Steve Collings highlights some of the key issues arising from the FRC’s recent triennial review of FRS 102.
On 23 March 2017, the FRC issued FRED 67 Draft Amendments to FRS 102 – Triennial Review 2017. This FRED proposed several amendments to FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland as part of the FRC’s triennial review of the suite of ‘new’ UK GAAP. In addition, there are also some amendments being proposed to FRS 105 The Financial Reporting Standard applicable to the Micro-entities Regime.
The changes to FRS 102 as part of the FRC’s triennial review, which were finalised on 14 December 2017, have been developed based on feedback received by the FRC and addressed many of the implementation issues that preparers of financial statements under the new reporting regime faced. The changes have also been designed to either clarify the requirements within the standard or improve the standard and hence should not be viewed as being arduous to implement.
The majority of the changes implemented as part of the triennial review were editorial and/or intended to clarify certain accounting treatments rather than make changes to those treatments. The amendments take mandatory effect for periods starting on or after 1 January 2019 and early adoption is permissible. However, with the exception of the director-shareholder loan to a small company and gift aid, any early adoption of an amendment means all the amendments must be adopted at the same time (i.e. an ‘all or nothing’ option). Loans to a small company from a director-shareholder or group of close family members of the director-shareholder and the gift aid amendments can be early adopted separately without having to early adopt the other triennial review amendments.
This article does not examine all the changes arising as part of the triennial review, but highlights some of the key issues, as described below.
There were a number of undue cost or effort exemptions contained within FRS 102, which the FRC have removed. As noted above, the International Accounting Standards Board (IASB) included a number of additional undue cost or effort exemptions within IFRS for SMEs as part of their review in 2015, but the FRC have decided not to follow the IASB’s stance on the grounds that some of the undue cost or effort exemptions contained in FRS 102 were not being applied with sufficient rigour. In some cases, it became apparent that the undue cost or effort exemptions were being viewed as accounting policy choices, which they are not.
An example of where the FRC removed a ‘popular’ undue cost or effort exemption was within the investment properties section of FRS 102 (Section 16 Investment Property). In the September 2015 edition of FRS 102, paragraph 16.7 said that where the fair value of an investment property can be reliably measured without undue cost or effort, then it should be measured at fair value with changes in fair value being recognised in profit or loss.
Some entities interpreted the undue cost or effort exemption in Section 16 as being an accounting policy choice, whereby they can either choose to measure investment property at fair value or measure such properties under the historic cost model. This was never the intention by the FRC and therefore to avoid confusion, the FRC removed the undue cost or effort exemption. The consequence of this is that all investment properties are now measured at fair value at each reporting date (although there are some exceptions for investment properties within a group – see the next section).
While, to some extent, the proposals appear to be going back to a similar treatment that applied under old UK GAAP, it is not a complete reversal as the accounting treatment for investment property under Section 16 continues to be at fair value through profit or loss rather than via a revaluation reserve.
Other areas where undue cost or effort exemptions were removed were in respect of:
- Section 14 Investments in Associates - paragraph 14.10
- Section 15 Investments in Joint Ventures - paragraph 15.15
- Section 16 Investment Property - paragraphs 16.1, 16.3, 16.4, 16.7 and 16.10
- Section 17 Property, Plant and Equipment - paragraph 17.1(a).
Under old UK GAAP at SSAP 19 Accounting for investment properties, paragraph 8(b) contained a scope exemption for groups which meant that property let to, and occupied by, another group member was not an investment property for the purposes of either the separate financial statements or the consolidated financial statements.
This scope exemption was not carried over into FRS 102 and proved to be problematic for group companies. As the scope exemption relating to groups was not carried over, it meant that where, say, a parent company rented out a property to a subsidiary, the property would be classified as an investment property in the parent’s own individual financial statements and hence should have been measured at fair value through profit or loss. In the consolidated financial statements, a consolidation adjustment would have to be done to reclassify the property from investment property to property, plant and equipment. This is because consolidated financial statements must show the results of the group in line with its economic substance, which is that of a single reporting entity and hence any intra-group issues are eliminated. Understandably, some groups were unhappy about this accounting treatment and questioned the usefulness of reclassifying in the separate financial statements and reversing it in the consolidated financial statements.
The FRC took on board feedback from some groups which criticised this requirement and have inserted new paragraphs 16.4A and 16.4B which deal specifically with investment property that is rented to another group entity. Paragraph 16.4A provides an accounting policy choice for group members to either account for such properties at fair value through profit or loss OR transfer them to property, plant and equipment (Section 17) and apply the cost model contained in that section in the individual financial statements of the group member. It is likely that the latter option will prove to be the most popular as effectively this will restore the position in FRS 102 to what it was in SSAP 19 for properties let to group members.
The treatments under FRS 102 where financial instruments are concerned has certainly not been without controversy and have proved somewhat challenging to many companies, particularly where there are loan transactions entered into at below market rates.
Financial instruments are dealt with in FRS 102 in Section 11 Basic Financial Instruments and Section 12 Other Financial Instruments Issues. In order to treat a financial instrument as basic, and hence be able to account for it under Section 11, the instrument had to meet the detailed conditions outlined in paragraph 11.9. The wording in Section 11 can be difficult to interpret in many situations and to aid clarity, the FRC have introduced a description of a basic financial instrument whose objective is to support the detailed conditions in paragraph 11.9. Paragraph 11.9A of FRS 102 says:
‘A debt instrument not meeting the conditions in paragraph 11.9 shall, nevertheless, be considered a basic financial instrument if it gives rise to cash flows on specified dates that constitute repayment of the principal advanced, together with reasonable compensation for the time value of money, credit risk and other basic lending risks and costs (eg liquidity risk, administrative costs associated with holding the instrument and lender’s profit margin). Contractual terms that introduce exposure to unrelated risks or volatility (eg changes in equity prices or commodity prices) are inconsistent with this.’
The intention of including a description of a basic financial instrument is that a relatively small number of financial instruments that would have otherwise been accounted for under Section 12 (as they breached the conditions in paragraph 11.9) would now be able to qualify for treatment as basic, and hence be accounted for under Section 11 and be measured at amortised cost rather than at fair value through profit or loss.
Loans from director-shareholders
It is not uncommon for a company to receive or make a loan to a director who is also a shareholder – and this is widespread among the SME sector. Invariably, such loans are often entered into at below market rates, or at zero percent rates of interest.
Under FRS 102, where there are formal loan terms in place and the loan is repayable after more than 12 months from the balance sheet date, the loan has to be discounted to present value using a rate of interest which is market rate and the difference between the loan amount and the present value (known as the ‘measurement difference’) is brought into the financial statements. This treatment did not arise under previous UK GAAP and hence was unusual territory for many preparers on transition to FRS 102. The accounting treatment for the measurement difference will depend on the substance of the arrangement (for example, in the case of a loan from a director-shareholder, the measurement difference will usually be treated as a capital contribution).
The requirement to obtain market rates of interest and the discounting of these types of loans from director-shareholders have proved to be particularly challenging for companies and the FRC took on board feedback received where this is concerned. Generally, a market rate of interest would be the rate of interest the small company would pay if it were to obtain a similar loan from its bank.
In order to provide relief - for a small company only - from the requirement to account for loans from a director to the small company at present value, the FRC introduced paragraph 11.13A into FRS 102 which will mean that a loan from a director or a close member of the family of that person (as defined in the Glossary to FRS 102) can be accounted for at transaction price rather than at present value. The triennial review extended the concession slightly to small groups of the director’s family. Paragraph 11.13A states:
‘As an exception to paragraph 11.13, the following financing transactions may be measured initially at transaction price:
(a) a basic financial liability of a small entity that is a loan from a person who is within a director’s group of close family members1, when that group contains at least one shareholder2 in the entity; and
(b) a public benefit entity concessionary loan (see paragraph PBE11.1A).
1 In this context, a director’s group of close family members shall be the director and the close members of the family of that director (see glossary definition of close members of the family of a person). This includes a person who is the sole director-shareholder of an entity.
2 For small LLPs this shall be read as a member who is a person.’
Therefore, loans from directors who are not shareholders will not qualify for the exemption. Loans from shareholders will qualify for the exemption if at least one close family member is a shareholder.
Care must be taken with this exemption because it is restrictive and only applies to loans from a director who is also a shareholder in the small entity, or a close member of the family of that person. Companies outside of the small companies’ regime will not be able to apply the exemption and the exemption does not apply to loans to a director-shareholder.
The concession is available for small companies from December 2016 year-ends onwards. The FRC brought forward the relief for small companies to allow those small companies with a December 2016 year-end the opportunity of taking advantage of it. Had they not brought it forward, a small company with a December 2016 year-end would have had to discount such loans, only to then reverse the effects of discounting in the December 2017 year-end, but a small company with a March 2017 year-end would have been able to take the option if they used the full nine months’ filing grace from Companies House. This was due to the timing of the finalisation of the amendments to FRS 102 (December 2017).
Section 1A Small Entities in FRS 102 has been extensively amended as part of the triennial review due to small entities in the Republic of Ireland being brought within the scope of Section 1A due to the enactment of the Companies (Accounting) Act 2017. The small companies’ regime for entities in the Republic of Ireland is available for periods starting on or after 1 January 2017. However, entities in the Republic of Ireland can early adopt the requirements as far back as periods beginning on or after 1 January 2015, provided that the financial statements have not yet been approved.
Section 1A sets out the presentation and disclosure requirements which a small company is required to follow in the preparation of their financial statements. Recognition and measurement is still based on full FRS 102.
The disclosure requirements for small entities in the UK are set out in Appendix C of Section 1A Disclosure requirements for small entities in the UK. The disclosure requirements which a small entity in the Republic of Ireland is legally required to make are contained in Appendix D Disclosure requirements for small entities in the Republic of Ireland. The five disclosures that were contained in Appendix D in the September 2015 edition of FRS 102 have been moved into Appendix E Additional disclosures encouraged for small entities. An additional paragraph has been inserted into Appendix E encouraging small entities in the Republic of Ireland to provide the disclosures in paragraphs 1AE.1(b), (c) and (e). These relate to the fact that an entity is a public benefit entity (if applicable), going concern disclosures and transitional disclosures on first-time adoption of FRS 102.
The FRC issued a separate FRED (FRED 68 Draft amendments to FRS 102 - Payments by subsidiaries to their charitable parents that qualify for gift aid). While FRED 68 was separately issued, it was dealt with as part of the triennial review.
There have been divergent practices where gift aid payments are concerned which were brought to the FRC’s attention. For accounting purposes, gift aid payments are a distribution, but for tax purposes they are a donation. A legal opinion obtained by the ICAEW confirmed that gift aid payments are a distribution and hence should be treated in much the same way as a dividend. There is an ICAEW technical release on this subject (TECH 16/14BL REVISED Guidance on donations by a company to its parent charity).
The problem that gift aid payments presented was whether they should be accrued at the balance sheet date where no Deed of Covenant was in place. Where a Deed of Covenant was in place, the treatment was less complex because the Deed of Covenant satisfies the recognition of a gift aid payment where payment is made after the year-end.
Paragraph 85 of the Basis for Conclusions of FRS 102 confirms that gift aid payments are to be recognised as a distribution to owners as they are similar to dividends (i.e. they are recognised within equity). Paragraph 85 also cross-refers to paragraph 32.8 of FRS 102 which specifically deals with dividends and states that where an entity declares a dividend after the balance sheet date, that dividend is not to be recognised as a liability. The same principles must be applied to gift aid payments and an expected gift aid payment must not be accrued unless a legal obligation to make the payment exists at the balance sheet date. Paragraph 85 of the Basis for Conclusions confirms that a board decision to make a gift aid payment to a charitable parent, which has been taken prior to the reporting date, is not sufficient to create a legal obligation.
More than half of the respondents to FRED 68 stated that, in their opinion, a liability should be recognised for an expected gift aid payment if, for example, there is a past practice of making such payments. The FRC concluded that this is inconsistent with the requirements of FRS 102 (i.e. paragraph 32.8 and dividends) and they did not agree that this reflects the substance of the transaction which is that of a distribution to owners and hence no amendment was made to FRS 102 in this respect.
As noted above, gift aid payments are distributions for accounting purposes and donations for tax purposes. When a subsidiary does not have a legal obligation to make a distribution of its profits to its owners at the balance sheet date, it will have taxable profits and hence will need to recognise a tax expense. This is because paragraph 29.14 of FRS 102 prohibits the tax effects of dividends being recognised before the dividend itself has been recognised.
The amendments to FRS 102 state that when it is probable (i.e. more likely than not) that a gift aid payment will be made within nine months of the reporting date to the same charitable group, or charitable venturer, and the payment will qualify to be set against profits for corporation tax purposes, the gift aid payment can be accrued.
The gift aid payment is recognised as a distribution to owners and the tax effects are recognised in profit and loss.
FRS 105 The Financial Reporting Standard applicable to the Micro-entities Regime
It was expected that FRS 105 would see significant amendments as it is based on the provisions in FRS 102. The most notable change in FRS 105 is the inclusion of micro-entities in the Republic of Ireland which have been brought within the scope of the micro-entities regime by virtue of the Companies (Accounting) Act 2017.
Micro-entities in the Republic of Ireland (RoI) are now able to apply FRS 105 for periods starting on or after 1 January 2017. Early adoption of FRS 105 is permissible provided the Companies (Accounting) Act 2017 is applied from the same date.
For UK micro-entities, there are two additional disclosure requirements which must be made at the foot of the balance sheet, which are:
- information about off-balance sheet arrangements as required by section 410A of the Act, and
- information about employee numbers as required by section 411 of the Act.
These disclosures apply for periods starting on or after 1 January 2017. They are a legal requirement and hence should have been included in financial statements for periods starting on or after 1 January 2016, but were omitted in the July 2015 edition of FRS 105.
Disclosures in respect of off-balance sheet arrangements and employee numbers were included as a result of amendments by The Companies, Partnerships and Groups (Accounts and Reports) Regulations 2015 (SI 2015/980). This statutory instrument made amendments to sections 410A and 411 by removing the phrase: ‘In the case of a company that is not subject to the small companies regime’. This means that all companies must disclose off-balance sheet arrangements and employee numbers.
In addition, the disclosure information necessitated by s396(A1) requires the micro-entity’s accounts to state:
- the part of the UK in which the company is registered
- the company’s registered number
- whether the company is a public or a private entity and whether it is limited by shares or by guarantee
- the address of the company’s registered office, and
- where appropriate, the fact that the company is being wound up.
This article was adapted from Chapter 1 of Steve Collings’ new book, A Practical Guide to UK Accounting and Auditing Standards (Bloomsbury Professional) (https://www.bloomsburyprofessional.com/uk/practical-guide-to-uk-accounting-and-auditing-standards-9781526503312/)
Steve Collings is the Audit and Technical Director at Leavitt Walmsley Associates Ltd. He is also a member of the UK GAAP Technical Advisory Group at the Financial Reporting Council.