The transitions to FRS 102 and FRS 105 is currently being undertaken by practitioners acting for small and micro-entities who chose not to early-adopt the new reporting regime.
The feedback so far is generally positive and practitioners seem to be handling the transition well. But it's not without some gripes. A common complaint seems to be around the length of some of the accounting policy disclosures generated by accounts production software systems, but software providers are reminding their customers that these can (and should) be tailored to be client-specific.
For example, it would be meaningless to have a half-page disclosure on assets under hire purchase and finance leases if the client does not have any such assets. Conversely, significant accounting policies which do require disclosure under FRS 102 should be concise and client-specific (i.e. avoiding boiler-plate disclosures). Accounting policies which are generated by the accounts production software system will invariably require some editing for different clients.
This article is the first of two articles and takes a look at some of the more common ‘issues’ faced by practitioners as they transition to ‘new’ UK GAAP and begin to implement FRS 102/105. This first article considers:
- Goodwill amortisation
- Micro-entity disclosures
- Investment property
- Directors’ remuneration
Under FRS 102, it is not possible to assign an indefinite useful life to goodwill. As a consequence, goodwill (and all other intangible fixed assets) must be amortised on a systematic basis over their useful economic lives. Where the directors are unable to assign a reliable useful economic life to goodwill, paragraph 19.23(a) sets a maximum amortisation period of ten years. Care must be taken where this rule is concerned because it is being misapplied in some instances.
Paragraph 19.23(a) of FRS 102 limits the useful economic life to ten years and acknowledges that this will only apply in exceptional cases. Many practitioners have seen the ten-year rule and assumed the standard limits the amortisation period to ten years across the board.
This is not the case. For example, if a client has, say, 15 years left to run for goodwill at the date of transition, this will invariably continue to be the case on transition unless there is evidence that the useful economic life remaining is clearly incorrect.
The ten-year rule in paragraph 19.23(a) will more than likely affect entities that previously did not amortise goodwill due to the directors assigning an indefinite useful life when the company acquired it. If the directors cannot come up with a reliable estimate of the goodwill’s useful economic life on transition, the ten-year rule kicks in and it may be deemed appropriate to amortise the goodwill over a much shorter period than ten years.
FRS 105 currently only requires two types of disclosure for micro-entities:
- Advances, credit and guarantees in respect of the directors
- Financial commitments, guarantees and contingencies
These disclosures are placed at the foot of the micro-entity’s balance sheet. However, there are two additional disclosures required by law in respect of the average number of employees and off-balance sheet arrangements.
These two additional disclosures will be included in FRS 105 as part of the FRC's triennial review. While the amendments to UK GAAP as a result of the triennial review are expected to take effect for periods commencing on or after 1 January 2019, these additional disclosure requirements may have an earlier effective from date as they should already be being disclosed in micro-entity’s financial statements.
Under previous UK GAAP, investment property should have been measured at open market value at each balance sheet date. Changes in the open market value were taken to the revaluation reserve as the alternative accounting rules were being applied.
Under FRS 102, investment property is measured at fair value at each reporting date with changes in fair value going through the profit and loss account as fair value adjustments. The change in accounting treatment is because the fair value accounting rules are being used under FRS 102.
Unlike previous UK GAAP, deferred tax is also brought into account under FRS 102. The deferred tax element is also taken to the profit and loss account as this follows its underlying transaction.
Some practitioners have confirmed that in some cases clients (or themselves) have not previously measured investment property correctly under previous UK GAAP and have, in fact, carried the properties under the historical cost accounting rules and charged depreciation.
This was not correct under previous UK GAAP. That is, unless the property was let to or occupied by a group member as SSAP 19 Accounting for investment properties scoped out properties let to, or occupied by, group members from the open market value measurement requirements.
Under FRS 102, all investment property (properties from which rentals are earned by the entity or which are being held for capital appreciation, or both) are measured at fair value through profit or loss.
While there is an ‘undue cost or effort’ exemption in paragraph 16.1 of FRS 102, it is difficult to justify its use and, in any event, the FRC are proposing to remove this, and many other, undue cost or effort exemptions in FRS 102 as they are being applied incorrectly (it is clear that many entities are applying the undue cost or effort exemptions as accounting policy choices, which they are not).
This incorrect accounting treatment is starting to become a common emerging issue when discussions take place concerning the differences in accounting treatment between old and new UK GAAP for investment property. Practitioners are advised to ensure they have a sound understanding of the rules in Section 16 as otherwise the financial statements will be misleading – and potentially materially misstated.
The requirement to disclose directors’ remuneration and other benefits for small companies was repealed by The Companies, Partnerships and Groups (Accounts and Reports) Regulations 2015 SI 2015/980 and most accounts production software systems default to non-disclosure as it is no longer a legal requirement for small companies to make such a disclosure.
However, it cannot be forgotten about entirely for small companies and, in some cases, it may still be a required disclosure to achieve a true and fair view.
Under FRS 102, Section 1A, paragraph 1AC.35 (which outlines the related party disclosures for a small company), only transactions which have been entered into with related parties that have not been concluded under normal market conditions require disclosure.
For example, if a small entity rents a property to a director and charges a peppercorn rent, rather than a market rent, this will need disclosure as the transaction is not being carried out under normal market conditions.
It is common for small companies to pay directors who are also shareholders a salary up to the PAYE threshold and for the balance of their remuneration to be taken in dividends. Many practitioners agree this is ‘normal market conditions’ although some question the structure of this remuneration and whether a salary up to the PAYE threshold is ‘normal’.
At the moment, there is no clear-cut answer where this situation is concerned. If the directors, or practitioner, considers their remuneration (whichever way it is structured) is not being concluded under normal market conditions, this will trigger a related party disclosure.
On the other hand, if it is considered to be normal market conditions, no related party disclosure will be needed. Most practitioners working with small entities that pay director-shareholders a salary up to the PAYE level with the balance in dividends agree this structure of remuneration is being concluded under normal market conditions, hence no disclosure is made and it is expected this will be the most common practice for small entities.
As is the case with any ‘grey’ area, it is always advisable to document any decisions taken in the event that something is challenged further down the line. One accountant may view the directors’ remuneration is being concluded under normal market conditions, whereas another may take a different view.
This article has considered some of the more common issues raised by firms since FRS 102 and FRS 105 started to be implemented mandatorily from December 2016 year-ends onwards.
Of course, there are many other areas which are causing a number of ‘issues’ for firms and some of these will be considered in the next article. Where there are uncertainties, it is always advisable to seek advice from either your professional body’s technical advisory helpline or a reputable training provider to avoid any errors which may then lead to problems further down the line.
It is also worthwhile downloading a copy of HMRC’s Overview Papers which consider the different accounting treatments and tax implications. A link to these papers is provided here.
About Steven Collings
Steve Collings, FMAAT FCCA is the audit and technical partner at Leavitt Walmsley Associates Ltd where Steve trained and qualified.