The new UK GAAP The Financial Reporting Standard for small and micro-entities.

ICAEW
The new UK GAAP
Exploring the challenges presented by FRS 102 The Financial Reporting Standard
applicable in the UK and Republic of Ireland and the new financial reporting regime
for small and micro-entities.
Volume 2
BUSINESS WITH CONFIDENCEicaew.com
Author biographies
Sarah Dunn ACA
Sarah is a Technical Manager in the Financial Reporting Faculty (FRF). Her responsibilities
include preparing ICAEW responses to consultations on financial reporting matters.
Before joining ICAEW in 2013 Sarah worked within the quality assurance and technical
team at Baker Tilly International, conducting quality assurance reviews across the globe
and providing technical support to member firms.
Eddy James FCA
Eddy is a Technical Manager in the FRF. He qualified with KPMG and has extensive
experience of writing and presenting professional development courses on a wide range
of subjects including IFRS, UK GAAP and US GAAP. Eddy is a member of the Financial
Reporting Council’s UK GAAP Technical Advisory Group. He is the co-author of ICAEW’s
Publications The Future of IFRS (2012) and Moving to IFRS reporting; Seven lessons learned
from the European experience (2015).
Marianne Mau FCA
Marianne is a Technical Manager in the FRF. Her responsibilities include keeping members
up to date on changes in financial reporting. Marianne qualified with BDO and before
joining ICAEW she was a presenter at BPP Professional Education, developing and
delivering training in IFRS and UK GAAP.
Dr Nigel Sleigh-Johnson FCA
Nigel is Head of the FRF. He has responsibility for overseeing the development of ICAEW
policy on financial and non-financial reporting issues. He is co-author of ICAEW’s
publications The Future of IFRS (2012) and Moving to IFRS reporting; Seven lessons learned
from the European experience (2015). Since 2014 Nigel has been a member of the
Department for Business Innovation & Skills’ expert working group on UK company law,
the Accounting Directive Stakeholder Group, and the FEE Taskforce on SME accounting.
Danielle Stewart OBE FCA FCCA
Danielle is a member of the faculty board and is Head of Financial Reporting at RSM.
She is deeply involved in the ongoing development of financial reporting in the UK, as
a founding member of the Financial Reporting Council’s UK GAAP Technical Advisory
Group, and in Europe, where she is a member of the European Financial Reporting
Advisory Group’s SME committee.
02
THE NEW UK GAAP
Introduction
UK GAAP IS CHANGING
FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland is
the cornerstone of a new financial reporting regime that represents the most significant
change to UK GAAP in a generation.
FRS 102 became effective from 1 January 2015 and was revised to bring small entities
within its scope with effect from 1 January 2016. The Financial Reporting Standard
for Smaller Entities (FRSSE) has consequently been withdrawn for accounting periods
beginning on or after 1 January 2016. Once these latest changes come into effect,
FRS 102 will be used by the majority of unlisted UK entities with the exception of
companies that take advantage of a new simplified regime for micro-entities. This
standard differs in many ways from ‘old’ UK GAAP and each reporting entity will need to
assess these differences carefully and determine their impact.
In a series of short articles first published in 2015 in Practicewire, ICAEW’s electronic news
bulletin for sole and small practitioners, staff and committee members of the Financial
Reporting Faculty outlined their views on some of the initial challenges reporting entities
face when seeking to apply FRS 102 for the first time. These articles are reproduced
below, as originally published. They were written primarily with practitioners in mind,
although many of the issues raised will be of common concern.
A first volume of articles published in 2014 is also available.
THE FINANCIAL REPORTING FACULTY
The Financial Reporting Faculty is committed to providing high quality, practical help to
ICAEW members and others navigating today’s complex world of financial reporting.
The faculty provides a range of resources on UK GAAP and IFRS reporting, including
practical factsheets, FAQs and webinars. All the resources can be found on the dedicated
section of ICAEW’s website at icaew.com/newukgaap. The faculty is also working with
ICAEW’s Technical Enquiries Services to expand the range of TES helpsheets available on
the new UK GAAP.
We hope that you find this second compendium useful. It is available online and, on
request, in hardcopy (from [email protected]).
Dr Nigel Sleigh-Johnson
Head of Faculty
December 2015
THE NEW UK GAAP
03
Contents
The new UK GAAP: intercompany loans
05
Accounting for forward contracts under the new GAAP
07
New UK GAAP and distributable profits: what your clients need to know
10
The revised UK small companies regime
12
The new financial reporting framework for small and micro entities
14
FRS 102 Exceptions and exemptions from retrospective application
15
Presenting accounts under FRS 102
17
04
THE NEW UK GAAP
The new UK GAAP: intercompany loans
Eddy James explains that care will be needed when accounting for intercompany loans
under the new regime
Intercompany loans and how to account for them under the new UK GAAP has turned into something of a hot topic. What
started as a trickle of enquiries a few months ago has turned into quite a deluge in recent weeks. In an attempt to stem the
tide, this article and two new ICAEW helpsheets address some of the most commonly asked questions.
Loans at non-market rates
Many intercompany loans are likely to be basic financial instruments. As such they will generally be measured at amortised
cost. This means that on initial recognition they will be measured at the present value of the future payments, discounted
at the market rate of interest for a similar debt instrument. Interest will then be recognised in profit or loss as the discount
unwinds over the life of the loan.
This will mean that a fixed-term loan with a zero or below market interest rate will be recorded on initial recognition at less
than its nominal amount. The difference between the amount initially recognised and the amount payable on the maturity of
the loan will be recognised directly in equity, as a transaction with owners.
Our understanding is that, if the loan is from the parent to the subsidiary, this difference would be treated as a capital
contribution, whereas if the loan was from the subsidiary to the parent it would be treated as a distribution. For loans between
subsidiaries, which are presumably at the behest of the parent, the difference would be treated as a distribution by the lender
and a capital contribution by the borrower.
Loans with no fixed term
The terms of many intercompany loan agreements are, of course, not formally or thoroughly documented. In such cases it
is likely that the loan will be classified as being repayable on demand and measured at cost. However, it would be wrong to
automatically assume that this is always the case, as even if the terms are not formally documented they may be evidenced
elsewhere. They could, for example, be recorded in a board minute.
The agreement between the two parties doesn’t even have to be in writing, but it will help if it is. Without written evidence it
is going to be hard to demonstrate what the agreed terms and conditions are and, consequently, it is likely that the loan will
be considered to be repayable on demand and classified as a current liability in the financial statements of the borrower.
I’d therefore recommend that the terms of all intercompany loans are clearly documented whenever possible. If loans are to be
classified as non-current liabilities, auditors will typically expect to see that an agreement clearly establishing payment terms of
more than one year or a notice period for payment of more than one year is in place before the year end.
The impact on the going concern assessment
In my view, intercompany loans that are repayable on demand should always have been recognised as current liabilities under
existing UK GAAP. But this certainly wasn’t always the case, and the thought of reclassifying them from non-current to current
liabilities will fill some with dread as it will make their balance sheets look much weaker. Some have even questioned whether
this will affect the going concern assessment.
However, we need to be careful here, as the parent company’s entitlement to call in the loan within 12 months and its
willingness to exercise its entitlement are two different things. A parent company may be able to request immediate
repayment but may choose not to do so. In assessing whether or not the subsidiary is a going concern, the auditor’s
assessment of the likelihood of the parent seeking repayment could be crucial.
If the parent formally defers repayment, then the accounting classification will change and the loan will be classified as noncurrent and measured at amortised cost. However, if the parent simply confirms a willingness to wait for repayment, then the
subsidiary’s directors and auditors have to make a judgement as to the likelihood of the parent keeping its promise - and the
implications for the subsidiary’s ability to continue if it does not.
Ultimately, I do not think that it is incongruous for a debt to be shown as current while the going concern note indicates a
more forbearing approach to payment.
THE NEW UK GAAP
05
Conclusions
There is much to consider when it comes to intercompany loans and the standard is sometimes rather opaque about what the
appropriate accounting treatment should be. Best practice solutions are starting to emerge and these are reflected above, but
thinking may continue to evolve. It is hoped however that this article will help shine some light into what, for many, remains
something of a murky area of accounting.
06
THE NEW UK GAAP
Accounting for forward contracts under
the new GAAP
Marianne Mau highlights important changes to the way we account for forward contracts
under the new UK GAAP
As has been discussed in recent articles on FRS 102, it isn’t safe to assume that smaller businesses will be unaffected by the
more complex accounting requirements for financial instruments on the basis that their financing arrangements are usually
straightforward. Among small businesses, the use of forward contracts, particularly foreign currency forward contracts, is a
reasonably common-place method of managing risk.
Managing risks using forward contracts
Any business buying or selling goods in a foreign currency may well want to manage the risk of foreign currency fluctuations,
and to mitigate the impact of those fluctuations on the cash flows and reported earnings of the entity. This can be achieved by
entering into an arrangement to buy or sell the foreign currency at an agreed future rate, matching the date that the foreign
currency is expected to be paid out or received.
These arrangements would usually be made with the bank, and each contract may be linked to a specific transaction, but
equally there could be a number of contracts to cover a pool of transactions.
Accounting under SSAP 20
For those companies applying UK GAAP and not previously adopting FRS 23 The Effects of Changes in Foreign Exchange Rates
(ie, the vast majority of UK companies), SSAP 20 Foreign currency translation provided the option of translating a transaction
at the rate ruling at the date the transaction occurred or at a matching forward contract rate. If the forward rate is used, no
exchange gains or losses are recognised in the accounts when recording the sale and eventual settlement.
The majority of entities take this approach when forward contracts are used.
Illustrative example under SSAP 20
Brit Ltd has a 30 June year end. On 1 June 2015, Brit Ltd sells goods to ASU Inc for $100,000 on three months credit ie, for
settlement on 1 September 2015. On 1 June 2015 Brit Ltd also enters into a forward contract to sell $100,000 on 1 September
2015 at a forward rate of £1:$1.62.
ASU Inc paid Brit Ltd on 1 September in full.
The £ to $ exchange rates are as follows:
Date
Spot rate
Forward rate
1.60
1.62
30 June 2015
1.57
1.59
1 September 2015
1.55
-
1 June 2015
Assuming that Brit Ltd applies the forward rate to the transaction, the accounting entries would be as below.
As at 1 June 2015, the date of the transaction:
DR (£)
Debtors
CR (£)
61,728
Sales
61,728
To record the sale of $100,000 at the forward rate of £1:$1.62
At 30 June 2015, the balance sheet date, no translation of the debtor is required as the forward rate has been used.
THE NEW UK GAAP
07
As at 1 September 2015, the date of settlement:
DR (£)
Cash
CR (£)
61,728
Debtors
61,728
To record the receipt of $100,000 at the forward rate of £1:$1.62
No exchange differences arise as the sale of the goods in a foreign currency and the forward contract are effectively treated as
one transaction. The rate of £1:$1.62 is used throughout.
Accounting treatment under FRS 102
FRS 102 takes a somewhat different approach, treating the sale and the forward contract as two separate transactions.
Section 30 Foreign Currency Translation requires foreign currency transactions (eg, the buying or selling of goods and services
in a foreign currency) to be recorded at the spot rate at the date of the transaction, and monetary items to be translated using
the closing rate at the balance sheet date. There is no option to use a forward rate. Any exchange differences arising at the
balance sheet date or on settlement are recognised in profit or loss.
Forward currency contracts will fall into the other financial instruments classification in FRS 102 and will therefore be
accounted for in accordance with Section 12 Other Financial Instruments Issues. Section 12 requires that the derivative contract
be recognised at fair value on initial recognition (which will usually be zero for forward currency contracts), and again at the
balance sheet date. Any changes in fair value are generally recognised in profit or loss. When foreign currency contracts are
part of a qualifying hedging arrangement they may be accounted for in accordance with the hedge accounting rules (see
below).
Illustrative example FRS 102
Using the same information as above, the accounting entries would be as below.
As at 1 June 2015, the date of the transaction:
DR (£)
Debtors
CR (£)
62,500
Sale
62,500
To record the sale of $100,000 at the spot rate of £1:$1.60
There will be no accounting entries for the forward foreign currency contract as its fair value is zero.
As at 30 June 2015, the balance sheet date:
DR (£)
Debtors
CR (£)
1,194
Exchange gain (P&L)
1,194
To retranslate the debtor of $100,000 at the year-end spot rate of £1:$1.57
Loss on derivative (P&L)
Derivative liability
1,165
1,165
To value the derivative at the year-end fair value (the difference between the agreed forward rate and the forward rate at the
balance sheet date for a contract maturing on 1 September 2015)
The impact of the exchange rates on the value of the debtor and the derivative almost cancel each other out, recognising the
effectiveness of the hedge. The difference between the gain on the debtor on the one hand and the loss on the derivative on
the other is attributable to the spot rate being used for debtor and the forward rate for the derivative.
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THE NEW UK GAAP
As at 1 September 2015, the date of settlement:
DR (£)
Debtors
CR (£)
822
Exchange gain (P&L)
822
To retranslate the debtor of $100,000 at the spot rate on settlement £1:$1.55
Loss on derivative (P&L)
1,623
Derivative liability
1,623
To value the derivative to fair value at settlement date (the difference between the forward rate at the previous balance sheet
date and the spot rate on 1 September 2015)
Cash
Derivative liability
61,728
2,788
Debtors
64,516
To record the settlement of the debtor and the derivative contract
Although it may be difficult to see at first glance, the overall impact on the P&L account over the life of the transaction is the
same. However, there may be differences year on year. This can be summarised as follows:
SSAP 20 (£)
1 June 2015
Sales
30 June 2015
Exchange gain on debtor
Exchange loss on derivative
61,728
-
1 September 2015
Exchange gain on debtor
Exchange loss on derivative
Total
FRS 102 (£)
62,500
1,194
(1,165)
822
(1,623)
61,728
61,728
Hedge accounting
When forward currency contracts are entered into to cover cash flows on foreign currency sales or purchases that have already
occurred (as in the illustrative examples above), there is no need to apply the special hedge accounting rules available in
FRS 102. This is because the differences arising on the hedged item (in this case the debtor) and the hedging instrument (in
this case the forward currency contract) are both recognised in profit or loss. Where forward contracts are used to cover future
highly probable foreign currency sales or purchases, then hedge accounting may be appropriate.
As these contracts are less common for small businesses, these are not considered further in this article. THE NEW UK GAAP
09
New UK GAAP and distributable profits: what
your clients need to know
Danielle Stewart explains that the new UK GAAP could affect your distributable profits
Any article on distributable profits has to start by pointing out that ICAEW’s definitive technical release, TECH 02/10 Guidance
on the determination of realised profits and losses in the context of distributions under the companies act 2006, is still the ‘go to’
guidance on this subject. This article will consider some of the potential impact of FRS 102 on the distributable profits of the
type of company typically encountered by small practitioners, against the backdrop of the well-established approach set out in
TECH 02/10 (see also the article on FRS 102 exceptions and exemptions below).
Investment property
Under FRS 102, fair value movements on investment property are recognised in the profit and loss account, rather than going
to a revaluation reserve as required by ‘old’ UK GAAP. This might lead you to think that they are realised profits available for
distribution; in fact they are not. Fair value accounting profits can only be classified as realised if they are ‘readily convertible
into cash’, which means that the entity has an unrestricted ability to convert the asset to cash virtually instantaneously at the
balance sheet date.
Fair value profits on investment properties are clearly not readily convertible into cash, and as such the fair value gains are not
realised profits. In light of this, it can be useful to have these gains separately identified; therefore you might want to transfer
fair value movements on investment properties out of retained earnings, into a separate subset of the P&L reserve, marked as
a non-distributable reserve.
Lease incentives
Under old UK GAAP, lease incentives were spread over the shorter of the lease term and the period until the next rent review
or break clause. Under FRS 102, the correct treatment is to spread the incentive over the entire lease term, which for these
purposes is the non-cancellable period for which the lessee has contracted to lease the asset, together with any further terms
for which the lessee has an option to continue to lease when, at the inception of the lease, it is reasonably certain that the
lessee will exercise that option.
There is, however, a transitional exemption allowing the entity not to restate the treatment of lease incentives existing at the
date of transition. This choice is available on a lease by lease basis.
All accounting adjustments connected with this do impact on distributable profits. If the entity applies FRS 102 retrospectively,
the impact is net of any tax effect.
Goodwill
Under FRS 102, goodwill has a finite useful life and is amortised on a systematic basis over its life. In the exceptional
circumstances where an entity is unable to make a reliable estimate of the useful life of goodwill, its life shall not exceed ten
years. This is significantly different from old UK GAAP which presumes a maximum useful life of 20 years but allows longer or
indefinite lives in some circumstances.
Any changes to the goodwill amortisation period will impact on distributable reserves, both as a result of any transition
adjustments where the useful economic life changes, and also in terms of the amortisation itself reducing distributable profits in the
future. Only goodwill in individual financial statements has an effect on distributable profits – consolidation adjustments never do.
Derivatives
Under old UK GAAP it was possible to choose between recognising the fair values of derivatives in the balance sheet, with
movements going to the profit and loss account, or simply disclosing their fair values in the notes to the accounts. Most
entities took the latter option.
Derivatives include interest rate swaps, forward commodity and currency contracts and interest rate caps or collars. Under
FRS 102, these derivatives, with a few specific exceptions, must always be brought onto the balance sheet and fair valued
with gains and losses recognised in profit and loss. As already mentioned above, profits or losses arising from the use of fair
value accounting, where the movement is readily convertible to cash ie, capable of being closed out or settled, are treated as
realised. Every derivative will need to be considered separately in this context, but surprisingly the answer is often that the fair
value gain or loss will be treated as realised. For example, the contract or risk position in relation to a typical ‘vanilla’ interest
rate swap can be offset in the market and it is normal market practice to do so, as the swap is valued using only observable
market data and could be closed out immediately. Any profit or loss on re-measurement is therefore a realised profit or loss.
This can have an enormous impact on distributable reserves, and is likely to cause some traps for the unwary.
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THE NEW UK GAAP
Deferred tax
The way deferred tax is calculated under FRS 102 is often referred to as a ‘timing differences plus’ approach, which is a
combination of both balance sheet and P&L driven, whereas the old UK GAAP approach was much more P&L driven. This has
the effect that more deferred tax will typically be recognised under FRS 102 than in the past. For example, additional deferred
tax will need to be recognised on revaluations of property, plant and equipment and investment properties.
The distributable profit impact of deferred tax normally follows the treatment of the gain or loss to which it relates.
Accordingly when assets are revalued to their fair value and the gain is regarded as unrealised, the deferred tax on that gain
should be treated as a reduction in that unrealised gain rather than as a realised loss.
Conclusion
The effect of the changes to UK GAAP arising from FRS 102 on distributable profits are quite complicated, but once you
understand and master the concepts involved, it should not present you or your clients with any significant difficulties.
THE NEW UK GAAP
11
The revised UK small companies regime
Sarah Dunn explains how recent changes to company law will affect small companies in
the UK
In March 2015 the UK Government approved new regulations that implement the requirements of the new EU Accounting
Directive into UK company law. While the changes introduced by the regulations are wide ranging, some of the most
significant relate to the small companies regime. An overview of these changes is provided below.
Revised size and eligibility criteria
The regulations increase the small company accounting thresholds. An eligible company will now qualify as small if it meets at
least two out of three of:
• turnover: not more than £10.2m (previously £6.5m);
• balance sheet total: not more than £5.1m (previously £3.26m); and
• average number of employees: not more than 50 (no change).
The eligibility criteria for small companies have also changed slightly with a revised definition of an ineligible group. Under
the new rules, a group is no longer ineligible solely because a public company is a member. Instead, this condition has been
replaced with a reference to a traded company. This will be important for a few companies.
Reduced information in small company accounts
The Accounting Directive restricts the information that can be required by member states in small company accounts. Those
restrictions are reflected in the requirements for small companies in FRS 102, as discussed below.
However, there is no change to the requirement for those accounts to show a true and fair view. Thus, directors will need to
consider carefully whether further disclosures, over and above those specifically required in FRS 102, may be required in order
for those accounts to show a true and fair view.
New option to prepare abridged accounts
The UK regulations also introduce greater flexibility in the formats of small company accounts. In particular, small companies
(excluding charities) will have the option to prepare for members abridged (rather than full) accounts. Small companies will be
able to choose to abridge the balance sheet, the profit and loss account, or both.
If choosing to abridge the accounts (whatever the combination), the directors will need to obtain approval by each and every
shareholder each year.
Withdrawal of abbreviated accounts
For accounts prepared in accordance with the new regulations there will no longer be an option for small companies to file an
abbreviated version of their full accounts at Companies House.
This means that, generally speaking, small companies will be required to file the version of the accounts as prepared for the
members. However, small companies will still have the option, regardless of whether the accounts prepared for members are
full or abridged, not to file the profit and loss account and/or the directors’ report at Companies House. If choosing not to file
the profit and loss account, specific information regarding the audit report will now need to be disclosed in the notes in the
filed accounts.
If a small company chooses to abridge the balance sheet and/or the profit and loss account, it will also be required to deliver
to Companies House a statement that all the members consented to the abridgement.
Interaction with UK accounting standards
In light of the changes to UK company law, the Financial Reporting Council has revisited UK accounting standards and in July
2015 published a new financial reporting framework for small and micro-entities.
The key changes to the standards include: the withdrawal of the FRSSE, with smaller entities brought within the scope of
FRS 102; a separate section in FRS 102 outlining the different presentation and disclosure requirements for such companies;
and a new standard (FRS 105) for companies eligible for and choosing to apply the micro-entities regime.
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THE NEW UK GAAP
Effective dates
The changes to company law outlined above, are effective for financial years beginning on or after 1 January 2016, with
early adoption permitted for financial years beginning on or after 1 January 2015. However, it is important to note that the
increased size limits cannot be early adopted for the purpose of audit exemption.
The changes to UK accounting standards also come into effect for financial years beginning on or after 1 January 2016. Early
adoption of FRS 105 is permitted. Early adoption of revised FRS 102 is permitted for financial years beginning on or after
1 January 2015. However, a small company choosing to early adopt revised FRS 102 must also early adopt the changes to UK
company law, and vice versa.
THE NEW UK GAAP
13
The new financial reporting framework for small
and micro entities
Sarah Dunn explains the new and revised UK accounting standards for small and micro
entities
This summer the Financial Reporting Council (FRC) issued a new financial reporting framework for small and micro entities.
But why more change so soon after the introduction of the new UK GAAP?
The simple answer is that recent changes to UK company law arising from a new EU Accounting Directive obliged the FRC to
revisit UK accounting standards to align them with the new legislation. As noted in my previous article, The revised UK small
companies regime, the changes to UK company law are significant, particularly in relation to the UK small companies regime.
Therefore some amendments to the standards were inevitable. However, the FRC also took the opportunity to carry out a more
extensive review of the small and micro entities financial reporting framework within the context of the new UK GAAP regime.
Some of the key features of the new regime for small and micro entities are discussed below.
Small entities
Under the new framework, the FRSSE is withdrawn, with small entities brought within the scope of FRS 102. This means
that all entities (excluding IFRS reporters and those that opt-in to the micros regime) will now apply a single up-to-date,
internationally-aligned UK standard.
There are no simplifications to the recognition and measurement requirements of FRS 102 for small entities. However, as
the new Directive restricts the information that can be required in small company accounts, a new section (Section 1A Small
Entities) has been added to FRS 102, setting out the different presentation and disclosure requirements applicable to such
companies. This new section will apply to both small companies applying the small companies regime and certain other
entities that would have met the criteria for the small companies regime had they been companies.
Despite the legal restriction on the information that can be mandated in small company accounts, those accounts must still
give a true and fair view. Directors will therefore need to apply their judgement when considering whether further disclosures,
over and above those specifically required by Section 1A of FRS 102, may also be needed in order for the accounts to show a
true and fair view. There is some guidance in the revised standard on this issue.
Micro-entities
The FRC has also issued a new standard, FRS 105 The Financial Reporting Standard applicable to the Micro-entities Regime, for use
by eligible companies choosing to apply the micro-entities regime.
The new standard is based on the recognition and measurement requirements of FRS 102, amended to comply with the legal
framework for micro-entities. For example, amendments have been made to accommodate the fact that the micro-entities
regime does not permit the revaluation or subsequent measurement of assets or liabilities at fair value. FRS 105 also reflects
the fact that very limited disclosures are required in micro-entity accounts.
Further simplifications have been made by the FRC that go beyond those required to comply with the law. These are
significant. For example, there is no requirement to account for deferred tax or for equity-settled share-based payments prior
to the issue of shares, and there are no accounting policy options.
Effective date
The new and revised standards come into effect for financial years beginning on or after 1 January 2016. Early adoption of
FRS 105 is permitted. Early adoption of revised FRS 102 is permitted for financial years beginning on or after 1 January 2015.
However, a small company choosing to early adopt revised FRS 102 must also early adopt the changes to UK company law,
and vice versa.
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THE NEW UK GAAP
FRS 102 Exceptions and exemptions from
retrospective application
Marianne Mau highlights some of the key exceptions and exemptions from full
retrospective application that are available on first-time adoption of FRS 102
We’re all familiar with the requirement to restate prior periods pretty much whenever there is a change in accounting policy in
order to ensure consistency in the way financial information is presented in the accounts. Therefore it should come as no great
surprise to hear that generally we need to apply retrospectively accounting policies changes that arise on first-time application
of FRS 102.
However, FRS 102 recognises that full retrospective application isn’t always practicable or, in some cases, desirable. Therefore
Section 35 Transition to this FRS sets out a list of exceptions to and exemptions from the normal rules that are available on
first-time adoption. In general, these exceptions and exemptions apply only for those transactions that took place before an
entity’s transition date. Transactions that take place on or after the transition date, including those arising in the comparative
period, should be accounted for in accordance with the general requirements of FRS 102.
Exceptions to retrospective application
There are four instances when FRS 102 prohibits full retrospective application of the requirements of the standard. These are:
• accounting estimates, which cannot be restated unless there is objective evidence that those estimates were in error;
• financial assets and financial liabilities derecognised before the transition date under old UK GAAP, which cannot be
recognised on adoption of FRS 102;
• measurement of non-controlling (minority) interests, which needs to be consistent with the accounting treatment of the
related business combination (see below); and
• discontinued operations.
Exemptions from retrospective application
FRS 102 lists 181 optional exemptions that can be selected on an individual basis. These exemptions are available to make the
process of transition easier, and could have a significant impact on the balance sheet, opening reserves and future reported
earnings, depending on the circumstances of the business.
Below we consider the exemptions most likely to be of general interest, but first-time adopters should familiarise themselves
with all of the exemptions to make sure that they are getting the maximum benefit from the choices available.
Deemed cost
In certain circumstances the carrying amount under old UK GAAP may be used as a surrogate amount for cost or depreciated
cost at the transition date, for example deferred development costs. This exemption can be useful as it avoids having to assess
whether any development costs capitalised under SSAP 13 Accounting for Research and Development meet the recognition
requirements under FRS 102.
There are also cases when a fair value or revalued amount can be used, for example for property, plant and equipment. This
can be particularly useful when a company has previously carried a property, say, at a revalued amount, but doesn’t wish
to continue with a policy of revaluation. Alternatively, a company can use fair value at the date of transition as a one off
revaluation. This might provide a useful boost to the balance sheet without giving rise to a commitment to keep the valuations
up to date.
Business combinations
FRS 102 requires acquisition accounting for almost all business combinations in its scope, with merger accounting not usually
permitted. The standard also has very specific requirements regarding the identification and measurement of a subsidiary’s
assets and liabilities at acquisition. However, a first-time adopter of FRS 102 may elect not to apply Section 19 Business
Combinations retrospectively to business combinations that occurred prior to the transition date.
This exemption is likely to prove popular, as it avoids having to establish fair values for assets and liabilities in accordance with
FRS 102 for business combinations, which may well have taken place some time ago.
If the option not to restate is selected, there must be no adjustment to the carrying value of goodwill on transition.
1 FRS 102 (August 2014) has 18 exemptions available on transition for accounting periods beginning on or after 1 January 2015. The latest edition of FRS 102 (September 2015), which
is applicable for accounting periods beginning on or after 1 January 2016, includes two further exemptions which are available only to entities eligible and choosing to adopt the small
company regime.
THE NEW UK GAAP
15
Lease incentives
Under FRS 102, lease incentives have to be allocated over the entire lease period, not just the period to the first rent review.
This could be a significantly longer period than at present and so the profit and loss impact could be significantly different
(see the previous Practicewire article in Volume 1 The new UK GAAP: why lease incentives will be spread more thinly under the new
regime).
When a lease containing an incentive clause is already in place at the date of transition to FRS 102, the entity can choose, on a
lease by lease basis, whether to retain its existing allocation over the period to the rent review, or restate its figures to spread
the incentive over the entire lease period. The choice could have a significant impact on reported earnings, and has knock-on
implications for tax and distributable profits. Therefore this warrants careful consideration.
Financial instruments – hedging
Accounting for financial instruments is more complex under FRS 102, but there are few exemptions available.2
As noted in earlier articles, derivative contracts, such as interest rate swaps or forward foreign currency contracts, are usually
recognised at fair value through profit or loss. However, if the derivative contract is part of a hedging arrangement, then
hedge accounting may be available subject to certain conditions being met. Full retrospective application would require all
the conditions to be met at the date of transition for any hedging transaction entered into prior to that date. However, the
transitional exemptions permit the documentation supporting the hedging arrangement, which would otherwise need to
be available at the date of transition, to be in place no later than the date that the first set of FRS 102 financial statements are
authorised for issue. This could be up to 33 months after the transition date.
Don’t forget to look at the detail within Section 35!
There is more detail to consider within Section 35 of FRS 102, both in terms of additional exemptions available and how
the exceptions and exemptions should be applied. This article provides only an overview of the numerous provisions in the
standard that may make for a less challenging transition to the new regime.
2 Two further exemptions have been introduced in the amendments to FRS 102 published in July 2015. However, these are only available to small entities eligible for and choosing to
apply the small company regime and are effective for accounting periods beginning on or after 1 January 2016, with early adoption possible subject to certain conditions. These are
not considered further in this article.
16
THE NEW UK GAAP
Presenting accounts under FRS 102
Sarah Dunn explains how the appearance of financial statements will differ under FRS 102
Although the new UK GAAP regime became effective from 1 January 2015, for many, the big test will be that first set of
financial statements prepared under the new standard FRS 102. With this in mind, it seems like an appropriate time to remind
ourselves what those accounts will actually look like, in particular those aspects that are different from accounts prepared
under the old framework.
Content
Starting with the fundamentals, a complete set of financial statements prepared under FRS 102 will include:
• a statement of financial position (balance sheet);
• either: a single statement of comprehensive income incorporating profit or loss for the period and items of other
comprehensive income; or a separate income statement (profit and loss account) and a separate statement of
comprehensive income;
• a statement of changes in equity;
• a statement of cash flows; and
• notes to the financial statements.
There is some flexibility regarding the titles of the primary statements, provided that the terms used are not misleading.
Therefore, entities can continue to refer to the ‘balance sheet’ if they prefer this to the ‘statement of financial position’ and the
‘profit and loss account’ rather than ‘income statement’.
Formats
In many respects the appearance of the statement of financial position and income statement will appear very familiar. This is
because they have been drawn from the existing formats set out in the Companies Act.
However, there are also some important differences. First, the statement of changes in equity must now be presented as a
primary statement rather than as a note to the accounts. However, if the only changes in equity in the periods presented arise
from the reported profit or loss, payment of dividends, correction of prior period errors and changes in accounting policy, it
is possible for a single statement of income and retained earnings to be presented in place of the statement of comprehensive
income and the statement of changes in equity.
Second, there are important changes relating to the statement of cash flows. To start, this statement will now need to
reconcile movements in both cash and cash equivalents. Cash equivalents are short-term, highly liquid investments that
are readily convertible to known amounts of cash and subject to an insignificant risk of changes in value. This definition
may appear familiar to some, as it is the same as that used in the original FRS 1 Cash Flow Statements. FRS 102 also provides
some guidance in this area, for example, it notes that an investment will qualify as a cash equivalent only when it has a short
maturity of, say, three months or less from the date of acquisition.
In addition, the movements in cash and cash equivalents will now be analysed under three headings: operating activities,
investing activities and financing activities. This contrasts with the nine headings required under old UK GAAP.
Language
Although the terminology used in FRS 102 derives from international standards, the balance sheet and profit and loss account
formats are derived from company law and therefore use different language. For example, FRS 102 may refer to ‘inventories’
but company law refers to ‘stock’. Therefore, as entities are (for now at least – see below) required to follow the language
outlined in company law, the terminology used will appear very familiar to that required under old UK GAAP.
THE NEW UK GAAP
17
Disclosures
There are a number of disclosures required on first time adoption of FRS 102 to explain how the transition has affected the
entity’s reported financial position, financial performance and cash flows. These are set out in FRS 102 in Section 35 Transition
to this FRS. Further guidance is also available in the FRC’s Staff Education Note 13 Transition to FRS 102, including an example of
the various required reconciliations and the corresponding notes.
More generally, there may also be new or different disclosures that require careful consideration when preparing a first set of
FRS 102 accounts. These will of course vary depending on the individual circumstances of the entity. It’s worth remembering
that qualifying entities that adopt FRS 102 may be able take advantage of a number of reduced disclosures in their individual
financial statements provided the shareholders have been notified in writing and have not objected. However, all entities
preparing financial statements in compliance with FRS 102 will be required to make an explicit and unreserved statement of
such compliance in the notes.
Further changes
Recent changes to UK company law arising from the new EU Accounting Directive will, in certain circumstances, enable
entities applying FRS 102 to adapt the company law formats in order to adopt IFRS language and layout. This change is part of
a wider package of changes to UK company law that comes into effect for accounting periods beginning on or after 1 January
2016, with early adoption permitted for accounting periods beginning on or after 1 January 2015.
18
THE NEW UK GAAP
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THE NEW UK GAAP
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