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FRED 82: FRC issues proposed changes to FRS 102

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A draft of the proposed changes to FRS 102, containing some significant proposals, has been published by the Financial Reporting Council.

20th Dec 2022
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The Financial Reporting Council (FRC) has issued FRED 82, a draft of proposed changes to FRS 102, containing some significant proposals for change across a range of areas. This 346-page document, Draft amendments to FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland and other FRSs – Periodic Review, was published on 15 December and all interested parties are encouraged to submit their comments by email by 30 April 2023.

It is impossible to summarise all the proposed changes in one article and so there will be more around this subject published before the comment close date covering the more notable proposals for change. 

It was pleasing to see the FRC confirm that no amendments to FRS 102 are proposed to reflect the expected credit loss model from IFRS® 9 Financial Instruments in this periodic review. Although, they have stated that they will reconsider this issue in due course. 

On-balance sheet lease accounting 

As expected, the FRC proposes to change the lease accounting requirements in FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland. There are no equivalent changes proposed in this area for FRS 105 The Financial Reporting Standard applicable to the Micro-entities Regime. The proposed changes are intended to align FRS 102 to IFRS 16 Leases (albeit with necessary simplifications). 

Interestingly, the International Accounting Standards Board® (IASB®) has decided not to change the equivalent Section 20 Leases in the IFRS for SMEs Accounting Standard in their current comprehensive review of that Accounting Standard. However, the IASB may well decide to align IFRS for SMEs with IFRS 16 during a future review.

Essentially, the vast majority of leases for a lessee (with some limited exceptions related to short-term leases and low-value leases) will be reported on-balance sheet. A short-term lease is a lease that, at the commencement date, has a lease term of 12 months or less. Draft para 20.9 in FRED 82 confirms that the value of an underlying asset is based on the value of the asset at the start of the lease. Draft para 20.11 cites the following examples of underlying assets that would typically be considered to be of low value:

  • tablet computers
  • personal computers
  • home printers and photocopiers
  • mobile phones
  • desk phones
  • televisions
  • small items of furniture
  • portable power tools. 

The FRC has cited “efficiency within groups” as one of the reasons for aligning lease accounting within FRS 102 to that of IFRS 16. Some entities applying FRS 102 could well be members of a group that prepares consolidated financial statements in accordance with IFRS Accounting Standards. Hence, the proposed change to lease accounting in FRS 102 would minimise accounting differences, thus enabling comparability. To that end, the proposed simplifications in FRS 102 are optional rather than mandatory. 

The simplifications within FRS 102, Section 20 are as follows.

  IFRS 16 FRS 102 simplification
Discount rate IFRS 16 requires a lessee to use the interest rate implicit in a lease. If that is not readily determinable, the lessee’s incremental borrowing rate is used to discount lease payments to present value. The lessee’s obtainable borrowing rate can be used as an alternative to the incremental borrowing rate. This is expected to be easier to determine so is deemed to represent a proportionate simplification.If, in exceptional cases, the lessee’s incremental (or obtainable) borrowing rate cannot be readily determined, the lessee can apply a publicly available rate (referred to as the gilt rate).
Determining a revised discount rate A lessee must revise the discount rate when there is a modification that is not accounted for as a separate lease.   FRED 82 proposes to reduce the number of situations where a lease modification requires a revised discount rate. 
Practical expedients for lease agreements containing multiple components Lease agreements may contain multiple components and both lessors and lessees must identify and separate lease and non-lease components in applying IFRS 16. For a lessee this will determine what proportion of the contract will be recognised on-balance sheet. There are additional practical expedients proposed for contracts containing multiple components (for example, draft para 20.33). 
Sale and leaseback transactions The approach taken by IFRS 16 where a sale and leaseback transaction is concerned is complex and there will often be a need to consider whether, in fact, the transfer qualifies as a sale in accordance with IFRS 15 Revenue from Contracts with Customers There is a simpler approach proposed for dealing with sale and leaseback transactions in FRED 82, which is broadly consistent with the approach currently in FRS 102 (January 2022). There is a requirement to consider if the transfer of an asset by the seller-lessee satisfies the requirements of FRS 102, draft Section 23 Revenue from Contracts with Customers (draft paras 20.128 to 20.130) or not (draft para 20.131) as this will affect the accounting treatment.
Variable lease payments Changes in lease payments arising from a change in an index or rate would trigger recalculation of the lease liability.  Draft para 20.74 provides an option for the lessee to choose not to remeasure the lease liability where there has been such a change. Where this is the case, the difference between the lease payments included in the lease liability at the commencement date and the revised lease payments is recognised in profit or loss in the period to which each payment relates (see also draft para 20.58). 

Revenue

The title of FRS 102, Section 23 is proposed for change from Revenue to Revenue from Contracts with Customers. Section 23 has been completely rewritten in FRED 82 and reflects a simplified version of IFRS 15 Revenue from Contracts with Customers. Notably, the five-step-model approach to recognising revenue is as follows.

  • Step 1 – Identify the contract(s) with a customer (draft paras 23.6 to 23.15)
  • Step 2 – Identify the promises in the contract (draft paras 23.16 to 23.40)
  • Step 3 – Determine the transaction price (draft paras 23.41 to 23.60C)
  • Step 4 – Allocate the transaction price to the promises in the contract (draft paras 23.61 to 23.74)
  • Step 5 – Recognise revenue when (or as) the entity satisfies a promise (draft paras 23.75 to 23.101).

The term “promise (in a contract with a customer)” is defined as: “An obligation to transfer a good or service (or bundle of goods or services) that is distinct.”

While many of the requirements in proposed Section 23 are consistent with the IASB’s Exposure Draft of the third edition of IFRS for SMEs, there are some FRED 82-specific amendments to permit entities to use an accounting policy for revenue which meets the requirements of both FRS 102 and IFRS 15 as follows:

  • The proposals require an entity to account for a warranty as a separate promise when the warranty provides the customer with a service in addition to the assurance that the product complies with agreed-upon specifications. This applies even if the warranty is insignificant to the contract.
  • FRED 82 proposes to allow an entity to account for an option to provide a customer with a material right as a separate promise when the effect of doing so is insignificant to the accounting of the individual contract.
  • There is a proposal to require refund liabilities to be measured based on amounts of consideration received that are not included in the transaction price, where such amounts are determined by considering the requirement to constrain estimates of variable consideration. 

For smaller entities applying FRS 102, Section 1A

Following the UK’s departure from the EU, the FRC is now able to require more disclosure from small companies in the UK. Previously, the FRC was constrained by the requirements of the EU Accounting Directive, but this is no longer the case. However, this does remain the case for entities in the Republic of Ireland so FRS 102, Section 1A, Appendix D Disclosure requirements for small entities in the Republic of Ireland remains unchanged. 

Some of the notable changes proposed in FRED 82 to FRS 102, Section 1A, Appendix C Disclosure requirements for small entities in the UK include:

  • A requirement to make an explicit and unreserved statement of compliance with FRS 102, including Section 1A. Currently this is an encouraged disclosure per FRS 102, para 1AE.1(a).
  • Mandatory going-concern disclosures to comply with draft para 3.8A, which states: “When an entity prepares financial statements on a going-concern basis, it shall disclose that fact, together with confirmation that it has considered information about the future as set out in paragraph 3.8. It shall also disclose, in accordance with paragraph 8.6, any significant judgments made in assessing the entity’s ability to continue as a going concern.”

In addition, the small entity will be required to provide disclosures relating to material uncertainties related to events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern as set out in para 3.9. Currently, this requirement is an encouraged disclosure per FRS 102, para 1AE.1(c).

  • There are additional disclosures proposed in respect of leasing arrangements (draft para 1AC.31A) including short-term leases, leases of low-value assets and variable lease payments (draft para 1AC.32A); provisions and contingencies (draft para 1AC.31B); share-based payment transactions (draft para 1AC.31C); and promises in contracts with customers (draft para 1AC.32B). 
  • Disclosures in respect of deferred tax (draft para 1AC.36A).
  • Dividends declared and paid or payable during the period (draft para 1AC.40). Currently this is an encouraged disclosure per FRS 102, para 1AE.1(d). 
  • Transition information on first-time adoption of FRS 102 (draft para 1AC.41). Currently this is an encouraged disclosure per FRS 102, para 1AE.1(e).

Constructive feedback

The comment period on FRED 82 is open until the end of April 2023, and all interested parties are encouraged to send in constructive feedback to the FRC at [email protected] for them to consider prior to finalising FRED 82. The proposed effective date for the amendments is for accounting periods commencing on or after 1 January 2025. Early application will be permitted, provided all the amendments are applied at the same time. Transitional provisions (for example where on-balance sheet lease accounting is concerned) are also contained in FRED 82.

Replies (7)

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By jon_griffey
20th Dec 2022 16:01

Who actually appoints the people who decide this stuff? We have had settled accounting treatment of leases for decades and now we have major change imposed on us. For what benefit? As if we don't have enough to deal with. I can understand maybe for listed entities etc but for FRS102 entities? What on earth is the point of adding more disclosure requirements to S1A entities when this is not required elsewhere? Has anyone suffered any loss from not having a deferred tax note for the past few years? Brexit should be used as an opportunity to reduce red-tape not increase it.

Thanks (1)
John Toon
By John Toon
21st Dec 2022 07:33

No surprises to see IFRS 15 and 16 come into FRS 102. This was telegraphed at the last triennial review when the FRC kicked the proverbial can down the road and they weren't going to be able to avoid the issue this time around.

Shame about the ECL - that's one of the more fun bits of IFRS.

As for why lease accounting should change - it's simple, it's all about equivalence. Why should a company that commits to use an asset have alternative accounting treatment simply because of the contractual means that it chooses to fund the utilisation of that asset?

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paddle steamer
By DJKL
21st Dec 2022 10:03

Not sure about "Promises", what is wrong with using something like "obligations" .

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Replying to DJKL:
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By Hugo Fair
21st Dec 2022 11:09

Quite ... this is in the context of Contracts after all.

[The only example of 'promise' that I can recall used to be the wording on BoE bank-notes ('I promise to pay the bearer ...').]

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Replying to Hugo Fair:
paddle steamer
By DJKL
22nd Dec 2022 19:05

Unilateral Gratuitous Promise within the Scots law of Contract is the only one I ever studied, never been relevant at work over the intervening 38 years.

https://www.everything2.com/title/gratuitous+promise

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Replying to DJKL:
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By Hugo Fair
22nd Dec 2022 19:33

Thanks ... I'd (not surprisingly) failed to encounter this intriguing concept before.

"Basically, a gratuitous promise is a one-sided contract, where one of the two parties (the promisor) gets nothing from the other party (the beneficiary)" ... so bang goes my memory of 'consideration' being paramount.

Still - seems unlikely to be relevant in the context of the areas covered by the article.

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By Robin Wishart
23rd Feb 2023 12:57

I suspect I've missed something - BUT - is it really being suggested that small Companies that rent their office or shop or whatever on a typical three to five year lease, will need to capitalise this? Surely there are small business exemptions?

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