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Avoiding the pitfalls

FRS 102 and 105: Avoiding the pitfalls

18th May 2016
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Many practitioners are now preparing to move their small company and micro-entity clients over to the new UK GAAP in the form of FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland or FRS 105 The Financial Reporting Standard applicable to the Micro-entities Regime.

As the new reporting regimes gather pace, issues and concerns are beginning to emerge that need to be addressed sooner rather than later in order that a client’s transition can be handled as smoothly as possible.

Small company and micro-entity reporting

The FRSSE (effective January 2015) is withdrawn in its entirety for accounting periods which start on or after 1 January 2016. Small companies that are not micro-entities will be moved under the scope of FRS 102, Section 1A Small Entities.

Section 1A of FRS 102 is a new section introduced into the September 2015 edition of FRS 102 and it outlines the presentation and disclosure requirements in respect of a small company. In terms of recognition and measurement of amounts, these are based on full FRS 102.

Micro-entities can choose to report under FRS 105, but the practitioner should bear in mind that while the standard will be appropriate for most micro-entities, it will not be appropriate for them all,  hence a micro-entity can choose to report under a more comprehensive framework if they so wish (for example, FRS 102, Section 1A). The appropriateness of FRS 105 should be considered on a case-by-case basis.

In addition, previous articles have mentioned that limited liability partnerships (LLPs) could not use FRS 105 and this has now been changed following the Department for Business Innovation and Skills updating the LLP Regulations, so micro-entity LLPs can now use FRS 105. The standard was reissued on 17 May 2016 to widen the scope of FRS 105 so it now includes micro-entity LLPs.

There still appears to be some confusion surrounding the ‘date of transition’ for these new rules. The rules in new UK GAAP are all retrospective, which means they must be applied to the start date of the comparative period reported in the accounts.

Therefore, a 30 April 2017 year-end will have a date of transition of 1 May 2015. Some accountants believe that the date of transition is the comparative year-end, but you have to go one step further back than this and restate the opening balance sheet position at the start of that comparative year.

Early adoption of the revised Companies Act 2006 and audit thresholds

The Companies Act 2006 was amended by SI 2015/980 and this saw an increase in the size of thresholds which determine a micro, small, medium and large company or group. The small company’s threshold has increased to £10.2m turnover, £5.1m balance sheet total, but the employee headcount numbers remain at 50.

The government took advantage of the maximum size thresholds permitted in the EU Accounting Directive, because they have estimated that some 11,000 businesses which would have been classified as medium-sized under the previous Companies Act 2006 will now be classified as small under the revised thresholds.

In addition, the government included an early adoption clause in the legislation permitting a company to early adopt the revised Companies Act for accounting periods starting on or after 1 January 2015, but before 1 January 2016 if the directors so wish. Care needs to be taken where early adoption of the new legislation is concerned.

If a company early adopts the new legislation, then it must adopt the new UK GAAP – i.e. a company that is now small under the revised thresholds must adopt FRS 102, Section 1A as a minimum; it must not adopt the FRSSE (effective January 2015).

The audit exemption thresholds have also been increased so they are aligned to the small company thresholds. However, there is no early adoption of the audit exemption thresholds permitted, and therefore if a company early adopts the new legislation and in turn adopts new UK GAAP, it cannot early adopt the audit exemption thresholds because the revised audit exemption thresholds only apply for accounting periods starting on or after 1 January 2016.

Other issues to note

The table below highlights some of the key points to bear in mind where FRS 102, Section 1A is concerned:


FRS 102, Section 1A

Cash flow statement

There is no requirement for a small company to prepare a cash flow statement.

True and fair view

The EU Accounting Directive restricts the disclosures that a small company is required to make in its financial statements. However, the mere application of the legally required minimum might not be enough to give a true and fair view; therefore additional disclosures may need to be made. The FRC has included an Appendix D to Section 1A which outlines five encouraged disclosure requirements.

Revalued assets

Fixed assets can be measured under the revaluation model in Section 17 Property, Plant and Equipment. Unlike FRS 15 Tangible fixed assets, there is no set time limit for obtaining up-to-date revaluations and Section 17 requires revaluations to be obtained with ‘sufficient regularity’. Therefore, where there has been a material change in fair value of an asset carried at revaluation, then an up-to-date revaluation will have to be obtained. Therefore, more professional judgement will be needed in this area.

It is worth emphasising that the revaluation reserve for property, plant and equipment revalued under Section 17 still exists. It is only investment property carried at fair value under Section 16 Investment Property which removes the revaluation reserve. Some practitioners are under the impression that the revaluation reserve has been removed in its entirety and this is not the case.


Internally generated goodwill must not be recognised on the balance sheet because there is no active market in which to derive a reliable cost. This is no different than previous UK GAAP at FRS 10 Goodwill and intangible assets. FRS 102 includes goodwill in Section 19 Business Combinations and Goodwill rather than in Section 18 Intangible Assets other than Goodwill.

Amortisation of intangible assets

All intangible assets must be amortised under FRS 102 as the standard does not permit any intangible fixed assets to have indefinite useful lives. Where management are unable to arrive at a reliable estimate of the useful economic life, the amortisation period is capped to ten years.

Investment property

Fair value gains and losses are taken direct to profit or loss rather than the revaluation reserve. In addition, investment property carried at fair value through profit or loss must have deferred tax brought into account. It should be emphasised that gains on investment property (net of deferred tax) are not distributable as a dividend to shareholders. This is because the gain is unrealised for dividend purposes as it is not readily convertible into cash.


Outgoing UK GAAP at FRS 3 Reporting financial performance and the FRSSE requires the correction of an error by way of a prior period adjustment if that error is ‘fundamental’ (the term ‘fundamental’ means the error destroys the true and fair view and validity of the financial statements). Under FRS 102, an error is corrected by way of a prior period adjustment if it is material, hence it is expected that more errors will be corrected through a prior period adjustment.

Non-market rate loans

Loans which are entered into a non-market rate for which there are no formal loans terms are regarded as being repayable on demand. Hence, they will be treated as current assets or liabilities depending on whether the reporting entity is the lender or the borrower – this may mean reclassifying some loans from long-term to current).

In some situations, long-term non-market rate loans will need discounting to present day values, which will give rise to measurement differences which must be brought into account. Staff Education Note 16 Financing Transactions, which is available free of charge from the FRC’s website, examines this concept in more detail.

Holiday pay accruals

Accruals for holiday pay entitlement earned by the employees but not paid until the next financial year will need accruing in the financial statements under Section 28 Employee Benefits. This will affect entities whose holiday year is not sequential to the financial year, or where staff are allowed to carry forward a number of days’ holiday into the next financial year.

Derivative financial instruments

Unlike previous UK GAAP, derivative financial instruments must be brought onto the balance sheet. Therefore, where a small company (not a micro-entity) has perhaps an interest-rate swap, or a forward foreign currency contract, an associated derivative financial asset or financial liability is brought onto the balance sheet at fair value through profit or loss, unless hedge accounting is being used in which case it is taken to other comprehensive income.

Disclosures on transition

The transitional disclosures outlined in Section 35 Transition to this FRS in FRS 102 are encouraged for small entities. However, where there has been a material impact on previously reported equity balances and profit or loss due to the retrospective application of the rules, it is advisable that the company makes the disclosures required by Section 35 in the form of reconciliations and explanations.

The table below highlights some of the points to note where FRS 105 is concerned:


FRS 105

True and fair view

Micro-entity financial statements prepared in accordance with the legally required minimum are presumed to give a true and fair view, and hence the directors do not need to consider any additional disclosure requirements. However, where the directors choose to make the additional disclosure requirements they must do so in accordance with FRS 102, Section 1A.

Deferred tax

Micro-entities are not permitted to account for deferred tax. Therefore, on transition any deferred tax balances are reversed back to profit and loss reserves and reversed in the comparative year/period.

Format 2 profit and loss account

Only a Format 2 profit and loss account is permitted (which classifies expenses by nature) under FRS 105; there is no option to prepare a Format 1 profit and loss account (expenses by function, i.e. cost of sales, distribution costs, administrative expenses and so forth). In addition, the line item descriptors on the Format 2 profit and loss account cannot be changed.

Fair values and revaluation amounts

The standard prohibits the use of fair values or revaluation amounts. Therefore, any assets that have been carried at fair value or revaluation must be restated to historic cost principles (i.e. cost less depreciation less any impairment losses) on transition, also in the prior year and going forward. In addition, it is not acceptable to use a previous GAAP revaluation as a deemed cost because the use of such valuations will be incompatible with the legislation. Care needs to be taken in this respect because restating to historic cost principles might have a detrimental impact on the entity’s balance sheet position.

Accounting policy options

Other than some transitional exemptions that can be applied by a micro-entity, there are no accounting policy options permitted in FRS 105 as the Corporate Reporting Council (previously the Accounting Council) concluded that to allow a micro-entity accounting policy options would confuse users. Therefore, it will not be possible to capitalise items such as development or borrowing costs. Such expenses are written off to profit or loss as they are incurred.

Grant accounting

Grants are accounted for using the accrual model only. There is no option to use the new performance method which is available to other companies.

Simpler treatment for financial instruments

There is no use of the effective interest method or amortised cost method and hence financial instruments, such as non-market rate loans will be accounted for at transaction price. However, financing transactions (where the entity defers payment beyond normal trading terms) are accounted for initially at transaction price which is the cash price charged for the goods by the seller on the date of the transaction.

The above lists are not conclusive, but highlight some of the issues that are notably different in the new regimes and which are frequently questioned by practitioners. It is important that a sound understanding of the different accounting treatments in the new regimes is obtained by accountants because if they are not, this will lead to the financial statements being incorrect, resulting in potentially incorrect tax calculations and some uncomfortable conversations having to be had with clients.


The transition across to the new regimes will inevitably cause more work for some clients, and planning for the transition sooner rather than later will avoid unnecessary costs and additional time being spent.

It is important that a sound understanding of the new requirements is acquired, because otherwise the scope for error is much wider – especially in light of the significantly different accounting treatments and disclosure requirements brought about by the new reporting regimes.

Replies (7)

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Kieran Phelan
By KPEM online
18th May 2016 18:23

Best article which summaries the new rules and UK GAAP that I have read so far.

The issue for many small practitioners, as is usually the case in such circumstances, is that clients see little or no value in any work done in making these transitions

Thanks (1)
By Paul Scholes
18th May 2016 19:13

Thanks Steve - great summary

Not something I'd noticed before but in not permitting the capitalising of many internally generated intangibles, section 13.5 of FRS 105, does not make reference specifically to Website or Software development costs which may have well been treated as tangibles in the past.

As the differentiation between tangible & intangible was an accounting policy issue, will this now mean that they fall under the "Development" expenditure mentioned above?

If so, will this also mean removing such historic assets from the balance sheet?

Thanks (2)
Tony Margaritelli, ICPA Chairman
By Tony Margaritelli
20th May 2016 08:29

Thank you Steve for a very good article on a subject that is growing in importance as each day passes. On FRS105 the point about The P&L format is well made. Thanks again and I'll keep a look out for any more of your articles on this subject going forward

Thanks (0)
By 1995117
20th May 2016 12:27

Thanks Steve, great timing and just when its most needed.

Thanks (0)
By istolethenut
20th May 2016 12:31

Hi Steven,

Thanks for this article; very insightful.

In relation to FRS 105 and Deferred tax, you say it should be reversed back to profit and loss. However paragraph 28.9 of FRS 105 states that

"On first-time adoption of this FRS, a micro-entity shall not retrospectively change the
accounting that it followed under its previous financial reporting framework for any of
the following transactions:
(a) Derecognition of financial assets and financial liabilities
Financial assets and financial liabilities derecognised under a micro-entity’s
previous accounting framework before the date of transition shall not be
recognised upon adoption of this FRS. Conversely, for financial assets and
liabilities that would have been derecognised under this FRS in a transaction that
took place before the date of transition, but that were not derecognised under a
micro-entity’s previous accounting framework, a micro-entity may choose:
(i) to derecognise them on adoption of this FRS; or
(ii) to continue to recognise them until disposed of or settled."

I'd be interested in your thoughts on that, please?


Thanks (2)
20th May 2016 18:07

Very useful, thanks.
For Holiday Pay, if an accrual is needed, should circumstances require. I assume a prepayment would need to be made if the calculations produce a negative?
This is quite likely if the Company has an August year end, with an April 1st start to the holiday year!

Thanks (1)
By petestar1969
06th Jun 2016 09:56

Does anyone have a link to show some examples of what the financial statements should look like under FRS 102?

I have a client whose company year end was 30 April. They have ceased to trade and I will be doing accounts for the 5 months ended 30 September 2016.

These accounts will need to be under the new regime and its unlikely my software company will have updated its software in time for me. The accounts will need to be done very quickly because there will be a loss for corporation tax in that period.


Thanks (0)