FRS102 What and when? The Financial Reporting Council has replaced the existing UK GAAP with The Financial Reporting Standard 102 (FRS102), which is applicable in the UK and Republic of Ireland. The new rules will apply for periods commencing from 1 January 2015; as a result the first accounting year-ends likely to be affected is 31 December 2015. Although the legislation only applies for year-ends commencing 1 January 2015, companies are required to prepare prior year comparisons under the same rules. This means that the opening balances of the prior period will need to be restated in line with FRS102. This is known as the transition date, for periods commencing 1 January 2015 the transition date will be 1 January 2014. An amended transition date balance sheet is not required to be presented in the financial statements, but will effectively have to be prepared to comply. As a result of the application of FRS102 there could well be a number of potential changes to the opening equity position. Within the first set of statutory accounts prepared under FRS102 the following disclosures will have to be made: An explanation of changes in accounting policy. A reconciliation of equity under UK GAAP as previously reported to the revised figure under FRS102. A reconciliation of the profit and loss for the last reported period prepared under UK GAAP and as reported in the revised figure under FRS102. Top 10 Implications of FRS102 1. Format of financial statements Other Comprehensive Income (OCI) replaces STRGL. May be combined with P&L if only items are dividends and error corrections/policy changes. 2. Statement of cash flows Includes cash-equivalents. Headings reduced to three: operating, financing and investing. 3. Deferred tax Must now be provided on asset revaluations e.g. investment properties. Discounting is not permitted. 4. Investment property Gains and losses go through P&L. Properties rented out to other group companies count as investment properties in parent (but not in group). 5. Business combinations Goodwill amortised over useful life, but if this cannot be estimated reliably then no more than five years. Separate intangible assets should be recognised if their fair value can be measured reliably. Default useful life is 5 years. 6. Disclosure exemptions for subsidiaries Provided certain conditions are met, subsidiaries may make reduced disclosures in their accounts, when reporting under FRS 102. 7. Financial instruments Unless simple, e.g. standard bank loan, must be stated at fair value. Intercompany loans at below market rate or interest-free will need to be discounted at market rate. 8. Defined benefit pension schemes Cost will either be recognised in parent company or spread across subsidiaries if there is an agreement on the basis of allocating surpluses or deficits. 9. Leases Total future lease payments must be disclosed and benefit of incentives such as rentfree periods must be spread over whole lease term. 10. Specialised activities e.g. agriculture Biological assets may be carried at cost or fair value, but subsequent changing from fair value to cost is not permitted.
Terminology changes There are a number of changes in terminology under FRS102. Below is a list of the main changes: UK GAAP terminology Profit and loss account Balance sheet Trade debtors Trade creditors Stock Cash flow statement Profit and loss reserves Statement of recognised gains and losses FRS 102 terminology Income statement/statement of comprehensive income Statement of financial position Trade receivables Trade payables Inventories Statement of cash flows Retained earnings Statement of changes in equity Main Changes Financial Instruments Under FRS102 financial instruments are recognised as either basic or other. Basic financial instruments include items such as cash, trade receivables and trade payables. These instruments are recognised initially at cost then re-measured at amortised cost. Other financial instruments include items such as interest rate swaps, forward contracts and complex loans. These instruments are initially recognised at fair value and then revalued to fair value with any movements being recognised in the income statement. Hedge accounting is allowed under FRS102 as long as certain criteria are met. A valuation of more complex financial instruments may be required at the transition date. This should be addressed as soon as possible as this will be more difficult to obtain retrospectively when the first accounts are prepared under FRS102. Employee benefits Under FRS102 companies will be required to accrue for short term benefits if they relate to previous service and are expected to be paid in the next twelve months. This will include wages, salaries, employers NIC, holiday pay, sick leave, profit share and bonuses, as well as non-monetary benefits such as housing, cars and subsidised goods/services for current employees. There are also changes to the disclosure of defined benefit pension schemes. Additional disclosures are required to cover the risk of the assets and the details of the policies in place.
Under UK GAAP companies were required to use an independent actuary at least every three years, however under FRS102 no independent actuary valuation is required, as long as the assumptions have not changed significantly. Where defined benefit pension scheme policies are multi-employer and are treated as a defined contribution policy under UK GAAP, this can continue under FRS102. However, if there is an agreement upon how deficits will be funded, the company shall recognise a liability for the contributions payable arising from the agreement and the expense in the income statement. Group plans can also be treated as above but if there is no agreement in place the net defined benefit cost of a defined benefit contribution scheme shall be recognised in the individual financial statements of the group company which is legally responsible for the plan. The other group companies should just recognise the cost equal to their contributions payable for the period. Under FRS102 additional disclosures are required to address this accounting method. Information will be required at transition date for such as a holiday pay accrual again this should be addressed soon rather than attempting this when the first accounts are prepared under FRS102. Leases FRS 102 classifies leases into finance and operating leases, respectively, depending on whether or not a lease transfers substantially all of the risks and rewards incidental to ownership from the lessor to the lessee. Such approach and classification is consistent with current UK GAAP (SSAP 21), however FRS 102 removes the presumption that a lease would be a finance lease if the present value of the minimum lease payments amounts to 90 per cent or more of the leased asset. This change may result in a different classification of some leases. FRS 102 also requires the classification of a lease depending on the substance of the transaction rather than the form of the contract. Another difference between FRS 102 and current UK GAAP is in respect of the recognition of lease incentives for operating leases, for example rent free periods. FRS 102 requires recognition of the incentive over the lease term while under current UK GAAP the benefit is allocated over the shorter of the lease term and the period ending when market rent will be payable, i.e. the period up to the first rent review. Thus under FRS 102 lease incentives may be spread over a longer period of time. At the transition date an entity has a choice whether to adopt the revised treatment under FRS102, o r to continue with the treatment under UITF28. There is some flexibility in that an entity can choose to recognise lease incentives differently for existing leases. Similarly an entity can assess the lease arrangement in place using the facts as at transition or commencement.
Investment properties The main change under FRS102 is the recognition of movements in value. Investment properties should initially be measured at cost and then subsequently revalued to fair value each year. Changes in fair value are recognised in the income statement not the statement of total recognised gains and losses (STRGL), which was previously the case under UK GAAP. If there is no reliable measure of fair value available then the cost less depreciation model may be used. The definition of investment property includes properties leased to other members of the same group in the individual accounts of the lessor (under current UK GAAP these are accounted for under FRS 15). Therefore group property companies will need to revalue properties rented out to fellow group undertakings on an annual basis with changes recognized in the profit and loss account. For group accounts purposes they will be accounted for as investment properties which is consistent with current UK GAAP. Potentially this could lead to significant changes in the result for the year which may affect banking covenants. In addition if a property was not previously classed as investment property but now is, then a valuation at transition is required and again maybe better addressed now rather than at the date of preparing the first financial statements under FRS102. Intangible fixed assets and goodwill The major change from UK GAAP is that all intangible assets, including goodwill are assumed to have a finite life. FRS102 assumes the useful economic life to be 5 years unless the company can make a reliable estimate to justify using a longer period. Non-financial assets are only tested for impairment where there is an indication of impairment, under current UK GAAP goodwill and intangibles with a useful economic life over 20 years are reviewed annually for impairment. Again, this could lead to significant effects on the net asset position and potentially banking covenants. Business combinations Under UK GAAP the recognition of separate assets and liabilities acquired under business combinations can only be done if the assets and liabilities are capable of being disposed of or settled separately. Under FRS102 there is no such requirement which means that more intangible assets will be separately identified from goodwill when purchased as part of business combinations. Government grants There are two methods for recognising government grants under FRS102: 1. Performance Model, under this model the company recognises income when the grant is received unless there are performance related conditions in this case the income is recognised
when the conditions have been met. Any grants received before criteria met are recognised as a liability. 2. Accruals Model, under this model the grant is classified as either relating to revenue or assets. If it is a revenue grant then the income is spread over the period of the related costs. Grants relating to assets are recognised in income over the useful life of the asset. Under UK GAAP grants were only permitted to be recognised under the accruals model. Borrowing costs Under FRS102 a company can capitalise borrowing costs directly attributable to acquisition, construction or production of a qualifying asset. The company has to apply this consistently to each class of qualifying assets. Where a company does not adopt this policy of capitalising borrowing costs, all borrowing costs are expensed in the profit and loss account in the period in which incurred. This is a new policy choice under FRS102. Deferred tax FRS 102 adopts a timing difference plus approach to deferred tax which will result in the recognition of more deferred tax assets and liabilities. The principal changes will be the recognition of deferred tax liabilities on upward property valuations and on unremitted overseas earnings. For companies with significant property revaluations this could have a substantial impact on the balance sheet net assets as additional deferred tax liabilities are recognised. This is a significant change and again impacts on the net asset position and hence potentially banking covenants. If you would like some further information regarding FRS102, please contact Chris Johnson either by e- mail at chris.johnson@pmm.co.uk or 01254 679131.