rest of FRS 102 which are based on the subsidiary’s transition date

The carrying values in 2 could be different from 1 where the exemptions result in measurements which are dependent on the transition date. In addition, differences could also arise where the accounting policies used by the subsidiary differ from those in the consolidated accounts (the section cites an example of the subsidiary using the cost model for its property, plant and equipment, with the group using the revaluation model). 

Similar exemptions are available for an associate or joint venture which becomes a first-time adopter later than the entity which holds significant influence or joint control over it.

Conversely, where the parent or investor becomes a first-time adopter later than its subsidiary, associate or joint venture the parent/investor will, in the consolidated accounts, measure the assets and liabilities of the subsidiary, associate or joint venture at the same carrying amount as in the subsidiary’s, associate’s or joint venture’s financial statements which takes into account consolidation and equity accounting adjustments as well as the effects of the business combination in which the parent acquired the subsidiary or transaction in which the entity acquired the associate or joint venture. 

Where the parent become a first-time adopter in respect of its separate financial statements earlier or later than for its consolidated accounts, the parent measures its assets and liabilities at the same values in both sets of accounts, except for consolidation adjustments.

Designation of previously recognised financial instruments

FRS 102 allows a financial instrument to be designated on initial recognition as a financial asset or financial liability at fair value through profit or loss, provided certain criteria are met. Section 35 allows an entity to designate any financial asset or financial liability at fair value through profit or loss provided the asset or liability meets the criteria in paragraph 11.14(b) at the transition date.

Hedge accounting

There are exemptions available in respect of hedge accounting that may be applied in respect of:

  • A hedging relationship existing at the date of transition
  • A hedging relationship which ceased to exist at the date of transition because the hedging instrument had expired, was sold, terminated or exercised before the transition date
  • A hedging relationship which commenced subsequent to the transition date
  • Entities that choose to take the accounting policy choice under paragraphs 11.2(b) or (c) or paragraphs 12.2(b) or (c) and apply IAS 39 Financial Instruments: Recognition and Measurement or IFRS 9 Financial Instruments

Conclusion

This article has considered some of the more critical aspects of Section 35 relating to first-time adoption of FRS 102, in particular the mandatory and optional exemptions to retrospective application. 

The second part of this article will take a look at the transitional disclosures and the explicit and unreserved statement of compliance which have to be made in an entity’s FRS 102 financial statements.

Steve Collings is the audit and technical partner at Leavitt Walmsley Associates. He is about to publish a book for Bloomsbury on the Audit and Accounts of Limited Liability Partnerships and recently wrote a book on FRS 102 with Paul Gee.

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By tobri
20th Jan 2015 17:48

FRS 102


Steve, my sole limited company client (audit exempt) has records that can only be described as shambolic.   I cannot see any application of FRS 102 here, am I right?

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Replying to Not Anonymous:
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By DMBAcc
01st Feb 2015 12:29

I am not sure ......

....anyone can answer such a vague question.  FRS102 has nothing to do with good or bad accounting records - that may be a matter you have to deal with Companies House and HMRC

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By musclefoot
10th Feb 2015 20:14

Interest free loan from parent company (non UK)

Hi Steve

Could you point me in the right direction regarding FRS102 rules on interest free loans from a parent company. I am a bit confused on what I have found so far, it seems as though I may need to recognise an interest charge if not repayable demand?

Thanks

Ross

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