Audit and Technical Partner Leavitt Walmsley Associates Ltd
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FRS 102 vs FRS 105: Which one should I use?

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Steve Collings considers the differences between FRS 102 and FRS 105 to aid practitioners in advising clients as to the appropriateness of each one and clear up some common queries when comparing the two standards.

28th Sep 2021
Audit and Technical Partner Leavitt Walmsley Associates Ltd
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Questions often arise as to the suitability of each standard depending on whether the client is a micro-entity or small entity.

At the outset it is worth noting FRS 105 is an optional standard. Just because a micro-entity may be eligible to use FRS 105 does not mean it has to (and there are genuine reasons why FRS 105 may not be appropriate to a micro-entity). FRS 105 should therefore be considered on a case-by-case basis.

FRS 102

FRS 102 contains a separate section in the form of Section 1A Small Entities. FRS 102, Section 1A only deals with the presentation and disclosure requirements for a small entity. Recognition and measurement principles are dealt with in full FRS 102. Hence, Section 1A is not a ‘one-stop-shop’.

The benefit of this is that if a small company outgrows Section 1A (ie it becomes, say, a medium-sized entity) then the disclosure requirements become more comprehensive as they will be based on individual sections of FRS 102 rather than Section 1A.

However, the recognition and measurement of amounts are still the same as when the company was small. Hence this avoids a transition to another alternative framework. 

FRS 102, Section 1A contains the disclosures required by company law. The section itself is optional – a small company need not apply Section 1A if they do not wish to, although most small entities do choose to apply Section 1A in practice.

The same recognition and measurement principles will apply to all entities, regardless of size, that report under FRS 102 (with one exception for small entities discussed below).

You cannot ‘cherry pick’ between standards

Therefore, an entity which qualifies as a micro-entity but chooses to report under FRS 102 will use the same recognition and measurement principles as a large entity. You cannot ‘cherry pick’ between standards so a micro-entity that chooses to report under FRS 102 cannot then apply certain provisions of FRS 105. It is one or the other.

There is one exception to full recognition and measurement principles which is available only to small entities (including small LLPs) in FRS 102, para 11.13A which relates to a loan to a small entity.

FRS 102, para 11.13A allows a small entity which receives a loan from a person who is within a director’s group of close family members (as defined in the Glossary to FRS 102), when that group of close family contains a least one shareholder, to recognise the loan at transaction price (i.e. at cost).

In practice, this would apply to a loan provided to a small entity that is covered by formal terms and which is at below market rates of interest. The exception in paragraph 11.13A means the small entity does not have to impute a market rate of interest and then discount the loan on initial recognition using that imputed rate of interest.

If the loan is not covered by formal loan terms (as is the case for most of these sorts of transactions within a small entity), then the loan would not be discounted anyway because it would be considered as being repayable on demand, so the loan would be recognised as a current liability in the small entity’s financial statements.

FRS 102, Section 1A, Appendix E Additional disclosures encouraged for small entities contains five encouraged disclosures which preparers cannot disregard.

Over the last 18 months, the most important one to consider is the going concern disclosure. FRS 102, Section 1A, para 1AE.1(c) encourages a small entity to provide the disclosures relating to material uncertainties [emphasis added] related to events or conditions that cast significant doubt upon the small entity’s ability to continue as a going concern as set out in paragraph 3.9.

This paragraph is important because going concern is such a fundamental concept. The fact that the paragraph encourages the small entity to disclose material uncertainties means that if the directors choose not to (on the basis that the disclosure is encouraged rather than legally required), it will be difficult to justify that the financial statements give a true and fair view. Hence, in the absence of such disclosures, the financial statements will contain material misstatement and will be misleading.

Keep in mind that professional bodies do not allow member firms to have their names associated with financial statements which are misleading, so this is a particularly important issue to consider.

FRS 105

FRS 105 is viewed as a ‘compliance framework’ rather than a ‘true and fair framework’. The standard is prescriptive and includes much simpler recognition and measurement principles and a vastly reduced disclosure regime (for UK-based micro-entities at least). There is only one format permitted for the profit and loss account (a Format 2 profit and loss account which presents expenses by nature).

 

A notable feature of FRS 105 is the presumption in law that if the micro-entity’s financial statements are prepared in accordance with the minimum legal requirements (ie FRS 105), the financial statements give a true and fair view. This means the directors need not consider making any additional disclosures, beyond those required in the standard, to achieve a true and fair view.

 

Other notable simplifications in FRS 105 are shown in the following table:

 

Borrowing and development costs

All borrowing and development costs must be expensed. There is no option to capitalise them.

Deferred tax

Micro-entities are prohibited from accounting for deferred tax.

Defined benefit pension plans

These are accounted for in the same way as defined contribution plans, ie contributions into the plan are accounted for as an expense. A liability is recognised in respect of any agreements to fund a deficit (a schedule of contributions) because the pension obligation is not reported on the micro-entity’s balance sheet.

Equity-settled share-based payments

Micro-entities need not account for equity-settled share-based payments prior to the issue of the shares (this is because of the prohibition in using fair values, noted below, and the lack of disclosure).

Financial instruments

Micro-entities are not required to use the amortised cost and effective interest method as they are considered to be too onerous, hence financial instruments are effectively recognised and measured at cost.

Foreign currency

There is no distinction between functional and presentation currency and the micro-entity must use contracted rates to translate assets and liabilities denoted in a foreign currency as opposed to closing rate.

Government grants

Government grants are measured under the accrual model. The performance method of grant recognition is prohibited under FRS 105.

Hyperinflation

The accounting issues relating to hyperinflation are not included in FRS 105 as hyperinflation is unlikely to be an issue for micro-entities.

Recognition of separately identifiable intangible assets in a trade and asset acquisition

This requirement is removed in FRS 105 because they are not required items in the financial statement formats.

Revaluations and fair value amounts

Micro-entities cannot revalue assets, nor can they apply fair value accounting. This is because use of the Alternative Accounting Rules and Fair Value Accounting Rules is prohibited in the micro-entities’ legislation.

Specialised activities

These consist only of agriculture. Activities such as extractive industries, service concessions, heritage assets and funding commitments are unlikely to apply to micro-entities.

Transitioning between frameworks

Applying the correct financial reporting framework at the outset cannot be over-emphasised.

Over the years, a common question asked by some practitioners is whether FRS 102 could be applied in year 1, then, if appropriate, FRS 105 in year 2, switch back to FRS 102 in year 3 and so on. This is not how the standards are designed to work and would create unnecessary work in having to do regular transitions.

A micro-entity (which is eligible to use FRS 105) should consider all the benefits and drawbacks of the standard before deciding on applying the standard.

Applying the correct financial reporting framework at the outset cannot be over-emphasised.

If, for example, the micro-entity has an investment property on the balance sheet and the directors want to reflect the property’s fair value at each reporting date, FRS 105 will not be appropriate because the investment property must be measured at cost less depreciation less impairment. To enable measurement of the investment property at fair value, the entity would have to report under FRS 102. Similarly, if an entity has a history of revaluing certain fixed assets, then FRS 105 may also not be appropriate as revalued amounts cannot be used under the standard.

Some micro-entities do outgrow FRS 105 and therefore will need to transition to FRS 102 (including applying Section 1A, if applicable) as a matter of course. Conversely, some small entities will contract and hence become eligible to use FRS 105 if they wish.

Whenever there is a switch between financial reporting frameworks, a transition must be carried out. This involves restating the transition date balance sheet (ie the opening balance sheet position at the start date of the comparative year) and then restating the closing comparative year to comply with the requirements of FRS 102 or FRS 105.

For example, if transitioning from FRS 102 to FRS 105, all fair value and revalued amounts must be removed from the date of transition and in the closing comparative year. Deferred tax balances must also be removed.

Conversely, if moving from FRS 105 to FRS 102 then there are additional accounting policy options that will need to be considered (eg whether to revalue assets or capitalise development costs). There are also mandatory requirements that must be considered, such as measuring investment property at fair value through profit or loss and accounting for deferred tax.

Conclusion

This article has considered some of the more notable issues relating to FRS 102 and FRS 105 and how they interact with each other – especially when it comes to transitioning between the frameworks.

The article does not cover every eventuality and preparers must, therefore, have a sound understanding of the differences of each framework in order to advise their client of the most appropriate framework correctly.

Steve Collings will be speaking at AccountingWEB Live Expo on 1-2 December 2021 alongside such guests as Rebecca Benneyworth, Peter Rayney, Paul Aplin, Anita Monteith, Carl Reader, Steve Collings, Reza Hooda plus representatives from HMRC. 

AccountingWEB Live Expo takes place on 1-2 December 2021 at Coventry Building Society Arena, Coventry. Registration is now open. A full content programme will be announced in early October enabling you to register for specific sessions. Please visit the AccountingWEB Live Expo website for full details and to sign up to our newsletter.

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Replies (13)

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By Catherine Newman
28th Sep 2021 18:34

Guess what. Who understands it and what difference does it make? Just get the return filed as quickly as you can.

Thanks (7)
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By raybackler
29th Sep 2021 09:55

Good article. However, I share Catherine Newman's concerns. Small business clients don't give a toss. In the main, issues like revaluation of assets, deferred tax, depreciation, capital allowances and handling of loans all bring groans along the lines of "that is what I pay you for". All they want to know is how much Corporation Tax they have got to pay and to keep down accountancy fees. Some are concerned to minimise disclosure at Companies House, but without a P&L being required under either standard that job is pretty well covered. The niceties of accounting standards just disappear over client's heads.

Thanks (7)
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By fishfishyfishfish
29th Sep 2021 11:02

A personal view but I have never understood what purpose FRS105 is meant to serve. It delivers financial statements of an inferior standard (the "P&L" is frankly a joke), yet requires (generally speaking) the same amount of effort and expertise to put together as a set of FRS102 accounts. Yes the level of disclosure appearing on the public record is somewhat reduced, but for most clients using 105 I doubt that is much of a consideration. 105 was the product of politicians wanting to be seen to be 'helping' small business, but what it really does is debase our profession.

Thanks (2)
Replying to fishfishyfishfish:
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By djn
29th Sep 2021 11:11

fishfishyfishfish wrote:

A personal view but I have never understood what purpose FRS105 is meant to serve. It delivers financial statements of an inferior standard (the "P&L" is frankly a joke), yet requires (generally speaking) the same amount of effort and expertise to put together as a set of FRS102 accounts. Yes the level of disclosure appearing on the public record is somewhat reduced, but for most clients using 105 I doubt that is much of a consideration. 105 was the product of politicians wanting to be seen to be 'helping' small business, but what it really does is debase our profession.

I agree with this. The FRS105 accounts are terrible.
Although a lot of clients probably don't care as they just want the accounts filed and tax figure.

Thanks (2)
Replying to fishfishyfishfish:
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By Paul Crowley
29th Sep 2021 12:26

On the software we use the FRS 105 accounts are more readily understood by the average client than the page after page of irrelevant nothings and notes that 102 produces

Most small businesses are looking to follow and understand the inportant figures on the P & L and balance sheet

A four year summary is even better
Comparing this year to last year is pointless if last year was odd

Thanks (3)
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By petestar1969
29th Sep 2021 11:07

We use FRS 105 wherever possible, much less effort and the clients generally couldn't care less (all they want to know is how much tax they have to pay).

Thanks (4)
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By [email protected]
29th Sep 2021 11:12

If the client is and will remain a micro entity then FRS105 is fine. it's simple and most never read the accounts once filed anyway.

If the entity is expected to grow beyond eligibility then go for FRS102 from the outset as it's much simpler than transitioning later and S1a isn't really that much more onerous than FRS105 (for a micro entity that doesnt need things like revaluations etc)

And of course there are some (Charities for instance) that have to use FRS102 regardless.

Thanks (4)
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By MattS
29th Sep 2021 12:18

Whilst FRS105 is not a perfect standard and has some areas that perhaps need tweaking, it is the appropriate standard for many small business.

I feel that in many cases it is actually under utilized, it would be interesting to see the stats on the uptake. Does some of this under utilization occur as they are not particularly pleasant to look at.

It can save businesses time, money and the need to over disclosure on the public record.

Thanks (2)
Replying to MattS:
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By Catherine Newman
29th Sep 2021 13:29

It is all a minefield. I have had accounts rejected by Companies House for not including a P&L with whichever legal jargon I used for micro-entities or small companies.

Why do we have to provide a note re average number of employees? It takes a long time to find it in the software.

Thanks (2)
Replying to Catherine Newman:
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By raybackler
29th Sep 2021 14:08

I can understand it for larger enterprises where figures are provided, but when it is less than 10 employees with no further financial information it adds very little to the accounts.

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Replying to Catherine Newman:
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By Paul Crowley
29th Sep 2021 14:48

The drafters made a mistake.
Rather than fix the mistake we all now waste time adding a note to accounts that were INTENDED to have no notes.
The only note needed is for Related parties
An irrecoverable loan to a director or shareholder is the note I want to read, especially if that is 90% of assets

Who cares about revaluations of property, and all that "clever" stuff that accounting bodies get so excited about?
Better for the accounting bodies to teach the big firms how to audit and how to read bank statements

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By JD
29th Sep 2021 21:59

Tend to use frs102 as it provides both the client and lenders with rather more information to understand what is going on with the business. Frs105, just feels as though only half a job has been done.

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By cwoodthorpe
21st Oct 2021 12:31

I’m not sure this is something that we should be deciding for clients. FRS 1021A discloses far more at Companies House in the way of notes so we always provide clients with the pros and cons of each and ask them want they would prefer. As others have said, most want as little as possible disclosed at Companies House.

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