A new year – a new UK GAAP comes onto the scene. FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland is now with us.
Many practitioners across the country will be gearing up to handle the challenges that this new financial reporting framework brings with it. The last 12 months have also seen considerable changes on the horizon for small and micro-entities that will be required to move across to new frameworks for accounting periods commencing on or after 1 January 2016 (typically December 2016) year-ends.
This article looks at some of the emerging issues that have cropped up over the last year in relation to FRS 102 and FRS 105 The Financial Reporting Standard applicable to the Micro-entities Regime. Further articles dealing with the technical aspects of FRS 102 and FRS 105 will also be published throughout the year to assist practitioners in understanding and interpreting the requirements of this new regime.
Unlisted companies which are not small
Companies which are unlisted and which are not eligible to apply the small companies’ regime in the preparation of their financial statements must apply FRS 102 for accounting periods commencing on or after 1 January 2015 (i.e. 31 December 2015 year-ends).
Transitional information should have been obtained in order that the transition across to the new regime can be undertaken because this will be needed to restate the opening balance sheet to become FRS 102-compliant and also to restate the prior year comparatives. Some of the ‘main’ points to note are as follows:
Goodwill
The August 2014 version of FRS 102 required goodwill to be amortised over a period of five years’ where management are unable to assign a reliable estimate of its useful economic life. The August 2014 version of FRS 102 was superseded by the September 2015 version which increases the cap on this amortisation period to ten years where management are unable to assign a reliable estimate of its useful economic life (this is because the EU Accounting Directive increased the period to ten years and so FRS 102 had to reflect the requirements of the Directive).
It is to be emphasised that the Financial Reporting Council have said that only in exceptional circumstances will there be an accelerated write-down of goodwill in moving over to FRS 102. This is because management should have considered the carrying value of goodwill at each balance sheet date under previous UK GAAP and where the carrying value exceeded recoverable amount, an impairment loss should have been recognised.
The remaining useful life and amortisation period should then have been reviewed; hence it is very likely that entities’ amortisation policies for goodwill (and other intangible assets) will still remain appropriate under FRS 102. Some practitioners have seen the five/yen-year amortisation period and assumed that this is the maximum period permitted in all situations; which is not the case.
Some entities that have previously not amortised goodwill because management consider it to have an indefinite useful life will have to start amortising it because FRS 102 does not allow goodwill to have an indefinite useful life.
Cash flow statement
The cash flow statement prepared under Section 7 Statement of Cash Flows will look quite different from the ones prepared under FRS 1 Cash flow statements. This is because under Section 7 principles, there are only three cash flow classification headings:
- Operating activities;
- Investing activities; and
- Financing activities.
Cash flows such as corporation tax payments and interest payments will generally fall to be classed as operating activities because there are no ‘taxation’ and ‘returns on investment and servicing of finance’ cash flow classifications in Section 7.
Reduced disclosures for group members
There are reduced disclosures available in FRS 102 for subsidiaries (and ultimate parents) which are found in paragraphs 1.8 to 1.13 and these are available in the individual financial statements for ‘qualifying entities’. The term ‘qualifying entities’ is defined in the Glossary to FRS 102 as:
‘A member of a group where the parent of that group prepares publicly available consolidated financial statements which are intended to give a true and fair view (of the assets, liabilities, financial position and profit or loss) and that member is included in the consolidation.’
Some disclosure exemptions are not available to financial institutions.
Where a subsidiary is consolidated in with a parent, it is worth considering whether the subsidiary can take advantage of some of the reduced disclosures available in FRS 102.
Date of transition
The rules in FRS 102 are retrospective; in other words they have to be applied as far back as the client’s ‘date of transition’. The date of transition is the start date of the earliest period reported in the accounts. Using quarter-end dates, for an accounting period commencing on or after 1 January 2015, the dates of transition are as follows:
Year-end
|
Date of transition
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31 December 2015
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1 January 2014
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31 March 2016
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1 April 2014
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30 June 2016
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1 July 2014
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30 September 2016
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1 October 2014
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For small companies which are not early-adopting FRS 102 with reduced disclosures, the date of transition will be one year later, i.e.:
Year-end
|
Date of transition
|
31 December 2016
|
1 January 2015
|
31 March 2017
|
1 April 2015
|
30 June 2017
|
1 July 2015
|
30 September 2017
|
1 October 2015
|
Disclosure requirements
FRS 102 has been drafted in a way that the majority of sections follow a set structure, starting with the ‘scope’ section, flowing through to ‘initial recognition’, ‘subsequent measurement’ and so forth.
For sections which deal with the recognition and measurement of amounts (i.e. not wholly-disclosure sections such as Section 33 Related Party Disclosures), the disclosure requirements are found at the end of each section. Hence if preparers are unsure what to disclose for, say, a change in accounting policy, the disclosure requirements for such can be found at the end of Section 10 Accounting Policies, Estimates and Errors.
Companies Subject to the Small Companies’ Regime
Companies which are classed as small in the eyes of the Companies Act 2006 will have to apply the provisions in FRS 102 (using Section 1A Small Entities) for accounting periods commencing on or after 1 January 2016 (see above for the dates of transition). Therefore there is a bit more breathing space for small companies, although not a lot. However, the transitional information will have to be gathered sooner rather than later in order to deal with the transition when the time arrives. If you are feeling brave, then FRS 102 with reduced disclosures can be adopted early.
One of the most notable changes that took place in 2015 was the transposition of the EU Accounting Directive into company law which restricts the levels of disclosures required in a small company’s financial statements. While many publications cite the EU Accounting Directive as only requiring ‘a minimum of 13 disclosures’, it is not necessarily as simple as that.
Firstly, the 13 disclosure requirements needed by the EU Accounting Directive cover several areas of the Companies Act 2006; hence in reality, there are actually 39 disclosure requirements. In drafting Section 1A of FRS 102, the Financial Reporting Council have mapped the 13 disclosure ‘topics’ to the Companies Act 2006 and have outlined the disclosures needed to comply with company law in Appendix C of Section 1A to FRS 102 Disclosure requirements for small entities. This is the reason why there appears to be a lot more than 13 legally required disclosures in Appendix C.
Secondly, small companies will still be required to produce financial statements which give a true and fair view and the mere application of the disclosures required by Appendix C might not be enough to give a true and fair view. Therefore the directors of small companies have a responsibility to make additional disclosures to achieve a true and fair view and the reality is that they will seek the advice of their accountant in order to do this (or the accountant will do this for the client as a matter of course). In recognition of this, the Financial Reporting Council have included an Appendix D to Section 1A of FRS 102 which outlines five encouraged disclosures that small companies should make in order to achieve a true and fair view. These five additional disclosures are as follows:
- A statement of compliance with FRS 102 (adapted to refer to Section 1A).
- A statement that the entity is a public benefit entity (if applicable).
- Going concern disclosures where there are uncertainties relating to going concern.
- Dividends declared and paid or payable during the period.
- On first-time adoption of FRS 102, the transitional disclosures required by paragraph 35.13 which explain how the transition has affected the entity’s financial position and performance.
It is also worth noting that Section 1A of FRS 102 deals only with the presentation and disclosure requirements of a small company. In respect of recognition and measurement the full provisions of FRS 102 will apply.
Many practitioners have expressed concern about the retrospective application of the rules as well as other accounting aspects of FRS 102. The FRC have made available some Staff Education Notes (SENs) dealing with specific issues which are helpful in understanding the new requirements of FRS 102. These can be downloaded free of charge from this link.
These SENs, whilst not authoritative, explain the application of the principles in FRS 102, but the FRC have acknowledged that these are not to be used a substitute for reading the detailed requirements of FRS 102.
Other Points Relevant to FRS 102 (for small and medium-sized companies)
Other points worthy of note in preparation for the first set of FRS 102 financial statements are as follows:
Investment property fair value gains and losses
These are to be taken directly to profit or loss, rather than a revaluation reserve. In addition, deferred tax on such properties carried at fair value (in accordance with Section 16 Investment Property) has to be brought into account in the financial statements.
Deferred tax
The scope for deferred tax is wider under FRS 102 and deferred tax is now required in three additional situations:
- Revaluations of non-monetary assets subjected to revaluation (e.g. investment property)
- Fair values in business combinations
- Unremitted earnings in subsidiaries and associates
Staff costs
Short-term employee benefits accrued by the employee by the balance sheet date but not paid at the balance sheet date (e.g. unpaid holiday pay) will need to be accrued under the provisions in Section 28 Employee Benefits.
Mandatory and optional exemptions from retrospective application
Within Section 35 Transition to this FRS are four mandatory exemptions from retrospective application (which must be taken up where necessary) relating to:
- Derecognition of financial instruments
- Accounting estimates
- Discontinued operations
- Measurement of non-controlling interests
There are also 18 optional exemptions and in respect of these optional exemptions an entity can take advantage of all, some or none of them. These are outlined in paragraph 35.10 of FRS 102 and one of the most common ones which appears to have attracted some attention by accountants is the use of a previous revaluation as deemed cost (paragraph 35.10(d)). Be careful with this exemption, however, because the previous GAAP revaluation must have been obtained at, or before, the date of transition (not after). These optional exemptions are worth considering because the primary objective of them is to reduce the burdens associated with the transition and whilst not every single optional exemption will apply to each client, they can prove quite useful where they do apply.
Loans at below market rates
This is proving to be a contentious issue and the most common type of transaction which this might apply to is an intra-group loan where one member of the group will make a loan to another member of a group and either not charge interest, or charge a rate of interest which is below market rates. The Financial Reporting Council have recently updated their Staff Education Note on this issue which can be found using the link above to the Staff Education Notes (Staff Education Note 16 is the relevant one). This SEN explains the rationale behind the treatment for measurement differences and how such differences are calculated.
Micro-entities
Micro-entities will use their own financial reporting framework, FRS 105 The Financial Reporting Standard applicable to the Micro-entities Regime. FRS 105 has been developed from the requirements of FRS 102 but considerable simplifications have been made to arrive at FRS 105. This standard is mandatorily effective for accounting periods commencing on or after 1 January 2016, but early-adoption is permissible.
The Financial Reporting Council are keen to emphasise that the appropriateness of FRS 105 should be considered on a case-by-case basis; this is because whilst it may be appropriate for some micro-entities, it will not be appropriate for others. Some of the main points to note where FRS 105 are concerned are as follows:
- Micro-entities are prohibited from recognising deferred tax because the rigidity of the financial statements, together with the lack of disclosure requirements will make it impossible for deferred tax to be distinguished from current tax.
- Micro-entities are not allowed to use the revaluation model or fair value amounts in the financial statements. This will affect micro-entities with investment properties on the balance sheet.
- There are no accounting policy options available in FRS 105; hence a micro-entity cannot choose to capitalise items such as development or borrowing costs – they are all written off to profit or loss.
- Government grants can only be accounted for using the accruals model; not the performance model which has been introduced into FRS 102.
- The contracted rate for foreign currency transactions can be used (this rate is not permitted in FRS 102).
- Only a Format 2 profit and loss account is permitted (no Format 1). A Format 1 or Format 2 balance sheet is permitted.
- Various publications cite only ‘two’ legally required disclosures, which relate to:
- advances, credit and guarantees granted to directors; and
- financial commitments, guarantees and contingencies.
These two disclosure requirements cover a number of areas of the Companies Act 2006 and hence the Financial Reporting Council have specified the required disclosures in an Appendix to Section 6, which is an integral part of FRS 105.
Conclusion
This article has considered some of the main issues relating to the transition to new UK GAAP. While small and micro companies have a bit more breathing space than other unlisted companies, getting to grips with the new regimes sooner rather than later is advisable and where practitioners have not yet started to think about the new standards, understanding what is different between old and new UK GAAP is the best place to start.