FRS 102: Are you ready?
Current Issues | Financial services | 2nd October 2015
A big change is looming for financial reporting standards in the UK. From 1 January 2015, the Financial Reporting Standards under UK GAAP was replaced with Financial Reporting Standard 102 (FRS 102). This means that if your accounting year runs to 31 December, you will be the first to be caught by it with the 31 December 2015 accounts.
There are some significant changes to the way certain transactions are handled so we have included below a summary of the key changes. We stress that this is not a substitute for reading the full standards and professional advice should be sought before any implementation.
FRS 102 applies to entities (companies and LLPs) which currently report under UK GAAP and are not reporting under Financial Reporting Standards for Smaller Entities (FRSSE).
Entities which qualify as small have the option to report under FRSSE, and the current version is FRSSE 2008. This was replaced with a slightly updated version from 1 January 2015, called FRSSE 2015. This means that FRS 102 and FRSSE 2015 are initially running in parallel.
It is envisaged, however, that this will only be in effect for one year, after which FRSSE 2015 will no longer be available and smaller companies will be brought into the scope of FRS 102 under a reduced disclosure version. We have summarised the key changes under FRS 102 below:
Cash flow statements
Currently a cash flow statement is required to have several headings, with certain items split out on the face of the cash flow statement (for example, dividends, taxation, acquisitions and disposals, etc.)
Under FRS 102, there are only three headings on the cash flow statement:
- Operating Activities
- Investment Activities
- Financing Activities.
The ‘Operating Activities’heading encompasses many of the items which would previously have been split out.
This has been around in the existing standards for some time, but FRS 102 requires its calculation for the following new situations which were previously exempt:
- Revaluations of non-monetary assets (including investment property)
Where an investment property has been revalued there is a potential timing difference on the gain which is subject to corporation tax. Therefore deferred tax should be accounted for on this difference.
- Fair values in business combinations
In a similar vein to the above, where assets in a business combination have been revalued, there will be a potential deferred tax liability and this should be accounted for.
- Unremitted earnings in overseas subsidiaries and associates
This will apply to income which the UK entity is entitled to, but has yet to receive. Assuming this income will be taxable once received, then there will be a potential deferred tax liability in relation to these amounts.
The new rules around holiday pay accruals are likely to apply to a large number of businesses. Where employees are entitled to carry holiday forward, or if the holiday year is not coterminous with the accounting year, the situation may arise where employees have unused holiday at the year-end. In this situation, an accrual for the value of that holiday pay is required. Firms can limit the effect of this by changing their holiday year to match the accounting year, and if deemed appropriate, stopping unused holiday being carried forward.
Fair value accounting
A large portion of FRS 102 is built around the concept of fair value accounting. These rules come into play for business combinations, investments, fixed assets and financial instruments. So if your business has any of these you may be affected by the new rules:
- Business combinations
Where intangible assets are acquired and where their values can be reliably measured, they must be split out and recognised separately from goodwill. This may mean they are then amortised over a different period to the remaining goodwill.
- Financial instruments
If your business holds instruments such as equity shares or derivatives, which can be reliably measured, they must be shown at fair value with the difference going to profit and loss. This would include foreign currency contracts for example. Financial instruments such as trade debtors, trade creditors and cash are considered to be ‘basic financial instruments’ and are treated the same as they are currently. The difference between old UK GAAP and FRS 102 is now financial instruments not considered basic may need to be recognised on the balance sheet, where they weren’t before. This includes items such as foreign currency contracts which now need to be held at fair value. Loans with a fixed repayment date also need to be accounted for differently and should be held at amortised cost rather than at the total amount outstanding. This means using the ‘effective interest method’ and a deemed cost of capital in order to arrive at amortised cost.
You now have the option to hold investments in subsidiaries, associates or joint ventures at either cost less impairment, or at fair value with changes going through either the profit and loss or other comprehensive income. Equity accounting can also now be used for investments in associates. This is where the change in net assets the investor is entitled to is recognised in the adjustment to value.
- Tangible fixed assets
These can either continue to be treated as they usually are (at cost less depreciation) or held at fair value and revalued each year. On transition to FRS 102 for small entities, an entity is allowed to use fair value as deemed cost then choose the cost model for subsequent measurement.
Goodwill and intangible assets
Intangible assets and goodwill should be written off over their useful economic life where this can be reliably estimated. Where the UEL cannot be reliably estimated the directors should choose a period which does not exceed ten years. Note that in the original draft of FRS 102 this was five years, and FRSSE 2015 has a maximum of five years, so the two standards differ in this respect.
Computer software was sometimes regarded as a tangible fixed asset under the old rules. It is likely that under FRS 102 this will be shown as an intangible fixed asset and therefore need separating out.
Where the value can be reliably measured, investment property should be carried at fair value (rather than cost) with changes going through the profit and loss. Under old UK GAAP this could be held at fair value with changes going through the revaluation reserve. FRS 102 removes the revaluation reserve and all changes in value are taken to the profit and loss.
However, it is important to note that any gains are not allowed to be distributed as a dividend as they remain unrealised. Therefore, the portion of the profit and loss reserve relating to un-distributable and distributable income will need to be kept track of. Upon transition to FRS 102 any revaluation reserve is moved into the profit and loss reserve.
If you have property let to and occupied by another group entity, under the current rules this is specifically excluded from the definition of investment properties. Under FRS 102, no such exemption exists so certain properties previously treated as fixed assets will now be classified as investment property.
Often leases will be granted with an incentive such as a reduced rent period or a rent free period. Current accounting treatment requires this discount to be spread over the period up until the first rent review or break clause. Under FRS 102, the incentive is spread over the entire lease term. This means that if a break clause is exercised then there will be an adjustment in that year.
Prior period adjustments
Under current UK GAAP a prior period adjustment is made only for ‘fundamental errors’. These are defined as those which ‘destroy the true and fair view’. Under FRS 102 a prior period adjustment should be made for ‘material’ errors. While there is no set in stone definition of these, it is likely that we will see more prior period adjustments under FRS 102.
FRS 102 allows the use of this in certain situations. If a business uses a foreign exchange contract, for example, to hedge against future cash flows on a sale in foreign currency, hedge accounting can be used.
Under the old rules, if you had a hedging instrument (such as a foreign exchange contract) which was matched to a particular hedged item (like a foreign currency sale) you could opt to just account for the sale at the rate of the exchange contract.
Under the new rules, the instrument needs to be separately accounted for. You may have a gain on the instrument, and a loss on the hedged item. If you use hedge accounting these gains and losses can be moved out of the P&L account and into Other Comprehensive income. This all ends up in the P&L reserve but some companies are opting to separate out the P&L reserve into a ‘cashflow hedge reserve’. Alternatively, if you don’t choose hedge accounting all the volatility goes through the P&L.
Under the new FRS 102 rules for small companies you only need to disclose related parties on non-commercial transactions (i.e. those not at arm’s length). Whether dividends to directors are included within this is still up for debate. Note this does not affect medium-sized FRS 102 entities.
The above is a summary of some of the key changes under FRS 102 and businesses should be considering how the changes will affect their financial reporting. Some of these items (such as deferred tax) will only likely affect the year-end financial statements, where others (such as lease incentives) could affect management accounts. Depending on your desire to have as few differences between management accounts and year-end statutory accounts as possible, you may wish to change the way certain things are accounted for during the year as well. There are certain transition rules and depending on your entity’s situation there may be a reconciliation within the first set of FRS 102 accounts showing the movement from UK GAAP to the new rules.
Specific advice should be obtained before taking action, or refraining from taking action, on any of the subjects covered above. If you would like advice or further information, please speak to your usual Shipleys contact.