The introduction of FRS 102 ‘The Financial Reporting Standard applicable in the UK and Republic of Ireland’ has resulted in some questions being asked by accountants concerning some of the accounting treatments within the new regime.
One of the most frequently asked questions relates to items of fixed assets that were previously carried under the revaluation model or at open market value (i.e. investment property) and the impact that new UK GAAP has on the accounting for such assets.
At the outset it is worth pointing out that FRS 105 The Financial Reporting Standard applicable to the Micro-entities Regime does not allow any assets to be carried at revaluation or at fair value.
This is not something the Financial Reporting Council have brought in. It is because the EU Accounting Directive does not recognise any of the fair value accounting rules or the alternative accounting rules – hence on transition to FRS 105 such micro-entities will have to remove any revaluation amounts or fair values (in paragraph 28.10(c) FRS 105 provides guidance on how to deal with this issue when a micro-entity has an investment property on its balance sheet and is reporting under FRS 105).
Section 17 Property, Plant and Equipment
Section 17 Property, Plant and Equipment in FRS 102 allows a reporting entity to carry property, plant and equipment (PPE) at cost or at revaluation. Unlike FRS 15 Tangible fixed assets, FRS 102 does not specifically require revaluations to be carried out every five years, with valuations in the intervening years where there has been a material change in valuation.
Instead, the standard requires revaluations to be carried out with ‘sufficient regularity’, noting that the carrying amount of the asset(s) should not differ materially from its fair value at the reporting date when the revaluation model is used.
In addition, where the reporting entity applies the alternative accounting rules as set out in SI 2008/410, all items within that asset class must also be subject to revaluation (this has not changed from the previous requirements). This is to stop reporting entities from ‘cherry picking’ those assets for revaluation on the basis that they happen to have increased significantly in value.
The requirement to obtain valuations ‘with sufficient regularity’ will mean professional judgement will have to be exercised on the part of the directors. Clearly the frequency of the revaluations will depend on the movements in the fair value of the asset(s) concerned, and the standard requires that where there has been a material change in value, then a revaluation will be required. On the flip side, where fair values are relatively stable, then fair values will be required on a less frequent basis.
The question arises as to what constitutes a ‘material’ change in fair value? There are no prescribed materiality limits within FRS 102 and hence the directors will have to use their judgement.
Ultimately, materiality will depend on whether the change in fair value would reasonably influence the decisions of a user of the accounts. Management may choose to obtain external valuations (particularly for assets such as buildings) to establish whether, or not, the change in fair value is material. Indeed, paragraph 17.15C of FRS 102 acknowledges that the valuation of land and buildings is normally carried out by professional valuers. Other factors such as general market conditions and the condition of the asset itself might also be considered in determining whether there has been a material change in fair value.
Fair value gains and losses for PPE
When an asset is subjected to revaluation under section 17 of the standard, the concept of the revaluation reserve still exists. It is only investment property where the concept of a revaluation reserve no longer exists (see below). Therefore the accounting for, say, a gain on revaluation of an item of PPE will still be the same as was the case previously; i.e. a revaluation gain will still be accounted for as:
- Dr PPE
- Cr revaluation surplus (within equity)
Revaluation gains are usually credited to other comprehensive income and accumulated in equity. However, where the gain reverses a previously recognised revaluation decrease on the same asset and that decrease was recognised in expenses, then the gain can be taken directly to profit or loss, to the extent that the gain reverses the previously recognised loss. Any excess is then reported within equity.
Revaluation losses are also recognised in equity (i.e. other comprehensive income) to the extent of any credit balance on the revaluation reserve. Any excess over and above the revaluation surplus is then reported in profit or loss.
Example – Revaluation loss
A company has a policy of revaluing an asset, and during the year to 31 December 2016 the asset suffered a revaluation loss of £18,000. The asset has an associated revaluation surplus of £10,000.
The company will use the revaluation surplus of £10,000 and the excess of £8,000 will be taken to profit or loss as follows:
A negative amount on the revaluation reserve cannot be created.
The accounting treatment for investment property carried at fair value through profit or loss under section 16 Investment Property is notably different than under SSAP 19 Accounting for investment properties and the FRSSE.
Previously, an entity carrying investment property at open market value would take any fluctuations in market value to a revaluation reserve, which was accumulated in equity and reported through the statement of total recognised gains and losses.
This is no longer the case under section 16, and instead all fair value gains and losses are reported through profit or loss.
It is important to emphasise that the concept of the revaluation reserve has been removed only for investment property carried at fair value under section 16 of FRS 102 (as mentioned above, the revaluation reserve has not been removed for property, plant and equipment carried under the revaluation model in section 17 of the standard). Some accountants are under the impression that new UK GAAP removes the concept of the revaluation reserve in its entirety, and this is not the case.
Net gains on investment property
When an investment property has increased in fair value, the gain is reported in profit or loss (as an operating gain). There are no associated tax implications, although deferred tax must also be brought into account for investment property accounted for at fair value to comply with the requirements in paragraph 29.16 of the standard; hence in respect of a gain, a deferred tax liability would also be recognised.
It should be noted that net gains arising on fair value fluctuations in investment property are not distributable to the shareholders in the form of a dividend. This is because the net gain is not a realised gain for dividend purposes. In order for a gain to be classed as a realised gain, the gain must be readily convertible into cash.
To prevent the company from inappropriately distributing net gains on investment property as a dividend to shareholders, it might be advisable for the company to have a ‘fair value reserve’ within the equity section of the balance sheet in which to take such undistributable reserves.
This article has been produced to clarify the accounting treatments for assets that are carried at fair value or revaluation under the new UK GAAP. Whilst investment property has come in for some considerable change in the accounting treatment under FRS 102, assets which are revalued under section 17 of the standard will still be accounted for in much the same way as in previous UK GAAP, although the frequency of revaluations under section 17 are not as prescriptive as under previous FRS 15.