Last month, AccountingWEB published an article on the pitfalls to be avoided where the new UK GAAP was concerned. This prompted a couple of questions concerning the implementation of the new standards for small companies who must apply the new reporting requirements for accounting periods starting on or after 1 January 2016 (although early adoption is permissible). These questions have also been asked regularly on CPD courses, so it was considered worthwhile to follow these questions up in an article.
One of the notable points of the new standards (FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland and FRS 105 The Financial Reporting Standard applicable to the Micro-entities Regime) is the reduction in volume when compared to outgoing UK GAAP. As a consequence, there is much more emphasis placed on professional judgement, particularly where there are no established practices. Indeed, on 2 June 2016 the Financial Reporting Council published a note on loans relating to social housing where divergent practices may arise, and it is expected that once the new reporting regimes are implemented there will be more clarification on such issues.
Website and software costs
FRS 102 does not specify the classification of website and software costs. Where an FRS does not deal with a transaction, event or condition, paragraph 10.4 requires management to develop an accounting policy in line with Section 2 Concepts and Pervasive Principles. Such a policy must be:
a) relevant to the economic decision-making needs of users; and
b) reliable, in that the financial statements:
i. represent faithfully the financial position, financial performance and cash flows of the entity;
ii. reflect the economic substance of transactions, other events and conditions, and not merely the legal form;
iii. are neutral, i.e. free from bias;
iv. are prudent; and
v. are complete in all material respects.
In order to qualify for capitalisation on the balance sheet, website development costs must meet the recognition criteria outlined in paragraph 2.27 which is as follows:
a) it is probable that any future economic benefit associated with the item will flow to or from the entity; and
b) the item has a cost or value that can be measured reliably.
Using this definition in the context of website development costs, if the website has the ability to allow customers to order goods or services from the reporting entity, then, providing the cost can be reliably measured, those costs will meet the recognition criteria for an asset and hence qualify for capitalisation. This is because the fact that customers can order goods or services creates a revenue stream for the business (i.e. ‘future economic benefit’).
Software costs are another type of expense which many accountants are questioning in terms of whether or not such costs should be regarded as tangible fixed assets or intangible fixed assets.
If the software is needed to enable the hardware to work (such as a Windows operating system) then the costs should be included within tangible fixed assets. However, if the software is not critical to the operation of the related hardware, then it can be treated as an intangible fixed asset. If the software is being developed internally (i.e. the software is an internally generated intangible asset) then regard must be had to paragraph 18.8H before any costs are recognised as an intangible asset on the balance sheet. Paragraph 18.8H says that an entity may recognise an intangible asset arising from development (or from the development phase of an internal project) if, and only if, the entity can demonstrate all of the following:
a) The technical feasibility of completing the intangible asset so that it will be available for use or sale.
b) Its intention to complete the intangible asset and use or sell it.
c) Its ability to use or sell the intangible asset.
d) How the intangible asset will generate probable future economic benefits. Among other things, the entity can demonstrate the existence of a market for the output of the intangible asset or the intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset.
e) The availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset.
f) Its ability to measure reliably the expenditure attributable to the intangible asset during its development.
It is to be noted that any research expenditure must always be recognised as expenses in profit or loss.
Reversal of deferred tax for micro-entities
Istolethenut questioned the reversal of deferred tax balances for micro-entities reporting under FRS 105 in light of the wording in paragraph 28.9 which says:
‘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.
b) Accounting estimates.’
Micro-entities are prohibited from accounting for deferred tax because it would not be possible for a user of the micro-entity’s financial statements to distinguish between amounts of tax which are current and amounts which are deferred. Paragraph 28.9 of FRS 105 relates to financial instruments and accounting estimates rather than deferred tax balances. Accounting estimates cannot be changed for the benefits of hindsight so, for example, if a micro-entity made a provision for damages in a legal case of £10,000 then on transition the micro-entity cannot increase or decrease this provision retrospectively – the estimate stays at £10,000.
In respect of deferred tax balances, the financial statements of a micro-entity must be restated to the carrying values that would have been recognised had FRS 105 always been the financial reporting framework adopted. This means that any deferred tax balances (assets or provisions for liabilities) must be reversed on transition and in the comparative year to reflect the fact that micro-entities cannot recognise amounts in respect of deferred tax.
Holiday pay accruals
Chris.slaneyandco.co.uk raised a question about holiday pay accruals and whether these could be holiday pay prepayments, rather than accruals. This is possible, as can be seen in the following example:
|Example: holiday pay accrual
A company has a financial year-end of 30 June 2016 and a holiday year of 31 December 2016. An employee has 30 days’ holiday per year and at the accounting year-end had taken 20 days’ of their entitlement.
In this example there will be a prepayment of five days’ holiday ((30 days’ x 6/12) less 20 days).
As accountants start to get to grips with the detailed intricacies of the new UK accounting standards, it is likely that many more issues will begin to emerge. Throughout the remainder of this year AccountingWEB will continue to publish articles looking at the detailed technical content of the standard in light of questions asked by accountants.
In addition, it is also worth mentioning the Staff Education Notes, which may help preparers in the event of a difficult situation or where clarification is needed. These notes are not a substitute for reading the standards themselves, but aim to clarify some of the most complex issues found in new UK GAAP.
About Steven Collings
Steve Collings, FMAAT FCCA is the audit and technical partner at Leavitt Walmsley Associates Ltd where Steve trained and qualified.