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FRS 102 vs FRS 105: How to treat financial instruments

20th Dec 2018
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One big variation between FRS 102 and FRS 105 is in the treatment of financial instruments. James Waller CA sets out the differences.

As with many other areas of FRS 105, the treatment of financial instruments is prescriptive, meaning a significant reduction in the accounting complexity. In contrast, FRS 102 gives a range of options for their treatment. Preparers may use the provisions set out in Section 11 and Section 12, or those set out in either IFRS 9 Financial Instruments or IAS 39 Financial Instruments: Recognition and Measurement. The only proviso for using the international standards is to ensure they comply with FRS 102 disclosure and presentation requirements.

As a result, there are some significant differences with accounting for financial instruments under the two standards – the main one of which is the use of fair value accounting.

Fair value accounting and cost measurements

FRS 102 permits fair value accounting with gains and losses passing through profit or loss, as well as the use of the alternative accounting rules, where gains and losses pass through other comprehensive income. FRS 105 prohibits the use of fair value, only permitting the use of historical cost.

All financial instruments under FRS 105 are therefore measured at cost or amortised cost. Some specific examples are:

  • fixed asset investments are measured at cost less impairment
  • derivatives are measured at the initial cost (often zero) – any transaction price is allocated to profit or loss over the term of the contract
  • other financial instruments are measured using a simplified version of amortised cost

For debt instruments, the amortised cost method is similar to that in FRS 102, although transaction costs are dealt with in a simpler manner:

  • if they are immaterial, they are expensed to profit or loss immediately
  • if they are material, they are added to or deducted from the proceeds of the loan and spread over the life of the loan on a straight-line basis (i.e. no need to calculate an effective interest rate)

The interest rate used is the contracted rate – there is no need to obtain the market rate. This is particularly important when considering related party loans. Under FRS 105, simply the borrowed amount would be recognised. Conversely, under FRS 102 it would be necessary to impute a market rate of interest (except for small companies receiving a loan from a director).

Hedge accounting

Hedge accounting is not permitted under FRS 105. The only exception is where a transaction will be settled at a contracted foreign exchange rate, or a related or matching forward contract is taken out against a transaction. In these cases, the contracted rate should be used to translate the transaction rather than the spot rate – similar to the ‘synthetic hedging’ option in old UK GAAP.

For more information on accounting for financial instruments, see the Financial Instruments Guide and Applying GAAP, available in Croner-i accounting and audit products. Visit www.croneri.co.uk for more information.

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