Life after FRSSE: FRS 105 explained
Many companies in the UK and Republic of Ireland with December 2015 year-ends are in their first year of reporting under new UK GAAP - FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland.
If that was not enough, companies at the smaller end of the scale are also set for some sweeping changes in the way that they will report financial information, says Steve Collings.
In January 2015, the Department for Business Innovation and Skills (BIS) issued its Response to the consultation on the UK Implementation of the EU Accounting Directive: Chapter 1-9 Financial statements and general requirements for audit. This response outlined how the Companies Act will be amended to incorporate the provisions of the EU Accounting Directive and the draft regulations are expected to come into effect on 6 April 2015. Companies will be mandatorily required to apply the new legislation for accounting periods commencing on or after 1 January 2016. However, it is permissible to early-adopt the new legislation once it hits the statute book so as to enable a company to have access to a less burdensome financial reporting regime.
Response by the Financial Reporting Council
On 19 February the Financial Reporting Council (FRC) issued the following exposure drafts which outlined their intentions for small and micro-entities:
- FRED 58 Draft FRS 105 ‘The Financial Reporting Standard applicable to the Micro-entities Regime’
- FRED 59 Draft amendments to FRS 102 ‘The Financial Reporting Standard applicable in the UK and Republic of Ireland – Small entities and other minor amendments’
- FRED 60 Draft amendments to FRS 100 ‘Application of Financial Reporting Requirements’ and FRS 101 ‘Reduced Disclosure Framework’
Included within the three exposure drafts is an ‘overview’ of the consultation which gives a brief outline as to their overall intentions. Three FREDs were issued by the FRC in order to make a distinction between the different standards which have been affected by the proposals.
In general, the new UK GAAP (once implemented) will start off with the micro-entities regime, flow through to the small companies’ regime, then full FRS 102 and finish with EU-adopted IFRS. The financial reporting requirements of each regime get progressively more complex and comprehensive the further up the line of standards you go. This increase in complexity represents the increasing size and complexity of the entities which are most likely to apply a given standard. For completeness, the following FRSs will eventually be in existence:
- FRS 100 Application of Financial Reporting Requirements
- FRS 101 Reduced Disclosure Framework
- FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland
- FRS 103 Insurance Contracts
- FRS 104 Interim Financial Reporting
- FRS 105 The Financial Reporting Standard applicable to the Micro-entities Regime
The regime is not rigid; in other words, an entity does have the option to choose to adopt a more comprehensive framework if it so wishes. The FRC acknowledges that some entities may decide, for example, not to choose the micro-entities regime, but instead choose FRS 102 for small companies or full FRS 102 (although the latter is not expected to be a common option). Factors which the FRC have suggested might be considered are:
- Whether an entity is eligible to apply that particular regime. Eligibility criteria may include the type of financial statements (i.e. individual or group) being prepared, company size thresholds and entity type
- Where a choice of regime exists, entities should consider which of the regimes is the most appropriate to the individual circumstances of an entity. Factors to consider will differ from company to company and may relate to certain characteristics or restrictions of a particular regime, the resources available and the information needs of users of the accounts, among many others
FRED 58 Draft FRS 105
The FRC has decided to ‘carve out’ the micro-entities regime into its own FRS and therefore FRED 58 proposes a standalone standard for entities which qualify as micro-entities and prepare their financial statements under that regime. Currently the micro-entities regime is embedded within the FRSSE (effective April 2008) and (effective January 2015) which is not ideal because the disclosure requirements are significantly reduced in the micro-entities legislation. Currently companies in the Republic of Ireland cannot apply the micro-entities regime because there is no equivalent Irish legislation; although the Irish Department of Jobs, Enterprise and Innovation have consulted on the possible enactment of the micro-entities legislation and should the legislation be enacted in Ireland, FRS 105 will be available to companies in the Republic of Ireland.
FRS 105 is based on the recognition and measurement requirements of FRS 102 which will mean that UK GAAP will all be based on a consistent framework. Key features of FRS 105 are as follows:
- There are only two primary financial statements: the balance sheet and profit and loss account. There is no requirement to prepare a cash flow statement or a statement of total recognised gains and losses
- The information presented in the balance sheet and profit and loss account is condensed; for example fixed assets are not split out between tangible and intangible fixed assets and investment properties
- No assets can be measured at fair value or at revaluation. The consequence of this is that any previous revaluations will have to be removed on transition
- The disclosure requirements are:
o total amount of any financial commitments, guarantees or contingencies that are not included in the balance sheet
o an indication as to the nature and form of any valuable security which has been provided
o the amounts of advances and credits granted to members of the administrative, managerial and supervisory bodies with indications of interest rates, main conditions and any amounts repaid or written off or waived
o any commitments entered into on their behalf by way of guarantees of any kind, with an indication of the total for each category
- Micro-entities can choose to include more voluntary information if the entity so wishes
- Micro-entities’ financial statements prepared in compliance with the minimal legal requirements are presumed to give a true and fair view due to the ‘deeming provisions’ within the legislation. There is no requirement for directors to consider what additional information may be needed in order for the accounts to give a true and fair view (unlike in current FRSSE where the directors are legally obliged to ensure the financial statements are true and fair)
In addition, the FRC has also made further simplifications which apply to micro-entities:
- No requirement to account for deferred tax
- No requirement to account for equity-settled share-based payment transactions
- All accounting policy choices have been removed, including the option to capitalise development and borrowing costs which now have to be expensed to profit or loss
- Government grants must be accounted for under the performance method not the deferred income method and hence a micro-entity will immediately recognise any government grant in profit and loss
More guidance has been included in FRS 105 to help aid preparers in understanding the accounting treatments required. In addition, FRS 105 does not reproduce the reporting requirements from company legislation applicable to micro-entities unlike the FRSSE, but it does incorporate those which relates to the financial statements themselves (a consequence of this is that the directors must satisfy themselves that they have met all their legal requirements).
There are strict eligibility criteria in FRS 105 and the standard itself is only eligible to companies. The following companies cannot adopt the standard:
- Any companies excluded from the small companies regime
- Financial institutions including credit, insurance and banking institutions
- Small parent companies which choose to prepare consolidated financial statements
- Companies that are not parent companies but their financial statements are included in consolidated financial statements
- Public companies
FRED 59 Draft amendments to FRS 102
Small companies which choose not to apply FRS 105 (or are not eligible to apply FRS 105) must, as a minimum, report under FRS 102 for small companies. FRS 102 has been amended by way of a new Section 1A Small Entities and the overall effect of this is twofold:
- Small companies reporting under FRS 102 for small entities will apply the full recognition and measurement principles contained in FRS 102, but retain the presentation and disclosure requirements that are appropriate to a small company
- It reduces the need for significant changes in accounting for certain transactions as the entity grows
Paragraph 1A.3 says that a small entity is to present the following as their complete set of financial statements:
a) a statement of financial position as at the reporting date in accordance with paragraph 1A.5
b) an income statement for the reporting period in accordance with paragraph 1A.9
c) notes in accordance with paragraph 1A.12 to 1A.15
Section 1A encourages a small entity to present a statement of changes in equity in accordance with Section 6 Statement of Changes in Equity and Statement of Income and Retained Earnings.
The new regulations will allow a small company to prepare ‘abridged’ financial statements provided that all the shareholders agree. Shareholders can only agree to prepare abridged financial statements for the preceding financial year and hence this agreement is an annual process (one agreement does not cover subsequent years).
Where an abridged balance sheet is prepared, management must consider the requirements contained in paragraph 1A.12 relating to the disaggregation of the balance sheet (and hence make additional disclosures in the notes).
The revised regulations also allow the statutory formats for the profit and loss account and balance sheet to be adapted. Paragraph 1A.7 says that where the small entity adapts one of the balance sheet formats, it must include line items which present the following and distinguish them between those which are current and those which are non-current:
a) cash and cash equivalents
b) trade and other receivables
c) financial assets (excluding amounts shown under (a), (b), (j) and (k)
e) property, plant and equipment
f) investment property carried at fair value through profit or loss
g) intangible assets
h) biological assets carried at cost less accumulated depreciation and impairment
i) biological assets carried at fair value through profit or loss
j) investments in associates
k) investments in jointly controlled entities
l) trade and other payables
m) financial liabilities (excluding amounts shown under (l) and (p))
n) liabilities and assets for current tax
o) deferred tax liabilities and deferred tax assets (these shall always be classified as non-current)
q) non-controlling interest, presented within equity separately from the equity attributable to the owners of the parent
r) equity attributable to the owners of the parent
Section 1A also requires the following sub-classifications of the line items presented when either of the balance sheet formats have been adapted:
a) property, plant and equipment in classifications appropriate to the small entity
b) trade and other receivables, showing separately amounts due from related parties and amounts due from other parties
c) trade and other payables, showing separately amounts due to related parties and amounts due to other parties
d) classes of equity, such as paid-in capital, share premium, retained earnings and items of income and expense that, as required by this FRS, are recognised in other comprehensive income and presented separately in equity
Where an abridged profit and loss account has been prepared the directors must also consider the requirements of paragraph 1A.12 in relation to the presentation of turnover (as an abridged profit and loss account can start at gross profit as opposed to disclosing turnover and cost of sales). Also, where one of the formats of the profit and loss accounts has been adapted, the entity must include, as a minimum, the following line items which present the following amounts for the period:
b) finance costs
c) shares of the profit or loss of investments in associates (see Section 14 Investments in Associates) and jointly controlled entities (see Section 15 Investments in Joint Ventures) accounted for using the equity method
d) tax expense including tax allocated to other comprehensive income
e) profit or loss
The disclosure requirements included in Section 1A incorporate the legal requirements brought in by the EU Accounting Directive. However, an important point to emphasise is that the directors still have a legal duty to prepare accounts which give a true and fair view. Applying the minimum disclosures required by law may not mean that the financial statements are true and fair and therefore the directors must consider making additional disclosures so that the financial statements do give a true and fair view.
The FRC are extremely keen that directors of small companies do not under-estimate the importance of the true and fair concept in companies’ legislation. In light of this, the FRC encourage the following disclosures to be made in the small entity’s financial statements:
a) a statement of compliance with this FRS as set out in paragraph 3.3
b) if relevant, a statement that it is a public benefit entity as set out in paragraph PBE3.3A
c) if relevant, the disclosures relating to going concern set out in paragraph 3.9
d) dividends declared and paid or payable during the period (for example, as set out in paragraph 6.5(b))
e) on first-time adoption of this FRS, an explanation of how the transition has affected its financial position and financial performance as set out in paragraph 35.13
Readers will note that the FRC has included cross-references to certain paragraphs within FRS 102. This was a deliberate action by the FRC to help preparers in understanding what needs to be disclosed so that financial statements give a true and fair view.
FRED 60 Draft Amendments to FRS 100 and FRS 101
FRS 100 Application of Financial Reporting Requirements has been amended to reflect the revised framework of accounting standards. The most notable amendments are the withdrawal of the FRSSE (effective January 2015) and the inclusion of FRS 105.
FRS 101 Reduced Disclosure Framework has been amended so that it remains consistent with the new provisions in company law and removal of references to the FRSSE. More flexibility has been included in FRS 101 relating to the formats of the profit and loss account and balance sheet which has been brought about by the EU Accounting Directive and therefore allows the use of IFRS-based presentation requirements similar to those used for the group accounts.
Small company financial reporting is undergoing significant changes and FREDs 58 to 60 are open for comment until 30 April 2015 – details of how to submit comments are set out at the back of each FRED.
The FRC is keen to receive feedback from the profession because this will help them in developing the FREDs into final standards. Time is of the essence for small companies because there is not much time before mandatory implementation of the new small companies’ regime comes into effect (the whole regime will be effective for accounting periods commencing on or after 1 January 2016). Earlier adoption of the new regime will be permissible.