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FRS 102: Stay ahead of the curve

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24th Feb 2016
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As chief executive of law firm, berg, Alison Loveday has helped clients who are battling financial disputes and miss-sold derivatives. As a result, the firm has seen the impact a lack of understanding of banking covenants can have on business owners-particularly so far as any breach of covenant is concerned.

The financial reporting standards, which have replaced UK GAAP, may potentially have a significant impact in this regard, although little focus appears to have been given to this aspect of the new standards. 

Here are some answers to key questions and some top tips to ensure accountants remain ahead of the curve. 

Who does this affect? 
The new standards will affect small companies with accounting periods after 1 January 2016 (together with the prior year comparables) and it’s essential therefore that businesses prepare themselves fully now. 

There are a number of changes being introduced by the new accounting standards, including capital values, holiday pay accrual and IP values. The change we are particularly concerned about, however, is the new requirement to account for derivative instruments on the balance sheet under FRS 102. 

We are concerned that many businesses remain unaware of this requirement, and the impact that including the derivative may have on the company's balance sheet. For many businesses, the impact is significant and it could take the balance sheet into a negative position. Furthermore, this could cause the business to inadvertently breach the banking covenants set out in its loan documentation. 

Why must accountants be wary?

Most business owners are not familiar with the detailed contents of their bank loans and covenants, which are often more than 40 pages long and have been drafted from the perspective of the bank. This has already had an impact in the scandal surrounding RBS's Global Restructuring Group and the business support units of other banks, where we saw banks engineer breaches to push businesses into default. In this instance, however, the banks will not need to do this, as the new accounting standard may result in businesses inadvertently breaching their covenants, as outlined above. 

What must clients do? 
Businesses will need time to consider the full impact of the new accounting standards, not simply in relation to derivatives, and it will take time to obtain appropriate advice, so that they can plan accordingly.

It is important that businesses engage with professional advisers – accountants and lawyers - at this early stage to allow time for the true impact of the new accounting standards to be assessed. 

Are the new rules a step in the right direction for small businesses?

I welcome the new rules, as previously business owners did not have visibility of the full impact of derivatives and therefore did not have the right information available to challenge the banks when being sold these products. However, that said, at this present time the true impact that FRS 102 might have on a company's balance sheet has not been fully understood and I remain concerned that business owners are going to be taken by surprise and may well unknowingly put themselves under significant pressure at a time when they can ill afford to deal with yet further change in the business. 

Alison Loveday is chief executive at berg.

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