As we approach the end of 2016, Steve Collings considers some of the key changes surrounding accounting and financial reporting that practitioners will face in 2017 (some for the first time).
Withdrawal of the FRSSE (effective January 2015)
For accounting periods starting on or after 1 January 2016, the FRSSE (effective January 2015) is withdrawn in its entirety and a transition to the new reporting regime will have to be undertaken. FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland will become mandatory for small companies that have not early-adopted the standard.
It is expected that many small companies will be preparing their financial statements under FRS 102 for the first time for their December 2016 year-ends. Effectively 2017 will see the end of previous UK GAAP being applied.
FRS 105 The Financial Reporting Standard applicable to the Micro-entities Regime is also mandatory for micro-entities choosing to report under the standard for accounting periods starting on or after 1 January 2016. As mentioned in previous articles, FRS 105 is an optional standard and a micro-entity may consider it appropriate to report under FRS 102 instead of FRS 105. Factors to consider might include:
- the pace of growth of the micro-entity (i.e. is it likely to outgrow FRS 105 in a relatively short timeframe?)
- the prohibition of revaluation and fair value accounting (see below)
- views of the bank or other lenders due to the lack of disclosure information required by FRS 105
- the client’s requirements
- impact on distributable reserves as more items are written off to profit and loss
- potential impact on credit-rating (some practitioners have stated that their micro-entity clients have suffered a reduced credit-rating due to FRS 105, although this cannot be substantiated).
The rules in both FRS 102 and FRS 105 are retrospective, meaning that the standards have to be applied as far back as the date of transition, which is the first day of the comparative period reported in the accounts. Thus, for a 31 December 2016 year-end, the date of transition is 1 January 2015, being the start date of the comparative period.
For a majority of small and micro-entities the impact of applying the standards retrospectively to the date of transition is expected to be fairly minimal. The tax consequences of transitional and prior year adjustments should also be considered. HMRC's Overview Paper which was updated in October 2016 offers guidance in this area.
Section 1A Small Entities
Small companies, and micro-entities choosing not to report under FRS 105, will be required to report under FRS 102, Section 1A Small Entities as a minimum. Again, the regime is flexible and a small company can choose to report under full FRS 102 if they wish. Section 1A of FRS 102 outlines the presentation and disclosure requirements and is structured as follows:
|Scope of this section||Paragraphs 1A.1 to 1A.4 outlines the types of entities which can apply Section 1A in the preparation of their financial statements.|
|True and fair view||Paragraphs 1A.5 and 1A.6 emphasise that small entities are required, by law, to prepare financial statements that give a true and fair view. To that end, additional disclosures over and above those required by Section 1A may be needed to achieve a true and fair view. Professional judgement will be needed in this respect.|
|Complete set of financial statements of a small entity||Paragraphs 1A.7 to 1A.11 give guidance on what constitutes a complete set of financial statements for a small entity (a cash flow statement is not required) and a small entity can prepare a statement of income and retained earnings in place of a statement of comprehensive income in certain situations (see Section 6 Statement of Changes in Equity and Statement of Income and Retained Earnings).|
|Information to be presented in the statement of financial position (balance sheet)||Paragraphs 1A.12 and 1A.13 outline the presentation requirements for the balance sheet. Paragraph 1A.13 also cross-refers to Appendix A in respect of the adapted balance sheet.|
|Information to be presented in the income statement (profit and loss account)||Paragraphs 1A.14 and 1A.15 outline the presentation requirements for the profit and loss account. Paragraph 1A.15 cross-refers to Appendix B in respect of the adapted profit and loss account.|
|Information to be presented in the notes to the financial statements||Paragraphs 1A.16 to 1A.20 provides guidance on what needs to be in the notes to the financial statements. These paragraphs go hand-in-hand with Appendices C and D.|
|Voluntary preparation of consolidated financial statements||Paragraphs 1A.21 to 1A.22 provides guidance for small groups that may voluntarily prepare consolidated financial statements.|
There are four Appendices which are integral parts of Section 1A as follows:
Appendix A to Section 1A: Guidance on adapting the balance sheet formats
Appendix B to Section 1A: Guidance on adapting the profit and loss account formats
Appendix C to Section 1A: Disclosure requirements for small entities
Appendix D to Section 1A: Additional disclosures encouraged for small entities
Appendices A and B provide guidance on adapting the statutory formats of the financial statements which is now permissible under the Companies Act 2006 following implementation of SI 2015/980. It is to be noted, however, that some software providers are not yet allowing this option because it is currently unknown, at the present time, how entities may wish to adapt their financial statements.
The flexibility to adapt the financial statements was primarily introduced by the Department for Business Innovation and Skills (which is now replaced by the Department for Business, Energy and Industrial Strategy) to allow for a smoother consolidation process for entities preparing Companies Act 2006 accounts which are then included in a parent’s IFRS consolidated financial statements in light of the flexibility afforded by parent companies under EU-adopted IAS 1 Presentation of Financial Statements.
Appendix C outlines the disclosure requirements which are required by law for a small entity and hence must be included (note paragraph 1AC.25 which relates to the disclosure of the tax treatment of amounts credited or debited to the fair value reserve is superfluous and does not need to be disclosed as this was repealed in SI 2015/980 and will be removed in the next edition of FRS 102).
Appendix D outlines the disclosures which the Financial Reporting Council (FRC) encourages small entities to make in order that the financial statements give a true and fair view. It should also be noted that additional disclosures beyond the requirements of Section 1A might be required in certain situations to achieve a true and fair view. This is where professional judgement will be needed.
Triennial review of FRS 102
The FRC is conducting its triennial review of FRS 102 in 2016/17. Originally the FRC planned to have any changes made to FRS 102 as a result of the triennial review effective in 2018. But the FRC postponed the triennial review for one year to allow more time for first-time adopters of the standard to implement it. This will also provide a more stable platform for small entities adopting the standard for the first time for their 2016 year-ends.
As such, changes to FRS 102 as a result of the triennial review are not expected to take effect until 2019. This will give entities, such as small entities, enough time to implement the standard and take on board incremental changes made as part of the triennial review.
It is expected that the first tranche of proposed changes to the standard will be incremental and of minimal impact to entities under the scope of FRS 102.
The FRC expect to issue an exposure draft of the first round of changes in the first quarter of 2017. The second tranche of proposed changes are likely to be more significant in nature and an exposure draft of these changes is expected towards the end of 2017 with an implementation date of these changes planned for 2022 so as to give practitioners sufficient time to do any impact assessments considered necessary and plan for the transition.
Previous articles have examined the detailed technical content of both FRS 102 and FRS 105. However, a couple of the more common issues causing concern among practitioners include:
- interest-free loans
- prohibition of revaluation and fair value accounting for micro-entities
- revaluation accounting under FRS 102
- holiday pay accruals
Interest-free loans under FRS 102 are more arduous in terms of accounting than under previous UK GAAP. This is because under FRS 102 most loans are accounted for using the amortised cost method, which in turn uses the effective interest rate to deal with the interest income or expense.
Previous articles have dealt with the accounting treatment for such loans and there is a useful staff education note on this issue. Where loans have no formal terms attached to them (for example, some intra-group loans or loans from a director-shareholder), they are generally treated as repayable on demand and recognised in the accounts at the amount which is payable on demand, discounted from the first date that the amount may be required to be paid.
Some interest-free loans that have previously been made have been presented in long term creditors under outgoing UK GAAP on the basis that repayment is not expected to be made for some time.
This will have to change under FRS 102 and loans without formal terms will have to be recognised as current liabilities as they will be considered repayable on demand. An impact assessment is advised so there are no unpleasant surprises after transition to FRS 102, because reallocating long-term creditors to current will reduce net current assets, turn net current assets into net current liabilities or increase net current liabilities.
Long-term loans which are below market rate (or interest-free) and which do have formal terms attached to them will generally need to be discounted using the effective interest method. This is illustrated in the staff education note, a link to which is attached above.
Prohibition of revaluation and fair value accounting for micro-entities
FRS 105 does not allow a micro-entity to revalue or fair value assets and liabilities. Therefore, if the micro-entity has previously revalued a fixed asset (such as a building), then it will have to remove the revaluation amount on transition to FRS 105. This concept also applies if the micro-entity has an investment property on its balance sheet that has been revalued at each balance sheet date under the FRSSE and hence the revaluation reserve will also disappear.
This is because the legislation does not recognise the fair value or alternative accounting rules in the Companies Act 2006. Assets can only be carried under the historic cost model (i.e. at cost less depreciation less impairment losses) which will mean that items such as investment properties will have to be depreciated.
In such situations, depreciation on an investment property is calculated and accounted for from the date of acquisition, not the date of transition, which is why it is vital that careful consideration of FRS 105 and its appropriateness in such situations is advised. All assets that have been revalued under previous UK GAAP are restated under FRS 105 to the value they would have carried at in the balance sheet under historic cost principles to comply with the micro-entities legislation.
If the micro-entity does not want to restate previously recognised assets at historic cost, then it will not be able to use FRS 105 and must report under FRS 102 (Section 1A) as a minimum. It is also worth noting that previous UK GAAP revaluations cannot be used as a deemed cost on transition for the purposes of FRS 105 and therefore impact assessments are advisable because restating assets that have previously been revalued upwards to historic cost principles are more than likely going to have a detrimental impact on the balance sheet position.
Revaluation accounting under FRS 102
There still appears to be some confusion surrounding the accounting treatment of revaluation gains and losses for investment property and revalued tangible fixed assets. Investment property carried at fair value is accounted for under Section 16 Investment Property and this section requires fair value gains and losses (together with the associated deferred tax consequences) to be taken to the profit and loss account. There is no concept of the revaluation reserve where investment property is concerned, although some entities are ring-fencing gains and losses that have passed through the profit and loss account in a separate reserve within the equity section of the balance sheet called a ‘fair value reserve’ as such reserves are not distributable.
The treatment of revaluation gains and losses for items of tangible fixed assets accounted for under Section 17 Property, Plant and Equipment is similar to outgoing UK GAAP. Revaluation gains are accumulated in the revaluation reserve within equity. Revaluation losses are also taken to the revaluation reserve to the extent that there is a credit balance on the revaluation reserve with any excess loss being taken to the profit and loss account. Deferred tax should also be recognised due to the timing difference plus approach that Section 29 Income Tax takes and these amounts should also be taken to the revaluation reserve.
Care must be taken to ensure a clear understanding of the requirements in FRS 102 and keep in mind that the accounting treatment for fair value gains and losses has only changed for investment property. The revaluation model in Section 17 is similar to the revaluation model in FRS 15 Tangible fixed assets and the FRSSE.
Holiday pay accruals
Holiday pay accruals appear to be causing an element of contention with some practitioners. Both FRS 102 and FRS 105 require accruals to be made for holiday pay accrued by employees, but not paid by the entity until the next accounting period.
Take care where concluding that such amounts are immaterial and hence will not be provided because in order to conclude that holiday pay accruals are immaterial, they will need either calculating or estimating in order to arrive at a conclusion as to whether or not they are immaterial. It is also worth noting that holiday pay provisions can be prepayments as well as accruals.
Abbreviated accounts for small and medium-sized entities are abolished for accounting periods starting on or after 1 January 2016 (or 1 January 2015 if the entity has early-adopted SI 2015/980). Previous articles have examined what will be filed with Companies House and currently it is expected that ‘filleted’ accounts will be the most popular for small companies with abridged accounts coming in close second.
Due to the increase in the thresholds that dictate whether a company or group is small, medium-sized or large, it is expected that many more entities will be able to claim audit exemption as a lot of companies previously classified as medium-sized will become small under the new thresholds.
However, if the entity was medium-sized under the old thresholds, but small under the new thresholds, and has early-adopted SI 2015/980 to take advantage of applying the small companies’ regime, then it must not claim audit exemption. This is because whilst the audit exemption thresholds have been increased so they are aligned to the new small company thresholds, there is no option to early-adopt the new audit exemption thresholds and hence they can only be applied for audits for accounting periods starting on or after 1 January 2016. For clarity, the new small company thresholds are:
|Turnover||Not more than £10.2 million (up from £6.5 million)|
|Balance sheet total (fixed assets plus current assets)||Not more than £5.1 million (up from £3.26 million)|
|Average number of employees||Not more than 50|
The two out of three rule still applies.
Revised auditing standards have also been issued that apply to audits of financial statements for periods commencing on or after 17 June 2016. Audit firms will note that the International Standards on Auditing (ISAs) are ISAs (UK) rather than ISAs (UK and Ireland) and reflect the provisions contained in the Audit Regulation and Directive. Find the revised auditing standards here.
2017 is expected to be a ‘full on’ year for many practitioners, particularly those that will be adopted FRS 102/FRS 105 for the first time.
Throughout 2017, further technical articles will be published to assist practitioners to understand the detailed technical requirements and updates on the triennial review will also be published so that practitioners are aware of the proposed changes to UK GAAP and as to where they can feed in their comments to the FRC.