Technical Bulletin TR 171/16 FRS 102. FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland

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1 Suitable for internal and external use Technical Bulletin TR 171/16 January 2016 FRS 102 FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland Overview - Introduction and purpose of the bulletin In our previous Technical Bulletin no. 154 we gave an overview of the change from old UK GAAP to FRS 102, particularly looking at processes and procedures and highlighting the decisions and potential actions that should be taken in advance in order to minimise the impact of unexpected and avoidable consequences. This Bulletin aims to give a more detailed overview of the key changes in accounting rules compared to those under the old UK GAAP. Whilst this does not purport to cover every change, it should give readers a good idea of the main issues that may result in significant changes to the accounts. For further advice please contact: Jenny Reed +44 (0) j.reed@uhy-uk.com or Colin Wright +44 (0) c.wright@uhy-uk.com The Bulletin does not cover service concession arrangements and financial institutions. Those affected should read the relevant parts of section 34 on specialised activities for further details. The Appendix to this Bulletin gives a brief bullet point summary of the key changes chapter by chapter, which it is hoped will be a useful source of reference. 1 of 24

2 INTRODUCTION AND EFFECTIVE DATE EARLY ADOPTION TERMINOLOGY On 9 July 2009 the International Accounting Standards Board (IASB) published the International Financial Reporting Standard for Small and Medium-sized Entities (IFRS for SMEs), and the ASB proposed that this should replace UK GAAP. The ASB issued an initial consultation document on 11 August 2009 proposing what became known as the three tier system. Several consultations and amendments later, the IFRS for SMEs became the Financial Reporting Standard for Medium-sized Entities (FRSME) and then finally morphed into FRS 102, the first version of which was published back in March Since then, we have seen a number of amendments and two new versions of the Standard. Selecting the appropriate version is important, as there are some key differences between the versions and not all entities can adopt the later versions early. The original March 2013 version has been superseded by the August 2014 version, which will be the one used by most first time adopters along with certain July 2015 and other interim amendments. This is the version on which this Bulletin is based and to which all references are made unless stated otherwise. This Bulletin is primarily interested in the key changes in FRS 102 compared to the old UK GAAP, looking at the application to medium and large companies only (small companies are covered in Technical Bulletin ). References to the Regulations are to SI 2008/410 for companies and SI 2008/629 for charities. The August 2014 version of FRS 102 may be adopted early as far back as periods ending on or after 31 December Unincorporated charities may not adopt FRS 102 early as their accounts preparation is governed by the charity Regulations which still require them to prepare accounts under the old 2005 SORP. It is possible to adopt the September 2015 version of FRS 102 early, but only by also early adopting SI 2015/980 at the same time. This version of FRS 102 can only be early adopted as far back as periods commencing on or after 1 January Doing so will permit the new, higher small company thresholds to be applied early for the purpose of accounts preparation (and hence eligibility to apply section 1A) but this cannot be applied early for audit threshold purposes. See Technical Bulletin TR 168/15 for further details. One of the most immediately obvious changes on reading FRS 102 is the change in terminology; traditional UK GAAP terminology has generally been replaced by its international equivalent. Hence stock is now known as inventory, debtors as receivables and fixed assets as property, plant and equipment (PPE). However, paragraphs 4.2, 5.5 and 5.7 state that the statement of assets and performance statement must be prepared in accordance with the formats in the company Regulations. Since these have not been updated for the terminology changes, our view is that these must still be complied with, and thus the old terminology must still be used in preparing statutory accounts. Paragraph 3.22 permits the use of other titles for the financial 2 of 24

3 statements as long as they are not misleading. Hence, for example, the statement of financial position can alternatively be called a balance sheet but either way, the line item wording must stay as per the Regulations. The term public benefit entity (PBE) has also been introduced. The consultation stage included a separate draft standard known as the FRSPBE containing specific accounting rules for public benefit entities. These were subsequently incorporated into FRS 102, the relevant paragraphs being prefixed by PBE for identification purposes. A PBE is an entity whose primary objective is to provide goods or services for the general public, community or social benefit where any equity is provided with a view to supporting the entity s primary objectives rather than with a view to providing a financial return to equity providers, shareholders or members. Thus PBEs encompass more than just charities, and hence may also include housing associations, cooperatives, community interest companies, clubs, societies etc. PBEs are required to give an explicit statement in the accounts that they are a PBE. The existence of PBE paragraphs within FRS 102 has not, however, negated the need for SORPs for charities, housing associations and higher and further education colleges, which have now been duly updated for FRS 102. Entities will also find the phrase fair value used frequently. Whilst this is not a new concept, many entities that previously accounted under the historical cost rules may not have come across it before. Fair value is defined as, the amount for which an asset could be exchanged, a liability settled, or an equity instrument granted could be exchanged, between knowledgeable, willing parties in an arm s length transaction. An extension of this is fair value through profit or loss. Under the old UK GAAP, entities opting to revalue assets accounted for the revaluation movements in the Statement of Total recognised Gains and Losses (STRGL). In some cases, under FRS 102 such movements are accounted for through the P&L. As discussed further below, this has significant implications for the determination of distributable reserves under company law. CONCEPTS AND PERVASIVE PRINCIPLES Most existing UK GAAP users will be familiar with many of the fundamental accounting concepts and principles that underpinned the old UK accounting standards. These concepts and principles were previously set out in a separate publication, the Statement of Principles for Financial Reporting. Under the new UK GAAP, concepts and pervasive principles are included within the Standard itself in Section 2. Many are unchanged, but their importance is such that it is strongly recommended that this section is read in full. Their importance arises from the fact that FRS 102 is a relatively short, accessible standard that does not include specific rules for every accounting eventuality. The Standard is principles based, and users are expected to apply the principles in Section 2 when FRS 102 does not give specific rules for the accounting for a particular matter (see accounting policies section below). 3 of 24

4 STATEMENT OF COMPREHENSIVE INCOME (SOCI) FRS 102 contains a choice for presentation of performance. Entities may continue to give two primary statements much as before, now called an Income Statement (P&L) and a Statement of Comprehensive Income (STRGL). Alternatively, a combined single Statement of (total) Comprehensive Income may be given. The two statement approach is likely to be the more popular option, as it has remained even for listed companies in the UK following EU-adopted IFRS. Switching between the two is a change in accounting policy and will have presentation and disclosure implications. Discontinued operations must now be presented in columnar format only, for every line item. Thus the option to present limited information in the format set out in P&L Example 1 to FRS 3 has been removed. The definition of a discontinued operation has also changed significantly compared to that in paragraph 4 of FRS 3. Any operations classified as discontinued in the comparative period should be reassessed under the new criteria and may need to be reclassified as continuing. STATEMENT OF FINANCIAL POSITION The statement of financial position is unlikely to look significantly different, especially if the option to retain the traditional title of balance sheet is taken. The only other key presentational change is that the specific requirement to disclose the net pension asset/liability on the face of the balance sheet has been removed. However, there is a general principle in paragraph 4.3 for an entity to present additional line items, headings and sub-totals when such presentation is relevant to an understanding of the entity s financial position. One other area that may cause issues within groups is section 4.7, which states that a creditor must be classified as falling due within one year unless the entity has an unconditional right to defer settlement for at least 12 months from the year end. It is not uncommon for intercompany trading balances and loans to remain unsettled for long periods (often years) with no formal agreement in place. Without a formal agreement or other documentation of terms, such loans are likely to be classified as being repayable on demand and measured at cost. It is common for auditors to request a letter of support from the lending group company (usually the parent company) confirming that such facilities will not be withdrawn for 12 months from the date the financial statements are approved. Whilst such letters support use of the going concern principle, they do not affect the classification of intercompany loans. Any reclassification of such liabilities from long term to short term creditors may affect key ratios and borrowing covenants. For groups wanting to avoid this outcome for existing loans, it is too late if they did not formalise terms before the transition date (which has long since passed), as these cannot be backdated. It is, however, worth bearing this in mind for any future loans. Groups may like to consider making additional disclosures explaining the nature of any informal group financing arrangements, in order to assist 4 of 24

5 users of the financial statements to understand the true liquidity position. CASH FLOW STATEMENT The only exemption in the August 2014 version of FRS 102 from presenting a cash flow statement is for group members qualifying for and applying the reduced disclosure regime in Section 1 (see below). Thus all other entities applying this version of FRS 102 must prepare a cash flow statement. Small entities can only obtain exemption from presenting a cash flow statement by adopting the September 2015 version of FRS 102 early and applying the reduced disclosure regime in Section 1A therein, (see Bulletin ). Readers may recall that the original version of FRS 1 required reconciliation to cash and cash equivalents, and this was only amended to a very strict definition of cash back in 1996 when the category of liquid resources was introduced. FRS 102 has reverted to a cash and cash equivalents reconciliation. The FRS 102 definition of cash is slightly more relaxed than that in FRS 1 in that there is no explicit mention of the 24 hour rule, but it still requires cash deposits to be available on demand. The new definition of cash equivalents is remarkably similar to that in the old FRS 1 except that there is no reference to the somewhat arbitrary three months maturity. The new style cash flow statement is in some ways simpler than its predecessor in that there are only three categories of cash flow on the face of the statement compared to FRS 1 s eight, namely: Operating activities Investing activities Financing activities The FRS also gives guidance as to how to classify cash flows under the new headings. However, there is a choice, in that only: Dividends and interest paid may be classified as either operating or as financing cash flows. Interest and dividends received may be classified as either operating or as investing cash flows. Whichever classification is selected, it must be applied consistently from year to year. OTHER PRIMARY STATEMENTS The requirement to produce a note of historical cost profits and losses has been removed entirely. A statement of changes in equity (similar, but not exactly the same as the reconciliation of movements in shareholders funds) must now be presented as a primary statement and with full comparatives. However, where the only changes to equity arise from profit or loss, payment of dividends, corrections of prior period errors and changes in accounting policy, this information may be tagged on to the bottom of the P&L to form a single statement of income and retained earnings. This is likely to be the case for many private companies. 5 of 24

6 NOTES TO THE ACCOUNTS Paragraph 8.4 is very prescriptive in setting out the precise order that the notes should appear in, with the accounting policies being presented immediately after the new mandatory statement of full compliance with FRS 102. This is followed by the notes supporting the primary statements, strictly in the order in which those primary statements and items appear, followed by any other disclosure notes. Some note requirements are subjective, where the level of detail of disclosure needed will require interpretation in accordance with the spirit of FRS 102, e.g. where the Standard refers to, information that enables users of financial statements to evaluate without being prescriptive as to what that information is. Accounting policies As noted above, accounting policies must now be included in the notes. This will require some rearrangement of the financial statements for those entities that previously disclosed accounting policies as a separate section of the financial statements. FRS 18 required disclosure of significant estimation techniques, but FRS 102 goes further in also requiring disclosure of critical judgments and sources of estimation uncertainty, including any key assumptions made. There is a significant change in the treatment of prior period errors. Under FRS 3 these were usually corrected in the current period, only being adjusted for in the prior period if considered to be fundamental. This required significant judgment and often resulted in disagreement between directors and auditors. Under FRS 102 prior period errors are accounted for as prior period adjustments if material, a more objective measure. Where the Standard does not specifically address the accounting for a particular transaction, other event or condition, an entity s management must use its judgement in developing and applying an appropriate accounting policy. In doing so, management is directed to refer to and consider the applicability of the following sources in descending order: a) the requirements and guidance in an FRS or FRC Abstract dealing with similar and related issues; b) where an entity s financial statements are within the scope of a Statement of Recommended Practice (SORP) the requirements and guidance in that SORP dealing with similar and related issues; and c) the concepts and principles in Section 2 (see above). Revenue The accounting rules for revenue are largely the same as those in Application Note G to FRS 5 and UITF 40. The appendix to Section 23 gives a number of practical examples of revenue accounting treatment which are based on those in IAS 18, but this will not cover every situation. Accounting for revenue is based strongly on the key principles set out in Section 23. Entities should read this section in detail, applying it to their own revenue streams and circumstances and not relying on the examples. The main difference relates to presentation and disclosure. The notes to the accounts will need to provide an analysis of revenue by type (sale of goods, rendering of services, interest, royalties etc) as specified in of 24

7 Government grants SSAP 4 required application of an accruals model to government grants, whereby revenue grants were deferred and matched against the relevance expenditure as incurred. FRS 102 permits a choice of either an accruals model or a new performance model, whereby revenue grants are recognised when any performance-related conditions have been met. The new charities SORP makes clear that the accruals model is still not available to charities. It is no longer possible to deduct capital grants from the carrying value of the related fixed asset. Since this was not permitted by the Companies Act, this change will make no difference to the vast majority of entities. There are also some additional disclosures needed, namely details of: Unfulfilled conditions and other contingencies related to grants recognised as income; and Other forms of government assistance that have directly benefitted the entity e.g. technical or marketing advice, the provision of guarantees and loans at zero or low interest rates. Share based payment Section 26 of FRS 102 is largely based on FRS 20, and hence there are only a few changes to the accounting for share based payment. The option to measure equity instruments at their intrinsic value in the rare case that an entity is unable to make a reliable estimate is no longer permitted. This may still arise with share options in an unlisted entity, in which case reference should be made to the general recognition principles in Section 2. For share based payment plans in groups, FRS 102 provides a simpler alternative to the standard accounting treatment, whereby the group members may recognise and measure the related expense on the basis of a reasonable allocation of the expense for the group as a whole. Groups taking this option must disclose this fact and the basis for the allocation. There are also generally fewer disclosure requirements relating to share based payment in FRS 102 than there were in FRS 20. Other employee benefits Section 28 of FRS 102 covers all employee benefits other than share based payment (see above). This section is very comprehensive, and includes matters not explicitly covered by UK GAAP previously e.g. short-term compensated absences. This is the source of the highly publicised holiday pay accrual. For entities whose holiday year coincides with their accounting year, the value of holiday accrued but not yet taken may not be material, but should still be calculated to demonstrate this. The figure will be zero for such an entity which does not permit employees to carry holiday entitlement forward. For entities whose holiday year and accounting year differ, this could end up being either an accrual or a prepayment, and could material for some entities. This will be a prior period adjustment, and so figures for the two previous years will also be needed to adjust the comparatives. 7 of 24

8 The same principles apply to all other short term compensated absences e.g. sick pay. In respect of termination payments, in the relatively rare case that these fall due more than twelve months after the period end, discounting is required. The other three key changes relate to the treatment of defined benefit pension schemes, the latter two of which are very significant if applicable: A pension asset or liability can no longer be presented net of the related deferred tax balance. Under FRS 17, where the members of a group were unable to identify their share of the underlying assets and liabilities, the scheme was accounted for at entity level as a defined contribution scheme, and only accounted for as a defined benefit scheme in the group accounts. Under FRS 102, if there is a contractual agreement or stated policy for charging scheme costs to individual entities, the net defined benefit cost must be thus allocated. Otherwise, the group entity that is legally responsible for the scheme must recognise the cost of the whole plan, other members of the group continuing to recognise a cost equal to their scheme contribution. Many entities are members of multi-employer or state defined benefit pension schemes, and being unable to identify their share of the underlying net assets and liabilities, account for such schemes as defined contribution schemes under FRS 17. Under FRS 102, such entities must recognise on the balance sheet the discounted net present value of any agreed deficit contributions. The impact on the balance sheets of affected entities could be very material indeed. Borrowing costs Foreign currency translation and hyper inflation Borrowing costs may still optionally be capitalised in respect of PPE and/or inventories. However, this policy choice may now be made on an asset class basis rather than the blanket approach required by the old UK GAAP. FRS 23 and 24 formed part of the package of financial instrument Standards which entities either adopted completely under the old UK GAAP or not at all. As a result, most entities transitioning to FRS 102 will have been previously applying SSAP 20 and UITF 9. The first point to note is a terminology change. Local currency under SSAP 20 becomes functional currency under FRS 102, which also contains more guidance than SSAP 20 on determining an entity s functional currency. The first key change is to the rules for translating foreign currency transactions. It is no longer permissible to use an agreed contracted rate or forward contract rate. An average rate may still be used, but whereas SSAP 20 merely stated that an average rate for a period may be used if the rates do not fluctuate significantly, FRS 102 goes on gives examples of a week or month as the period in question. Whilst these are merely examples, it is suggestive that selecting a year as the period (which many companies have done in the past) may not be appropriate. Similarly, at the period end the closing rate must be used and not a contracted rate or forward contract rate. The second key change is the introduction of a presentational currency. This 8 of 24

9 was never mentioned in SSAP 20, but was included in FRS 23 (and IFRS) as an option. Entities applying FRS 102 may now select a presentational currency of their choice, which need not be the same as their functional currency. For entities whose functional currency is that of a hyperinflationary economy, there is no longer the option to use a stable currency as an alternative functional currency (as permitted by UITF 9). Entities that have previously adopted the package of Standards including FRS 24 will therefore see little change. Income tax Somewhat confusingly, income tax in the context of FRS 102 includes all domestic and foreign taxes that are based on taxable profit. For most entities this primarily means corporation tax and deferred tax, and the main changes in this area all relate to deferred tax. The timing difference approach to deferred tax largely remains, but there are some additional recognition requirements that will, in certain circumstances, give rise to new deferred tax balances, particularly on: Revaluation gains and losses on non-monetary assets e.g. on revalued PPE and investment properties; and Differences between the fair value of the net assets recognised in a business combination and the values thereto for tax purposes. Property investment companies will be particularly hard hit by these new requirements, which may affect key ratios and banking covenants. Finally, FRS 19 permitted the discounting of deferred tax balances, whereas FRS 102 does not. Intangible assets and goodwill The useful economic life (UEL) of intangibles and goodwill is one aspect of FRS 102 that has caught the eye of many commentators. The two key changes are: a) Intangible assets and goodwill can no longer have an indefinite useful economic life (UEL) and must be amortised. This is one area where FRS 102 diverges further from IFRS than the old UK GAAP, since FRS 10 and IAS 38 both permit an indefinite UEL. b) The FRS 10 rebuttable presumption that the UEL of goodwill or an intangible does not exceed twenty years unless otherwise demonstrated is not included in FRS 102. Instead, where an entity is unable to make a reliable estimate of UEL, the life cannot exceed five years. This last point has proved highly controversial. As a result, the five year rule was subsequently changed to ten years in the September 2015 version of FRS 102, which applies to periods commencing on or after 1 January Affected entities wanting to avoid this apparent inconsistency in the rules should consider adopting the September 2015 version early as noted above. Although not what FRS 10 required, some entities may previously have used a UEL of twenty years when they were unable to make a reliable 9 of 24

10 estimate, in which case this may need to be shortened on transition to FRS 102. This is a change of estimate and not a change of accounting policy, so should be accounted for prospectively and not as a prior period adjustment. FRS 10 s mandatory review of UELs at the end of each reporting period has been replaced by review only when there are indicators of a change. The effect of the removal of an indefinite UEL and the aforementioned rebuttable presumption is that impairment reviews are only now required where there are indications of impairment, i.e. no automatic reviews when the UEL exceeds a certain length (previously twenty years) or at the end of the first full year after acquisition. Furthermore, although impairment charges must first still be allocated to goodwill, intangible assets are no longer prioritised over other assets within a cash generating unit (CGU). Property, plant and equipment (PPE) For entities that revalue asset classes, the rules regarding valuations have, at first glance, been significantly relaxed. FRS 15 included detailed guidance on the type and frequency of valuations that would satisfy the overall requirement for the carrying value to be the current value. FRS 102 simply states that revaluations should be made with sufficient regularity to ensure that carrying value does not materially differ from fair value at the period end. In practice, therefore, this should not make much difference, since a valuation will always be required if it is suspected that there has been a material change in value during the period. The basis of valuation has also changed. FRS 15 required non-specialist properties to be valued on the existing use basis, with disclosure of the value on an open market value where this is materially different. FRS 102 requires fair value (equivalent to open market value) to be used. Investment property The definition of an investment property no longer excludes property let to another group company as long as it is held for rental earnings and/or capital appreciation. This may result in some properties being reclassified at the date of transition in the individual financial statements of the lessor, whilst continuing to be shown as PPE in the consolidated accounts. Mixed use property (e.g. where an entity rents out part of its own operational building) should ideally be split between investment property and PPE. However, where the fair value of each part cannot be measured reliably without undue cost or effort, the entire property should be accounted for as PPE. This issue was never explicitly addressed by SSAP 19, although in practice, entities may have adopted the FRS 102 approach previously. Charities should note that this represents a change in the rules, since the 2005 SORP required such properties to be classified according to their primary use unless each part was clearly distinguishable. The main accounting change is that movements in the fair value of investment property are now shown in the P&L (FVTPL). There is no requirement to transfer such gains and losses to a non-distributable revaluation reserve, although entities may choose to do so and this is recommended. Those that choose not to will need to keep a separate record of distributable reserves since unrealised, non-distributable profits will then 10 of 24

11 end up in the P&L reserve and determining the legality of dividends will otherwise become impossible. Where the fair value of an investment property cannot be obtained without undue cost or effort, it must be classified and accounted for as PPE, although should the situation change in the future, such property would need to be reclassified again. The SSAP 19 requirement to depreciate investment property held on a short lease (in order to avoid the situation whereby the rentals are taken to income but the lease is amortised against the revaluation reserve) has gone as this anomaly no longer arises when accounting at FVTPL. Heritage assets Business combinations No significant changes. Most business combinations will continue to be accounted for as acquisitions, with acquisition accounting now called the purchase method of accounting. Merger accounting may only be used under FRS 102 when: a) a business combination meets the definition of being a group reconstruction ; or b) a PBE combination is in substance a merger (dealt with separately in section 34). A group reconstruction is defined in the glossary as either the transfer of ownership of a subsidiary within a group or to another entity or group under common ownership, adding a new parent company or combining two entities into a group that were previously under common ownership. Crucially, there must be no change in the ultimate ownership. Although the company law criteria for merger accounting have recently been amended, these changes do not apply until 2016 without early adoption. Entities applying the August 2014 version of FRS 102 will therefore need to look carefully at business combinations to ensure they qualify for merger accounting under both FRS 102 and company law. The criteria for recognition of an intangible asset in a business combination have been softened such that it no longer needs to be capable of being separately disposed of. As a result, more intangibles may be identified separately from goodwill than was previously the case. Finally, deferred tax must now be recognised on fair value adjustments made to assets or liabilities acquired in a business combination. Inventories, biological assets and extractive industries Net realisable value is now termed estimated selling price less costs to complete and sell. Other than this there are no significant changes regarding non-specialised stocks. Under the old UK GAAP the accounting for agricultural stocks (livestock, growing crops and harvested crops) was primarily covered by HMRC s Helpsheet IR232 (formerly and better known as BEN 19) and in most cases required such stocks to be carried at the lower of cost and net realisable value (NRV). Such matters are explicitly covered by FRS 102 in Section 34 on specialised activities. Entities now have a choice between the cost and 11 of 24

12 fair value (FVTPL) models on a class by class basis. However, if the fair value model is chosen, it is not permitted to subsequently revert to the cost model. Entities operating in extractive industries (oil, gas, mining etc) accounting under old UK GAAP will have been following the Oil and Gas SORP. This SORP is not being retained under the new UK GAAP, and instead extractive industries are covered by Section 34 of FRS 102. This states that such entities should apply IFRS 6 with a couple of minor modifications: a) In applying IFRS 6, references made to other IFRSs therein should be taken to be references to the relevant section or paragraph in FRS 102. b) When applying the impairment rules in paragraph 21 of IFRS 6, a cash-generating unit (CGU) or group of CGUs shall be no larger than an operating segment, and hence the reference in IFRS 8 Operating Segments should be ignored. Unusually, there is a relevant transitional paragraph at 34.11C (i.e. not in Section 35 with the others) whereby the impracticality of applying particular requirements of paragraph 18 of IFRS 6 (impairment testing and disclosure of any resulting impairment) to previous comparatives must be disclosed. Financial instruments Under the old UK GAAP entities could optionally apply the package of financial instrument-related FRSs (i.e. the IFRS rules). FRS 102 contains an option to account under IAS 39 and IFRS 9. However for the majority of entities applying UK GAAP, sections 11 and 12 bring about some of the most fundamental accounting changes in FRS 102. The first stage is to identify financial instruments and then to decide whether they are basic or other. Basic instruments are precisely that, the simpler instruments that are commonly found in many entities such as cash and deposits, straightforward loans, accounts receivable and payable, bonds, non-convertible preference shares and non-puttable shares etc. Examples of instruments that will not qualify as basic include convertible debt and derivatives such as forward contracts, options and interest rate swaps. Section 11 contains several pages of criteria and examples to assist in this assessment. Most basic instruments other than financing transactions are initially measured at transaction price including transaction costs, and thereafter at amortised cost using the effective interest method, and the Standard includes a worked example at A financing transaction may take place in connection with the sale of goods or services, for example, if payment is deferred beyond normal business terms or is financed at a rate of interest that is not a market rate. Financing transactions are accounted for at present value discounted at market rate. This gives rise to two issues: a) How to determine a market rate of interest; and b) How to account for the measurement difference that arises when a market interest rate is used. There is no official guidance on how to determine a market rate of interest, 12 of 24

13 but factors to consider are the purpose of the loan, the relationship between the transacting parties, other external borrowings and the borrower s gearing, the existence of any available security, the loan maturity, repayment profile, interest basis and currency. How the measurement difference is accounted for depends on who is lending to whom and the terms of the loan. In the situation of a donor lending cheaply to a charity, the measurement difference would be accounted for in the SOFA as a donation. Financing transactions are a particular issue for groups with intercompany loans, which are typically at below market rate, and often interest-free. Here, the measurement difference is not always written off to the P&L. For example, for an intercompany loan with a fixed term and no repayment demand features: Loan from parent to subsidiary the parent is effectively subsidising the subsidiary with a cheap loan, akin to a recapitalisation. Thus in the parent s accounts, the measurement difference is debited to cost of investment, and recognised in the subsidiary s books as a capital contribution. Loan from subsidiary to parent the subsidiary is now transferring value to the parent via the cheap loan, akin to declaring a dividend. Thus in the parent s accounts, the measurement difference is credited to the P&L as income from the subsidiary, and recognised in the subsidiary s books as a distribution to the parent. This particular issue can also arise when a loan is made to another entity under common ownership at the behest of the owner. In this situation the distribution is to the owner, who is then deemed to be recapitalising the loan recipient entity. There are two key questions arising from this accounting treatment: Is the distribution considered a distribution for company law purposes and, if so, are there sufficient distributable reserves? It is likely to be a distribution, although most commentators suggest that legal advice should be sought on this point should it arise. What are the tax implications? There is clearly a higher finance charge in the P&L, but crediting capital can also have tax consequences. The advice of a UHY tax specialist is therefore highly recommended! Investments in shares that qualify as basic instruments are accounted for at FVTPL unless fair value cannot be measured reliably in which case they are measured at cost less impairment. This effectively removes the option to account for investments in listed shares at cost less impairment. Other (non-basic) financial instruments are generally accounted for at FVTPL, again unless fair value cannot be measured reliably. Accounting for the annual movement in fair value through the P&L may result in significant earnings volatility for some entities. Hence all derivatives will be included in the balance sheet, compared to the current treatment of disclosure only. Valuing such instruments can be difficult, especially when 13 of 24

14 needed at the previous balance sheet date and at the date of transition. Auditors are unable to prepare material valuations for use in financial statements that they audit, so external specialist advice may be needed. As a result of the above accounting changes many more disclosures will be required by entities that have not previously adopted FRS 29. This topic is too large to do full justice to in this Bulletin, and many entities do not have complex financial instruments. Directors who think their companies will be significantly affected by these issues are strongly recommended to have urgent discussions with their advisors. The ICAEW has also produced a number of factsheets on specific aspects of financial instrument accounting. Provisions and contingencies Liabilities and equity No significant changes. Readers may recall that some years ago, the financial statements were required to disclose details of the rights and restrictions (including rights to dividends and repayment of capital) relating to each class of shares. This disclosure has been resurrected in paragraph The implications of accounting at FVTPL on the determination of distributable reserves are covered above. There are no changes to the classification of liabilities and equity compared to FRS 25, although most of the detailed guidance material from the latter has not been included in FRS 102. There is a new requirement to disclose the fair value of non-cash assets distributed to shareholders in some circumstances, but this is not expected to affect many entities. Leases The old GAAP basic principles of accounting for operating and finance leases remain largely unchanged, but the classification of leases requires more judgment under FRS 102. This is due in part to the change in definition of a finance lease. The general principle remains that a lease is a finance lease if it transfers all substantially the risks and rewards incidental to ownership. The old 90% rule and rebuttable presumption in SSAP 21 have been removed, and are replaced by five situations in paragraph 20.5 which would normally lead to a finance lease classification, and a further three indicators in paragraph 20.6 which could lead to the same conclusion. Whilst a straight line basis generally applies to operating leases, there is no requirement to spread increases that are purely inflationary over the life of the lease; these may be accounted for as incurred. Under UITF 28, operating lease incentives are spread over the shorter of the lease term and the period ending on a date from which it is expected the prevailing market rent will be payable (often the period up to the first rent review). Under FRS 102 these must be spread over the full lease term. For lessors, the option to use the net cash investment approach has been removed, and thus the net investment approach must now be used. 14 of 24

15 Related parties The definition of a related party is consistent with that in the latest version of FRS 8. However, there are some new disclosures: Remuneration of key management personnel (in aggregate); Separate disclosure for each type of related party (the categories are set out in section 33.10); and Additional disclosures in respect of outstanding balances (terms and conditions, guarantees etc). Although the concept of key management is not new, it is possible that many entities will not have needed to make any such disclosures before now. Entities should give some thought as to who qualifies as key management, noting that the glossary definition specifically includes any director. Interestingly, there is no longer an explicit requirement to disclose the name of related parties, although the nature of the relationship must be given. The name of an entity s immediate and ultimate parent must still be disclosed. Related party transactions may only be disclosed as being on an arm s length basis if such terms can be substantiated, which can be difficult. Events after the end of the reporting period REDUCED DISCLOSURE REGIME Section 32 of the Standard is broadly in line with the requirements of FRS 21 so there are no significant changes. The only change of note is that whilst dividends declared after the period end are still not recognised as a liability, the amount of such a dividend may be shown as a separate component of retained earnings. There is a reduced disclosure regime in section 1 of FRS 102 that mirrors the FRS 101 regime for IFRS users. The regime may be applied by any member of a group included in publicly available consolidated financial statements. Hence the exemptions apply to subsidiaries, intermediate parents and ultimate parents in their individual financial statements, but not in consolidated financial statements, whether for the ultimate parent company or for any sub-group, even if prepared voluntarily. There are three conditions that must be complied with: 1) The shareholders must first be notified in writing. Objections can be raised by: a) the immediate parent company; or b) a shareholder or shareholders holding in aggregate 5% or more of the entity s total allotted shares; or c) a shareholder or shareholders holding in aggregate more than 50% of the entity s allotted shares not held by the immediate parent. 2) FRS 102 must otherwise be applied. 3) The notes must give a brief narrative summary of the disclosure exemptions adopted and disclose the name of the parent in whose consolidated financial statements it is included, and from where those financial statements may be obtained. 15 of 24

16 The main disclosure exemptions available are: Reconciliation of the number of shares outstanding at the beginning and at the end of the period; Cash flow statement; Financial instrument disclosures* Share-based payment disclosures (subject to certain conditions)*; Total compensation paid to key management personnel. * Provided that equivalent disclosures are included in the consolidated financial statements of the group in which the entity is consolidated Exemption not available to financial institutions For those now considering the disclosure of related party transactions within groups, this exemption (for wholly owned members) is included in section 33.1A rather than section 1. CONSOLIDATED ACCOUNTS The rules for producing consolidated accounts have not changed significantly. However, FRS 102 has introduced a new concession whereby subsidiaries held as part of an investment portfolio must be measured at FVTPL rather than being consolidated. This will be welcome news to venture capitalists and other investing companies. Equity accounting is still required for associates but the somewhat arbitrary three month limit on the gap between non-coterminous year ends has disappeared. A liability need not be recognised for losses in excess of the value of the investment in an associate unless the investor has an obligation to make payments on behalf of the associate. Equity accounting is also required for joint ventures, with the disappearance of gross equity accounting. SPECIALIST ENTITIES Some of the accounting issues pertaining to specialist entities such as pension schemes and PBEs are addressed within the Standard itself in Section 34 and its appendices. As noted earlier, the more niche topics such as financial institutions, extractive industries and service concession arrangements are not covered by this Bulletin. Agricultural stocks and heritage assets are covered earlier in this Bulletin; the other topics in section 34 are looked at below. Retirement benefit plans (in most cases, pension schemes) are required to apply paragraphs to in addition to the rest of the Standard. These paragraphs give either alternative requirements to those given elsewhere in the Standard (e.g. disapplying paragraph 3.17 and instead listing the contents of a set of pension scheme accounts) or add additional disclosures relevant to such entities. These paragraphs do not negate the need for the pension SORP which has been updated for FRS 102 and is available from the Pensions Research Accountants Group (PRAG). As mentioned earlier, there are a number of paragraphs prefixed by PBE which apply only to PBEs and, in certain cases, entities within PBE groups. 16 of 24

17 With the exception of the statement required by paragraph 3.3A as noted above and a cross-reference paragraph at the start of certain Sections, these are all included in Section 34. There are three topics covered: Incoming resources from non-exchange transactions These are defined in the glossary as lop-sided transactions, whereby one party receives something of value and the other party receives something of either lesser or no value e.g. a charitable donation. The relevant paragraphs are supplemented by Appendix B which goes into the topic in more detail. These paragraphs caused significant debate during the development of FRS 102 as there was concern that charity shops would need to recognise second hand goods donated for resale at fair value. However the final version of FRS 102 states in PBE that where this is not practicable (the cost benefit may be taken into account under PBE 34.69), the income shall be included in the period when, in this case, the goods are sold. This is specifically confirmed in the Appendix at PBE 34B.4, and thus for most charity shops, there will be no change in accounting. The recognition rules for non-exchange transaction revenue refer back to the general income recognition criteria in FRS 102. These require that it be probable that economic benefits associated with the transaction will flow to the entity. This is a much lower burden than virtually certain, the phrasing used in the 2005 SORP, which has been updated to reflect this change. As a result, it is possible that in some cases income will be recognised by PBEs earlier than it would have been previously. Having said that, legacies are specifically addressed by Appendix B to Section 34 and the wording is such that in practice the accounting for legacies will not significantly change. The only new provision is that entities that are in receipt of numerous immaterial legacies may adopt a portfolio approach to income recognition where individual identification and consideration would be burdensome. PBE combinations Combinations which are in substance a gift are accounted for by acquisition accounting under Section 19 (see above). Combinations meeting the criteria of a merger may apply merger accounting, the mechanism of which is then explained and the disclosure requirements given. Merger criteria are considered above. Concessionary loans By definition, these are loans at below market rate that are not repayable on demand. Section 34 gives the option to recognise such loans at the initial transaction cost and thereafter at cost less any impairment, adjusted for any accrued interest. This is significantly different to the accounting that would otherwise be required under Section 10 (see above). Concessionary loans should be separately disclosed either on the face of the statement of financial position or in the notes. Individual loans may be aggregated unless doing so obscures significant information. Disclosure is also needed of the terms under which such loans have been made and any loan commitments not taken up at the period end. 17 of 24

18 Funding commitments The rules on recognition of funding commitments are based on the same principles as those for the recognition of any other liability, and are unlikely to result in any change to current accounting practice either for PBEs or commercial entities. There are, however, some additional disclosure requirements re such commitments required by TRANSITIONAL RULES ACTION There are a large number of transitional provisions and concessions available to entities on first time adoption of FRS 102. The majority of these are given in Section 35, although there are some which are noted in the main body of the Standard. The transitional provisions are not covered in detail in this Bulletin. If they have not done so already, entities transitioning to FRS 102 should discuss the implications of the new UK GAAP with their advisers as a matter of urgency, and consider which (if any) of the many transitional provisions and concessions to adopt. SOURCES FRS 102 (August 2014 and September 2015) Extant UK GAAP Charities SORPs 2005 and 2015 Companies Act 2006 SI 2008/410 SI 2015/980 UHY partners and staff may access all source information via Bloomsbury Professional Online. Both old and new accounting standards may be obtained from the FRC at tandards-in-issue.aspx The new Charities SORP may be obtained from the SORP microsite at Legislation may be obtained from the government website at 18 of 24