Question of the week:
1. How will implementing FRS101 and FRS 102 affect my business and what should I be doing now to plan ahead (my year end is 31st December)?
2. Which is the better one to comply with?
These were the 2 coupled questions posed by Colin from a manufacturing company.
This is a complex area and here is the answer from Nicholas Brann, one of Tectona’s 15 finance gurus – we think he has done a great job of distilling the answer as it is tempting to simply give chapter and verse – especially for an accountant.
For accounting periods beginning on or after 1 January 2015 you will probably need to change your reporting. In essence, you will need to decide whether you are going to opt for one of:
- New UK GAAP (Generally Accepted Accounting Principles)
- IFRS (International Financial Reporting Standards).
For some, the decision will be easy; others need to take a number of factors into account. Whichever camp you are in you need to talk to your accountant to make sure you get it right – adopting a new GAAP means changing more than the numbers and decisions taken now will affect your future financial position.
Let’s cover off the easy one first – FRS 101 applies to subsidiaries of listed companies that have adopted IFRS (International Financial Reporting Standards). If you are in that category you would most likely have already received direction from your holding company.
The adoption of FRS 102 is far more complex and will lead to some changes to the format of the financial statements and the disclosures required, but for many businesses there will be changes to the numbers as well. FRS 102 will change:
- the recognition criteria for various assets and liabilities
- the basis on which some items are measured
- the treatment of certain gains and losses compared to current UK GAAP.
The starting point for applying FRS 102 will be to restate the opening balance sheet at the start of the comparative period for the first accounts prepared under FRS 102. This is known as the date of transition. So, if a company prepares its first accounts under FRS 102 for the year ending 31 December 2015, its date of transition will be 1 January 2014.
The important point, therefore, is that if you are adopting FRS102 from 1st January 2016 you actually need to go back to restate the balance sheet as at 1st January 2015 so that you can do comparatives and work out prior year adjustments. This can be pretty time consuming and to assess how long it will take you will need to consider each of the following categories and work out whether or not adoption of FRS102 would produce different answers from existing UK GAAP.
To simplify things we have produced 2 answers – this being the full fat one which gives you quite a bit of detail.
1. Investments in listed shares
Under current UK GAAP, investments held in listed shares may be measured at cost or fair value.
FRS 102 requires the use of fair value for investments in shares which are publicly traded or where the fair value can be measured reliably. Movements in this fair value are recognised in profit or loss.
2. Investment property
Current UK GAAP requires investment properties to be revalued each year to open market value.
FRS 102 requires revaluation each year to fair value (equivalent to open market value) with value changes taken to profit or loss. The cost less depreciation model is used only if fair value cannot be measured reliably without undue cost or effort.
3. Financial instruments
FRS 102 classifies financial instruments into ‘basic’ and ‘other’.
a. Basic financial instruments
These include items such as trade receivables (debtors), trade payables (creditors) and straight forward bank loans. Under FRS 102 they are measured mostly at amortised cost, with certain types being measured at cost or fair value. However, most receivables and payables that are classified as current assets or current liabilities will be measured at the undiscounted amount of cash expected to be paid or received.
b. Other financial instruments
This category will include instruments such as foreign exchange forward contracts and loans with complex terms. Under FRS 102 these are almost all measured at fair value at each balance sheet date with movements recognised in profit or loss. Many of these instruments would not have been recognised on the balance sheet under current UK GAAP – but simply disclosed.
Hedge accounting is permitted under FRS 102 but only for certain specified types of hedges.
4. Accounting for business combinations
FRS 102 does not change the requirements for consolidated accounts to be prepared. It requires the use of acquisition accounting for all business combinations within its scope, although merger accounting will still be available for group reconstructions provided certain conditions are met, and for some public benefit entity combinations.
5. Intangible assets and goodwill
a. Useful economic lives
For intangible assets and goodwill, current UK GAAP presumes a maximum useful life of 20 years, but this can be rebutted if a longer or indefinite life can be justified.
Under FRS 102, intangible assets and goodwill always have a finite life. If no reliable estimate can be made, the useful life will be limited to a maximum of five years.
b. Recognition in business combinations
The FRS 102 criteria for recognition of the identifiable assets and liabilities of an acquiree differ from current UK GAAP, where such assets and liabilities have to be capable of being disposed of or settled separately.
There will be no equivalent ‘separation’ requirement in FRS 102, meaning more intangible assets are likely to be identified separately from goodwill.
6. Defined benefit pension schemes
a. Valuation methodology
The valuation method required by FRS 102 is the projected unit credit method – the same as under current UK GAAP.
However, FRS 102 provides a number of simplifications where this basis would require undue cost or effort.
FRS 102 also does not require the use of an independent actuary, whereas the requirement under current UK GAAP is to obtain a valuation by a qualified actuary at least every three years.
b. Multi-employer schemes
Where an employer is unable to identify its share of the assets and liabilities of a multi-employer defined benefit pension scheme, the scheme will continue to be accounted for as a defined contribution scheme under FRS 102 – as is permitted by current UK GAAP. However, where a funding agreement is in place to fund a deficit on such a scheme, FRS 102 requires the recognition of a liability in relation to the payments due under that agreement.
7. Lease accounting
a. Classification of leases
FRS 102 classifies leases into finance leases and operating leases based on whether the lessee or the lessor holds the risks and rewards of ownership.
This is the same principle as current UK GAAP; however current UK GAAP also includes a presumption that where the present value of the minimum lease payments is 90% or more of the fair value of the asset, then the lease is a finance lease. FRS 102 does not include this ‘90% test’ so the classification of some leases may change.
b. Recognition of lease incentives
Under current UK GAAP, the value of a lease incentive, such as a rent-free period, is spread over the period to the first rent review, being the point at which the rent is reset to market rates. Under FRS 102, lease incentives are spread over the whole lease term, which may be a significantly longer time period.
8. Deferred tax
Current UK GAAP takes a timing difference approach to deferred tax based on the mismatch between the periods in which gains and losses are recognised in the financial statements and the period in which the tax effects arise.
FRS 102 is based on the same approach, but also requires deferred tax to be recognised on items such as the revaluation of property.
Although the differences appear subtle, the change is likely to make the calculation of deferred tax considerably more complex and give rise to deferred tax in more situations.
Discounting of deferred tax balances is a permitted treatment in current UK GAAP but is not allowed under FRS 102.
9. Foreign exchange
a. Foreign exchange forward contracts
Under SSAP (Statements of Standard Accounting Practice) in current UK GAAP, where matching forward contracts are in place for a transaction, the contracted rate can be used for translation of the matched transaction.
Under FRS 102 this option is not permitted – instead, a foreign exchange forward contract will be recognised on the balance sheet as a financial instrument at fair value and the associated debtor or creditor will be retranslated at the year-end rate.
b. Presentation currency
FRS 102 allows translation of financial statements into any currency (‘presentation currency’) from its ‘functional currency’, broadly equivalent to local currency under SSAP 20.
Whereas under current UK GAAP accounts have to be prepared in the local currency.
Do feel free to contact Tectona if you need more guidance on this complex topic. Contact Tectona.