Impact of change
in accounting standards to FRS 102
During the course of 2015 and 2016 a major change is
taking place concerning the accounting standards that govern the way a set of
accounts is put together. This could change both the figures and the
explanations in your accounts, including making retrospective changes to the
prior year figures that are shown. There can also be taxation impacts in some
situations.
The purpose of this letter is to set out a brief overview
of the possible areas of change. It is written on the basis that you are
currently using Financial Reporting Standards (FRS) and Statements of Standard
Accounting Practice (SSAPs) or the Financial Reporting Standard for Smaller
Entities (FRSSE) issued by the old Accounting Standards Board and you will be
moving to FRS 102. Small companies are generally affected in the same way as
larger companies, although there are a few differences which are highlighted
below.
Without a full analysis of your accounts and a discussion
with you regarding your choices of accounting policies and what are termed
transitional exemptions, it is not possible (at this stage) to identify the
precise areas of change. We would be happy however, to discuss completing this
exercise with you and to carry out additional work that you may require with
regard to accounting or tax as a result of these changes.
Summary of key changes
Financial statements
These might look a little different to your current
accounts. There are some new choices for terminology, moving to more
internationally used phrases such as property, plant and equipment instead of
tangible fixed assets and inventories instead of stock. The primary statements
required are now:
·
Statement of Financial Position (previously the Balance
Sheet);
·
Statement of Comprehensive Income; or
o Income
statement (previously the Profit and Loss) and a separate
o Statement
of Comprehensive Income (previously the Statement of Total Recognised Gains and
Losses)
·
A Statement of Changes in Equity (not required
for a small entity)
·
A Statement of Cash Flows (not required for a
small entity)
·
Notes
Cash flow statement
Small companies are not
required to have a cash flow statement, but for others, the format of this has
changed quite significantly. There are now just three main headings, operating,
financing and investing activities.
For subsidiaries there is
no automatic cash flow exemption, but there is a reduced disclosure regime
which would permit the Statement of Cash Flows, together with other
disclosures, to be omitted if certain conditions are met.
Financial instruments
These include a wide range of assets and liabilities
which are financial, rather than tangible or intangible in nature. For example,
cash, debtors and creditors are all financial instruments. The main changes in
respect of these items are that:
·
Investments in shares that are not group
companies must be measured at fair value if possible, with any unrealised or
realised gains or losses reflected in the profit or loss.
·
Derivatives, which includes items such as a
forward currency contract, an interest rate swap, futures or options all need
to be recognised in the balance sheet at their fair value with gains or losses
in the profit or loss. In the past these were ignored until the contract was
completed. The new treatment means that you will need to check if you have any
such contracts and obtain a valuation for them, together with the valuation
method used.
·
Loans that are not at a market rate need to be
put into the accounts as if they are at market rate. This requires the
calculation of notional interest at a market rate. (Public benefit entities,
such as charities, do not need to do this though).
Foreign currency translation
The rules have changed so that where you have foreign
currency transactions you will always need to translate the amounts at the rate
ruling on the date of the transaction (the spot rate). In the past, you were
able to use the rate of any related forward contract, or a contracted rate if
one was agreed.
There is a requirement in FRS 102 to establish the
functional currency of the entity. Normally this will be pounds sterling for a
UK company, but if most of its cash flows are in another currency, or impacted
by another currency then this may not be the case. We can discuss the impact of
this if you think it might apply.
Hedge accounting
Because the impact of the changes described for foreign
currency and financial instruments can be to increase the volatility in the
profit and loss and not to match related transactions, there is the ability to
use hedge accounting. This is a complex process but ensures close matching of
related contracts, such as a foreign currency purchase and forward foreign
exchange contract. If you think you may wish to use hedge accounting please
discuss this with us.
Business combinations, associates and joint ventures
Acquisitions, or so called business combinations, are
usually dealt with in the consolidated accounts if these are required (small
groups are not required to prepare consolidated accounts). Under the new rules
you are more likely to have to recognise intangible assets, such as customer
lists, that you have purchased as part of the acquisition. Previously, these
would often have just been part of the goodwill figure.
There are also some minor changes regarding associates,
joint ventures and the accounting treatment of acquisitions or disposals
achieved in stages.
Related party transactions
There have been some changes to the definitions and to
the disclosure requirements, although these are fairly minor, unless you are a
small company. Small companies will only need to disclose limited related party
transactions and in particular only those which are not at a market rate.
Goodwill
If you cannot reliably estimate the life of goodwill,
there are new rules that require the maximum life to be 10 years (or in some
cases in 2015 only, 5 years). This may mean that some adjustments are needed to
the amortisation period and/or value of goodwill in your accounts.
Investment property
If you hold investment property you will have to show it
at fair value in the balance sheet, as now, but changes in value will go
through the profit and loss for the year.
Property, plant and equipment
There are only minor changes to the rules here, although
a transitional option exists which allows you to use a valuation of an asset as
its deemed cost. This means you could, for example, value a property just once
and then treat that value as if it were cost. This avoids having to continue
valuing on a regular basis, which is required if you want to adopt the revaluation
model. Instead, this transitional option allows a one-off uplift of the value
of an asset.
Lease incentives
If you are a lessee or lessor of an asset under an
operating lease then any lease incentives, such as rent free periods, will now need
to be spread over the whole lease term. Currently they are just spread over the
period to the first rent review. The lease term is now defined as the period over
which there is reasonable certainty that the lease will continue, even if there
is a break clause before that. This can have taxation implications, so you may
wish to discuss this with us, as there are various options on transition.
Deferred tax
The rules for this have now been tightened up, meaning
that deferred tax is required on some items that were previously exempt. This
means that deferred tax will need to be recognised on all revaluations and also
sometimes on unremitted earnings from a subsidiary. This will generally mean
that your deferred tax figure will be higher than before.
Employee benefits
The new rules mean that it will be necessary to consider
whether you need an accrual for holiday pay, where holiday is due at the
year-end but has not been taken. If this amount is material it will need to be
calculated each year and put into your accounts. It is usually only material if
the holiday year and the accounting year are different, or if you allow staff
to carry over significant amounts of holiday into the next year.
There have been some changes to the accounting for
defined benefit pension schemes, but as these are rare please ask for further
information if this affects you.
Share-based payments (FRSSE companies)
FRSSE companies have been exempt from the requirement to
account for equity settled share-based payments. However, under FRS 102 they
will now need to be accounted for. For other companies, the requirements for
these are essentially the same as under the
current rules.
Transitional changes
The general rule when dealing with the move to FRS 102 is
that all the changes are applied retrospectively, through the calculation of
what is termed a prior year adjustment. However, as this would sometimes be
very onerous there are a number of transitional exemptions, enabling the new
rules to be applied only in the future. These do not cover all the changes
though, so in the first year there will probably be adjustments made to
reserves and disclosures will be needed to explain the impact on the balance
sheet and profit and loss. (Small companies are not required to give these
disclosures although they are likely to be helpful to anyone using the
accounts).
Practical impacts of the changes
There are some areas of
your business that could be impacted adversely by the changes in the accounting
rules if you do not consider the issues. Broadly speaking they include any
contract, covenant or other agreement which is based on or refers to your
accounts or specific figures in them. In particular, because the profit can be
more volatile and include items such as gains on investment properties that are
not yet realised, you should consider the following:
·
Is there likely
to be an impact in meeting any bank covenant requirements?
·
Do I need to
change any bonus or profit related pay agreements to exclude gains on items not
yet realised?
·
Are there any
earn-out agreements, on for example a business acquisition, which are based on
profit in the accounts, but have not taken account of the changes due to FRS
102?
·
Do I need to
make any tax elections in connection with financial instruments, so that tax is
only charged when the final transaction takes place?
·
Do I need to
consider the impact of tax on my tax flow forecasts?
We appreciate that these
changes are wide-ranging and complex and we will, of course, be happy to advise
and provide additional services to ensure that the transition to FRS 102 is
dealt with as smoothly as possible. Please do call if you wish to discuss these
matters further or to arrange for a quote to be provided for any additional
services that you might require in connection with the transition to FRS 102.
Yours sincerely
