As we approach the end of 2015, practitioners across the country have begun to think about the impact that the new UK GAAP reporting frameworks will have for their small and micro-entity clients; particularly as the new standards are applied retrospectively to the date of transition.
For clarity, small companies (and micro-entities that choose not to report under FRS 102) will report under FRS 102 with reduced disclosures (which is the term this article uses). Others are referring to it as ‘FRS 102 for small companies’ or ‘FRS 102 “light”’ but the term used in this article means FRS 102 for small companies.
FRS 105 The Financial Reporting Standard applicable to the Micro-entities Regime
The micro-entities’ regime is proving to be divided in terms of its popularity. Many practitioners welcome the new simplified regime, while others question how HM Revenue and Customs (HMRC) will react to the significantly reduced level of disclosures.
FRS 105 can only be applied by incorporated companies (see the ‘Eligibility’ section below). Therefore, entities such as Limited Liability Partnerships, charities, financial and credit institutions and micro-entities whose financial statements are included in consolidated financial statements will be ineligible to apply the standard. In terms of advising clients as to the appropriateness of FRS 105, it is important first and foremost to consider whether the client will actually be eligible to use the framework. If the micro-entity is a business which is not prohibited from using FRS 105, then the thresholds for applying FRS 105 are as follows:
- Turnover not more than £632,000 (pro rata for a short accounting period)
- Balance sheet total (fixed assets plus current assets) not more than £316,000
- Not more than 10 employees
A client may be eligible to apply FRS 105 as its financial reporting framework and in many cases FRS 105 will be appropriate. However, practitioners are being strongly advised to consider FRS 105 on a case-by-case basis and not simply apply the framework because (a) it is a much more simplified framework or (b) because there are significantly fewer disclosures that have to be made. Some of the more common factors that should be considered are as follows:
As mentioned earlier in this section, the eligibility criteria for FRS 105 is very restrictive and the term ‘micro-entity’ is defined as an entity that meets all of the following conditions:
- It is a company established under company law;
- It qualifies as a micro-entity in accordance with section 384A of the Act; and
- It is not excluded from being treated as a micro-entity under section 384B of the Act.
Micro-entities are a subset of small companies as defined in the Act.
Assets carried at revaluation under outgoing GAAP
Where a micro-entity has, for example, an investment property which is carried at open market value in accordance with the FRSSE (effective January 2015), it will not be able to apply the alternative accounting rules/fair value accounting rules under FRS 105 because the legislation does not recognise any of the fair value accounting rules or the alternative accounting rules.
Therefore, any assets carried at revaluation or at fair value have to be restated to cost. In the case of an investment property, FRS 105 at Section 28 Transition to this FRS at paragraph 28.10(c) outlines the procedures to restate such properties to cost.
In addition, paragraph 28.10(c)(iii) then requires accumulated depreciation to be recognised since the date of initial acquisition calculated on the basis of the useful life of the main structural element. This is a particularly important issue to consider when undertaking an impact assessment as it could affect the overall balance sheet position quite significantly in some cases.
Where clients wish to continue reporting assets at revaluation or at fair value, then they must adopt FRS 102 with reduced disclosures as a minimum.
Pace of growth of the entity
If a micro-entity is, say, a new start-up client and the pace of growth of the client is expected to be fast, it may be beneficial to use FRS 102 with reduced disclosures rather than FRS 105.
Rigidity of the financial statements
Under FRS 105 you can only prepare a Format 2 profit and loss account (not a Format 1). A Format 2 profit and loss account is structured as follows:
- Other income
- Cost of raw materials and consumables
- Staff costs
- Depreciation and other amounts written off assets
- Other charges
- Profit or loss
A Format 1 or a Format 2 balance sheet can be prepared. However, you cannot alter the structure of the statutory formats. In addition, there is no disaggregation of the balance sheet under FRS 105 because the statutory formats are only preceded by a letter and not Roman numerals or Arabic numerals.
Therefore, fixed assets will not be disaggregated into intangible fixed assets, tangible fixed assets and investment property; there will just be one line item called ‘Fixed assets’. Similarly, current assets are not disaggregated into the order of liquidity (stock and work in progress, debtors, bank and cash); there is only one line item showing current assets.
Prepayments and accrued income, however, will be shown directly underneath current assets in a Format 1 or Format 2 balance sheet and one practitioner expressed surprise at seeing this, but it is correct (accruals and deferred income are shown underneath provisions for liabilities in a Format 1 balance sheet but shown underneath creditors amounts falling due after one year in the Format 2 balance sheet).
Accounting policy options
Accounting policy options have been removed in FRS 105 and therefore if you have a micro-entity that chose to capitalise development costs (or capitalise borrowing costs as part of the construction of an asset), they will not be able to do so under FRS 105 principles.
Such costs must be written off to profit or loss instead. This is because allowing accounting policy options could cause confusion to users because of the lack of detail in the formats of the financial statements as well as the lack of supporting disclosures to explain the accounting policy choice taken.
The lack of accounting policy options should also be included as part of an impact assessment in deciding whether FRS 105 is appropriate or whether FRS 102 with reduced disclosures is more appropriate (as there are more accounting policy options in FRS 102 with reduced disclosure).
The way in which financial instruments are accounted for under the provisions of FRS 102 with reduced disclosures is proving to be very controversial – particularly in respect of intra-group loans whereby a market rate of interest has to be imputed where the loan is at below market rate (or interest-free).
This is because Section 11 Basic Financial Instruments in FRS 102 with reduced disclosures only uses the amortised cost method to account for such loans. Imputed market rates of interest in lending arrangements which are conducted at non-market rates have been removed in FRS 105 on the grounds that the FRC feel it would be too onerous for micro-entities to apply; so the accounting for such loans under FRS 105 principles is simpler.
FRS 102 with reduced disclosures also requires the use of the effective interest method to allocate interest charges/income to profit or loss. The requirement to use the effective interest method has been removed in FRS 105 on the basis that the FRC view this method to be too onerous for micro-entities.
The micro-entities’ regime is renowned for its sheer lack of disclosure requirements and this aspect of the regime may prove to be very attractive for some practitioners. There are only two legally required disclosures in the legislation which, according to Section 6 Notes to the Financial Statements in FRS 105 are:
- Advances, credit and guarantees granted to directors as required by section 413 of the Act (see paragraph 6A.1 in the Appendix to this Section); and
- Financial commitments, guarantees and contingencies as required by regulation 5A of, and paragraph 57 of Part 3 of Schedule 1 to, the Small Companies Regulations (see paragraphs 6A.2 and 6A.3 in the Appendix to this Section).
The notes to the financial statements are included at the foot of the balance sheet. However, the reductions in disclosure requirements are not necessarily as simple as they look.
This is because the above disclosures cover several areas of the Companies Act 2006 and in recognition of this, the FRC have included an Appendix to Section 6 Company law disclosure requirements which is an integral part of FRS 105 and outlines the complete disclosures needed to ensure the micro-entity fully complies with its legal obligations.
This article covers some of the main issues that should be considered by practitioners when establishing whether a client should report under the micro-entities’ framework, FRS 102 with reduced disclosure or full FRS 102; although it does not cover every issue which practitioners should consider and the appropriateness of a standard must be considered on a client-by-client basis.
About Steven Collings
Steve Collings, FMAAT FCCA is the audit and technical partner at Leavitt Walmsley Associates Ltd where Steve trained and qualified.