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The new UK GAAP: FRS 102 explained

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26th Mar 2013
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In the second of a series of articles on the new UK GAAP, Steve Collings considers some of the more practical changes that will be brought about by FRS 102 The Financial Reporting Standard applicable in the United Kingdom and Republic of Ireland and examines the issues that users of the FRSSE will need to be aware of.

Introduction

On 14 March 2013, the Financial Reporting Council (FRC) finally published FRS 102 which will apply to unlisted entities. This marked the end of a lengthy period of uncertainty within the profession as to the direction in which UK GAAP, as we currently know it, will go.

Based on the International Financial Reporting Standard for Small-Medium Entities (IFRS for SMEs), FRS 102 brings about a simplified reporting regime for entities that will fall under its scope as well as introducing more up-to-date and relevant accounting requirements that have fallen behind in existing UK GAAP. Current UK GAAP is far too complex and practitioners have often complained about the onerous requirements imposed on themselves and their clients due to the voluminous nature of current UK GAAP.

FRS 102 is 350 pages long and in contrast to current UK GAAP at 3,000 pages long, the sheer reduction in volume will, on its own, be a welcome feature of FRS 102. Roger Marshall, an FRC board member and chairman of its accounting council said that FRS 102 “modernises and simplifies financial reporting for unlisted companies and subsidiaries of listed companies as well as public benefit entities such as charities.”

FRS 102 becomes mandatory for accounting periods commencing on or after 1 January 2015, with early adoption permissible and there are a lot of issues that practitioners dealing with clients for whom this standard will be applicable must consider well before this date.

Accounting changes

FRS 102 (which was exposed as FRED 48) brought with it some welcome changes that were not previously incorporated into the previous exposure draft (for example the option to capitalise borrowing costs as part of the cost of a self-constructed asset). It also removed the concept of ‘public accountability’ which (if mandated) would have resulted in various entities having to apply EU-adopted IFRS which would have been wholly inappropriate given the vast disclosure requirements contained in EU-adopted IFRS.

The good news is the UK standard-setters have always foreseen an international-based accounting framework being adopted and, wherever possible, have always tried to align UK GAAP to its international counterpart. There are, however, some notable changes that will be brought about and some of the more notable issues relate to the following:

Subsequent expenditure on fixed assets

FRS 15 Tangible Fixed Assets goes into a lot of detail where ‘subsequent expenditure’ is concerned (in fact there is a whole section on subsequent expenditure in paragraphs 34 to 41 to FRS 15). The main thrust of this section of FRS 15 is to outline the situations when a company incurs costs on existing fixed assets and when these costs should be capitalised and when they should be written off to the profit and loss account. In a nutshell, capitalisation of subsequent expenditure in FRS 15 can only occur in three circumstances:

  • Where the subsequent expenditure provides an enhancement of the economic benefits of the tangible fixed asset in excess of the previously assessed standard of performance
  • Where a component of the tangible fixed asset that has been treated separately for depreciation purposes and depreciated over its individual useful economic life, is replaced or restored
  • Where the subsequent expenditure relates to a major inspection or overhaul of a tangible fixed asset that restores the economic benefits of the asset that have been consumed by the entity and have already been reflected in depreciation

FRS 102 itself does not explicitly cover subsequent expenditure as such and therefore the issue of accounting for subsequent expenditure will become much more subjective. Users of FRS 102 would therefore be directed to the Concepts and Pervasive Principles that are contained in Section 2 to FRS 102 to determine whether capitalisation is appropriate or whether the costs should be written off directly to the P&L account.

Investment properties

There have been some complaints already about the way in which fair value fluctuations in investment properties are to be accounted for under FRS 102. 

Currently SSAP 19 Accounting for Investment Properties requires all investment properties to be carried in the balance sheet at their open market value, with changes in market value going through the revaluation reserve account and reported in the statement of total recognised gains and losses.

Paragraph 16.7 to FRS 102 essentially extinguishes the use of the revaluation reserve and requires all changes in fair value to be recognised in profit or loss and therefore significant presentational change will be required as illustrated in the following example:

Company A Ltd has an investment property and on 1 January 2015 the value of this property (as determined by a chartered surveyor) was £200,000. On 31 December 2015, the surveyor confirmed the value had increased to £210,000.

Under previous SSAP 19, the entries to bring the investment property up to fair value on 31 December 2015 would be:

DR investment property               £10,000

CR revaluation reserve                 £10,000

However, under FRS 102, the accounting entries are:

DR investment property                £10,000

CR profit and loss account           £10,000

An important point to emphasise is that the £10,000 gain would not be a realised profit that could be distributed to shareholders by way of dividend.  An alternative treatment could be to send all fair value gains and losses to a non-distributable reserve account however there is nothing contained within legislation that would require this.

The reason for revaluation gains and losses being transferred to profit or loss seem to originate from the accounting requirements in IAS 40 Investment Property. The international standard also treats fair value gains and losses in the same way and this is because the standard recognises that investment properties are not subjected to depreciation charges nor impairment testing and thus such fluctuations in fair value should be taken direct to profit or loss.

Leases

The guidance notes to SSAP 21 Accounting for Leases and Hire Purchase Contracts (specifically paragraph 22 in the Guidance Notes) specify a numeric benchmark where leases should be treated as a finance lease and hence capitalised in the balance sheet and this numeric benchmark is where 90% or more of the minimum lease payments in the lease equate to the asset’s fair value price and thus the treatment is that of a finance lease with the asset being recognised on the balance sheet with a corresponding lease obligation as a liability. 

FRS 102 is much more subjective where leasing arrangements are concerned and contains eight scenarios which may be indicative of a finance lease:

  • The lease transfers ownership to the lessee by the end of the lease term
  • The lessee has an option to purchase the asset a price significantly lower than fair value at the date the option becomes exercisable
  • The lease is for the major part of the asset’s useful economic life
  • At the inception of the lease, the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset.  (Note no benchmark percentage)
  • The leased assets are so specialised that only the lessee can use them
  • Costs associated with the cancellation of the lease are borne by the lessee
  • Gains/losses from the fluctuation of the leased asset’s fair value accrue to the lessee
  • The lessee has the ability to continue to lease the asset for a secondary period for a peppercorn rent

There is scope in the future to substantially change the way in which leases are accounted for given the current project at the International Accounting Standards Board (IASB) in collaboration with the US standard-setters which, in a nutshell, requires most leases to be recognised as a finance lease and only a select few leases being treated as operating meaning we could see more finance leases than we currently do at present.

Cash flow statements

Currently the FRS 1-style cash flow statement is prepared under the following headings:

  • Operating activities
  • Dividends from joint ventures and associates
  • Returns on investment and servicing of finance
  • Taxation
  • Capital expenditure and financial investments
  • Acquisitions and disposals
  • Equity dividends paid
  • Management of liquid resources
  • Financing

This is set for major change in the way FRS 102 at Section 7 requires a cash flow statement to be prepared and therefore substantial reclassifications will be required in the year FRS 102 is adopted.  The classification of cash flows will require more thought on the part of the preparer of the financial statements because FRS 102 requires cash flows to be classified under three headings only, split between:

  • Operating activities
  • Financing activities
  • Investing activities

Operating activities are the day-to-day revenue-producing activities that are not investment or financing activities. This category is essentially a ‘default’ category, encompassing all cash flows that do not fall within investing or financing classifications.

Investing activities are those activities that involve the acquisition and disposal of long-term assets; for example monies used for the purchase of fixed assets and cash receipts from the disposal of fixed assets.

Financing activities are those activities that change the equity and borrowing composition of the company. For example, if a client issues shares in the year to raise cash, the proceeds from the issue would be a financing activity. Similarly, where a client raises a loan, such proceeds would also be classified as a financing activity.

Employee benefits

Possibly one of the biggest headaches to be borne out of the new FRS 102 will be the requirement for short-term employee benefits to be accrued in the accounts. For the purposes of FRS 102, short-term employee benefits include:

  • Wages, salaries and employers NICs
  • Paid annual leave and paid sick leave when the absences are expected to occur within 12 months after the reporting period in which the employees render the related employee service
  • Profit-sharing and bonuses payable within 12 months after the reporting period in which the employees render the related service
  • Non-monetary benefits such as medical care, housing, cars and free/subsidised goods or services for current employees

Therefore an entity that has employees that have untaken holidays at the balance sheet date that will be paid for in the next financial year will need to make an accrual for such entitlements. There is currently no explicit requirement in current GAAP to require this treatment although FRS 12 at paragraph 11(b) does make reference to accruals being liabilities to pay for goods or services that have been received or supplied but have not yet been paid and does make reference to an example of accrued holiday pay.

Terminology

You will note some differing terminology contained within FRS 102. I suspect that there may be a mix of terminology used but with the majority of financial statements being referred to their traditional names. Examples of the differing terminology are shown in the table below:

Traditional term

FRS 102 term

Profit and loss account

Income statement/statement of comprehensive income

Balance sheet

Statement of financial position

Cash flow statement

Statement of cash flows

Profit and loss reserves

Retained earnings

Statement of recognised gains and losses

Statement of changes in equity

Traditional terms that are used in the UK are derived from Regulations and therefore financial statements prepared under FRS 102 are more than likely still going to refer to a ‘balance sheet’ and a ‘profit and loss account’. In addition, paragraph 3.22 to FRS 102 does permit the use of alternative titles but only if doing so does not mislead users (which I doubt would be the case).

FRSSE

Companies eligible to apply the FRSSE will still be able to do so and this will be the FRSSE (effective January 2015). There have been changes made to the FRSSE as a consequence of FRS 102 and some of the more notable changes include:

  • References to FRS 102 and the deletion of references to FRSs/SSAPs/UITFs
  • Inclusion of the FRC rather than the Accounting Standards Board 
  • Requirement for users to consult FRS 102 as guidance to best practice where the FRSSE (effective January 2015) does not specifically deal with an issue
  • Requirement for goodwill and intangible assets to be amortised over a five-year period where management are unable to assign a useful economic life (currently the amortisation period in such situations is a maximum of 20 years)
  • Close family in connection with related parties have been clarified to include:

1.       the person’s children, spouse or domestic partner

2.       children of that person’s spouse or domestic partner

3.       dependents of that person or that person’s spouse or domestic partner

  • The definition of ‘public benefits entities’ have been included within the Part C ‘Definitions’

Where small companies are concerned there has been a project undertaken at the BIS to cut company red tape and on 27 February 2013, a press release was issued by BIS announcing that thousands of businesses are to be spared from red tape. Part of this relates to ‘micro entities’ being exempted from certain accounting requirements so as to enable them to draw up shortened balance sheets and profit and loss accounts. This consultation ends on 30 March 2013 and the EU has defined a micro-business as one that either has a:

  • Balance sheet total of £289,415 (€350,000)
  • Net turnover of £578,830 (€700,000)
  • An average of 10 employees during the financial year

Under the proposals (and subject to certain conditions), micro-entities will be relieved from having to:

  • present ‘prepayments and accrued income’ and ‘accruals and deferred income’
  • recognise certain types of prepayments and accrued income and accruals and deferred income
  • present notes to the financial statements
  • prepare an annual report
  • publish annual accounts provided the financial data information contained in balance sheet items is filed with a designated competent authority (the ‘competent authority’ being referred to in Appendix 1 of the proposals as a central register, commercial register or companies register - thus Companies House effectively)

The proposals say that only the following items will need to be disclosed at the foot of an abridged balance sheet as follows:

  • All commitments by way of any types of guarantee
  • Advances and credits to a director including guarantees and commitments entered into on their behalf
  • Acquisition of own shares

There are many within the profession that object strongly to these proposals rendering financial information prepared under such proposals to be misleading, uninformative and out of touch with reality. However, the considerations do acknowledge that it is not clear what level of administrative burden will be relieved, or potential savings may be made by micro-entities if the UK exercises this option and indeed if this option is exercised, the figures in the accounts will be prepared in different ways using a mix of accruals and the (controversial) cash-based method. These issues will be covered in a future article.

Conclusion

Further articles on the changes to UK GAAP that affect medium and small companies will be published to aid practitioners on the changes that are affecting the UK at the present time.

Planning for such changes cannot be over-emphasised and practical issues will be considered in future articles.

Steve Collings is the audit and technical partner at Leavitt Walmsley Associates and the author of ‘Interpretation and Application of International Standards on Auditing’. He is also the author of ‘The AccountingWEB Guide to IFRS’ and ‘IFRS For Dummies’ and was named Accounting Technician of the Year at the 2011 British Accountancy Awards.

Replies (4)

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By tadek
07th Apr 2013 10:58

IFRS v FRC

Hi - i am not presently residing in the UK, but South Africa which country has now moved to adopting the Financial Reporting Standards of the IFRS Foundation and International Accounting Standards Board ie both IFRS and IASB pronounements. I am curious as to why the UK would not also now fully adopt the statements of the IFRS Foundation in place of what seems to be statements that are peculair to the UK.  This seems even more of an irony when i see that the headoffice of the IFRS foundation is based in London. I aplogies if this  comment is not directly related to the article at hand but i wonder which pronouncements i should follow that if the FRC or the increasingly more wodely recognised and influential IFRS and IASB - Thanks

Thanks (1)
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By Rvaneeta
16th Apr 2013 11:32

Intangibles Assets

Hello there,

It is not clear to me what is categorised as Intangible assets under the FRS 102.  Can anyone tell me where I can get more info about this.

Thanks

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By AndrewV12
17th Apr 2014 13:21

Less is more

FRS 102 is 350 pages long and in contrast to current UK GAAP at 3,000 pages long, 

I welcome the reduction in the wording between FRS 102 and GAAP, lets be honest who is likely to even look at a document 3000 pages long, let alone read or interpret it.

 

Concise reports with relevant practical examples are 10 times better than wordy reports trying to cover every all bases.   The FRS 102 sounds like a work of art, On another matter is there a date in place when the FRSSE will be removed. 

Is FRS 102 to replace the FRSSE or complement it. 

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By [email protected]
17th Oct 2016 11:42

How does FRS 102 apply to Licence income?

Say I sign a contract with a customer on 1 Jan 2016 for a SAAS service under which I incur installation costs of £9000 and installation is completed on 30 June 2016. On successful completion of installation the contract stipulates a payment to be made to me of £10,000 and the contract stipulates 3 further licence payments of £10,000 annually on the anniversary of the installation date.
How do I recognise income?
Do I take in £40,000 less £9,000 = £31,000 in 2016 or £1,000 in 2016 and £10,000 in 2017, 2018, and 2019?

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