Introduction 83 Accounting Policies and Errors 85 Statement of Cash Flows
(Cash Flow Statement) 86 Consolidated Financial Statements 87
Deferred Taxation 87
Defined Benefit Pension Plans 88
Employee Benefits 88
Fair Value Accounting 89
Fixed Assets 89
Goodwill and Intangible Assets 90 Investment Properties 91 Leases 92
Revenue Recognition 93
Inventory (Stock) Valuations 94 Differences between FRS 102 and
IFRS for SMEs 94
INTRODUCTION
UK GAAP has been in existence for many years and financial reporting has evolved considerably over those years. The prevalence of International Financial Reporting Standards (IFRS) has gathered faster pace with many jurisdictions seeing the benefits of uniform financial reporting and hence the adoption of IFRS. In the UK and Republic of Ireland, it had been the intention by the (now defunct) Accounting Standards Board (now the Accounting Council of the Financial Reporting Council) that the UK and Republic of Ireland would adopt the use of an international-based financial reporting framework. This transition started in 2005 when all listed entities in the UK were mandated to apply EU-endorsed IFRS to their financial statements, closely followed in 2007 by those companies listed on the Alternative Investment Market. The decision to introduce an international-based framework in the UK was based on the fact that IFRS itself was becoming more widespread and the promotion of uniform accounting policies to give companies access to wider capital markets as well as improving consistency in the way entities report financial information has moved up the ranks considerably over the last decade.
In March 2013, the Financial Reporting Council (FRC) issued FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland. FRS 102 applies to unlisted entities and the publication of this FRS marked the end of a lengthy period of uncertainty within the accountancy profession as to the direction that UK GAAP was to take. FRS 102 was re-published in August 2014 to take account of changes to the financial instruments sections of the standard.
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Based on the International Accounting Standards Board’s IFRS for SMEs, FRS 102 brings about a simplified reporting regime for entities that will fall under its scope as well as introducing more up-to-date and relevant accounting requirements, which had fallen behind in the old UK GAAP. The Accounting Standards Board acknowledged some years ago that old UK GAAP had become far too complex and preparers of financial statements in the UK often complained about the onerous requirements imposed on them and their clients due to the voluminous nature of the old UK GAAP.
FRS 102 (August 2014) is 360 pages long (including the Appendices) in contrast to the old UK GAAP, which was in excess of 3,000 pages long, and this reduction in volume was hugely welcomed in the UK and Republic of Ireland. Roger Marshall, an FRC board member and Chairman of its Accounting Council, said that FRS 102
‘modernises and simplifies financial reporting for unlisted companies and subsidiar- ies of listed companies as well as public benefit entities such as charities’.
FRS 102 is largely a set of 35 stand-alone chapters. However, the FRC have included some cross-referencing for EU-endorsed IFRS to be consulted (for example, with regards to financial instruments).
The standard becomes mandatory for accounting periods commencing on or after 1 January 2015, although earlier adoption is permissible. In reality it is unlikely that the take-up for early adoption will be significant.
A point worth emphasising is that rules in FRS 102 are retrospective and hence the comparative year must be restated to conform to the requirements of FRS 102.
Therefore, assuming a 31 December 2015 year-end, it is the balance sheet as at 31 December 2013 that will form the backdrop for the new FRS 102 financial statements.
This is because the date of transition is the start date of the earliest period reported in the financial statements.
FRS 102 was originally exposed as FRED 48 and brought with it some welcome changes that were not previously incorporated into the previous Exposure Draft (for example, the option to capitalise borrowing costs as part of the cost of a self-con- structed asset). It also removed the concept of ‘public accountability’, which is con- tained within IFRS for SMEs and (if mandated in the UK and Republic of Ireland) would have resulted in some entities having to apply EU-endorsed IFRS, which would have been wholly inappropriate given the vast disclosure requirements contained in full EU-endorsed IFRS that would have applied to, for example, small pension schemes. It was difficult to define the concept of ‘public accountability’ in the eyes of legislation and so this concept was dropped in FRS 102.
As the UK standard-setters had always foreseen that the UK and Republic of Ireland would eventually report under an international-based financial reporting framework, they did, wherever possible, try to align old UK GAAP to its interna- tional counterpart. However, with a new financial reporting regime comes some new accounting practices and methodologies and FRS 102 does bring about some notable changes to old UK GAAP, which are covered in the next sections. FRS 102 also intro- duces terminology that is found in international GAAP and that differs from the termi- nology used in the Companies Act 2006. The following table outlines the differences in this terminology.
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Company law terminology FRS 102 terminology
Accounting reference date Reporting date
Accounts Financial statements
Associated undertaking Associate
Balance sheet Statement of financial position
Capital and reserves Equity
Cash at bank and in hand Cash
Debtors Trade receivables
Diminution in value [of assets] Impairment
Financial year Reporting period
Group [accounts] Consolidated [financial statements]
IAS EU-adopted IFRS
Individual [accounts] Individual [financial statements]
Interest payable and similar charges Finance costs
Interest receivable and similar income Finance income/investment income
Minority interests Non-controlling interest
Net realisable value [of any current asset] Estimated selling price less costs to complete and sell
Parent undertaking Parent
Profit and loss account Income statement (under the two-statement approach) Part of the statement of comprehensive income (under the single-statement approach)
Related undertakings Subsidiaries, associates and joint ventures
Stocks Inventories
Subsidiary undertaking Subsidiary
Tangible assets Includes: property, plant and equipment; investment property
Trade creditors Trade payables
ACCOUNTING POLICIES AND ERRORS
Accounting policies and errors are dealt with in Section 10 Accounting Policies, Estimates and Errors. Paragraph 10.4 of FRS 102 tells financial statement preparers that if FRS 102 does not specifically address a transaction, or other event or condition, an entity’s management must develop and apply an accounting policy, which is:
r Relevant – information is relevant to aid the decision-making process of users.
r Reliable – will result in the financial statements faithfully representing the financial position, performance and cash flows. In addition, the policy must also reflect the economic substance of the transaction(s)/event(s)/condition(s) rather than reflecting the legal form. To achieve reliability the policy adopted must be neutral, prudent and complete in all material respects.
FRS 18 Accounting Policies was very similar, but in some cases the end result and impact on profit or loss would not necessarily be the same.
Under the previous GAAP, FRS 3 Reporting Financial Performance required the correction of ‘fundamental’ errors by way of a prior-year adjustment. The term ‘fun- damental error’ was described in FRS 3 as an error that essentially destroys the truth
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and fairness of the financial statements. Section 10 requires an error to be corrected by way of a prior-year adjustment if it is ‘material’ and therefore it is likely that there will be more errors corrected by way of a prior-year adjustment under FRS 102 than was the case under the old UK standards.
STATEMENT OF CASH FLOWS (CASH FLOW STATEMENT)
The statement of cash flows is a mandatory statement under FRS 102 and there are no situations exempting companies under the scope of FRS 102 from preparing such a statement, although small companies are exempt from preparing a cash flow statement and a company applying FRS 101 Reduced Disclosure Framework is also exempt from preparing such a statement, provided the cash flow statement is included in the consolidated financial statements prepared by the parent.
FRS 1 Cash Flow Statements required a cash flow statement to be prepared using the following standard cash flow classifications:
r Operating activities
r Dividends from joint ventures and associates r Returns on investments and servicing of finance r Taxation
r Capital expenditure and financial investments r Acquisitions and disposals
r Equity dividends paid
r Management of liquid resources r Financing
Section 7 Statement of Cash Flows of FRS 102 requires the statement of cash flows to be prepared using three types of cash flow classification – those arising from:
r Operating activities, r Investing activities and r Financing activities.
Operating activities are the day-to-day revenue-producing activities that are not investing or financing activities. This category is essentially a ‘default’ category, encompassing all cash flows that do not fall within investing or financing classifications.
Investing activities are those activities that involve the acquisition and disposal of long-term assets, for example monies used for the purchase of fixed assets and cash receipts from the disposal of fixed assets.
Financing activities are those activities that change the equity and borrowing composition of the company. For example, if a client issues shares in the year to raise cash, the proceeds from the issue would be a financing activity. Similarly, where an entity raises a loan, such proceeds would be classified as a financing activity.
FRS 102 is going to require a lot more reclassifications of cash flows due to the reduced number of cash flow classifications. For example, corporation tax paid would have appeared under the ‘Taxation’ heading under FRS 1. Taxation is now incorporated
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within operating activities and only included within investing or financing activities if any of the corporation tax paid can be specifically attributed to investing or financing activities.
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated (and separate) financial statements are dealt with in Section 9 Con- solidated and Separate Financial Statements. There are not many significant changes between Section 9 and FRS 2 Accounting for Subsidiary Undertakings. However, FRS 102 does allow an accounting policy choice for subsidiaries that are held for resale and these can be measured at cost less impairment or at fair value. These ele- ments of the investment portfolio must be excluded and measured at fair value, which will result in more subsidiaries being excluded.
There is no impact on profit or loss where there is a change in non-controlling (minority) interests but the parent still retains control of the subsidiary. Such transac- tions are accounted for as a transaction with equity holders. Although the changes are not likely to impact a large range of business – where they do have an impact there are some important differences that entities need to take on board.
The definition of a subsidiary is slightly different from previous UK GAAP but any practical impact is likely to be unusual.
DEFERRED TAXATION
Deferred tax is dealt with in Section 29 Income Tax of FRS 102 and this Section requires deferred tax to be recognised in respect of all timing differences at the end of the accounting period. This is a similar concept to the previous FRS 19 Deferred Tax.
However, FRS 102 uses a timing difference ‘plus’ approach for deferred tax, which will result in larger deferred tax balances being recognised because Section 29 brings in three additional situations that will trigger deferred tax considerations:
1. Revaluations including investment property (this includes all revaluations rather than only when there is an agreement to sell the revalued asset).
2. Fair values on business combinations (which result in adjustment to the good- will recognised).
3. Unremitted earnings on overseas subsidiaries or associates (rather than only to the extent that the distribution has been agreed).
FRS 102 also combines all aspects of taxation into Section 29, whereas the old UK GAAP had a separate FRS 19 for deferred tax, FRS 16 Current Tax, SSAP 5 Accounting for Value Added Tax and tax issues relating to retirement benefit plans were also mentioned in FRS 17 Retirement Benefits.
FRS 102 also contains a prohibition preventing entities discounting deferred tax assets and liabilities down to present day values. In practice, hardly any entities dis- count deferred tax balances down to take account of the time value of money, so this prohibition is going to go largely unnoticed.
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DEFINED BENEFIT PENSION PLANS
FRS 102 deals with defined benefit pension plans in Section 28 Employee Benefits and paragraph 28.18 provides a number of simplifications where the valu- ation basis (the Projected Unit Credit Method) would require undue cost or effort.
Section 28 does not require the use of an independent actuary to provide a valua- tion as FRS 17 Retirement Benefits did. However, the entity must be able to meas- ure its obligation and cost under a defined benefit pension plan without undue cost or effort. Therefore, unless the reporting entity employs an actuary, companies are going to have to use the services of an actuary to arrive at the valuation required to incorporate the defined benefit pension plan into the financial statements and also to provide necessary disclosure notes for the plan. In addition, Section 28 does not require a comprehensive actuarial valuation to be carried out annually. In periods between comprehensive actuarial valuations, and provided the principal actuarial assumptions have not changed significantly, Section 28 recognises that the defined benefit obligation can be measured by adjusting the prior period measurement for changes in employee demographics (for example, the number of employees and their salary levels).
There is also a change in FRS 102 relating to the net interest on the net defined benefit plan liability that may have a significant impact, depending on the assets held by the plan. This is calculated as a single item by multiplying the net defined benefit plan’s liability by the discount rate used to determine the present value of the plan’s liabilities. Under the previous FRS 17, a reporting entity would have calculated an expected return on plan assets and an interest cost relating to the plan’s liabilities and so the revised approach in Section 28 is likely to have a potential impact on an entity’s earnings.
This could also impact group planning, in terms of whether to introduce a contrac- tual agreement or stated policy of charging the costs of defined benefit pension plans to individual group entities.
EMPLOYEE BENEFITS
The main issue surrounding this area in Section 28 Employee Benefits is the fact that the Section requires accruals for holiday pay (as well as other short-term benefits provided to employees that have accrued, but have not been paid at the reporting date). Under the previous UK GAAP, many companies did not make accruals for such transactions (despite FRS 12 Provisions, Contingent Liabilities and Contingent Assets citing an example of unpaid holiday pay accrued, but not paid by the entity until the subsequent accounting period as meeting the definition of a liability). The difficulty under FRS 102 is potentially going to be in the calculation of holiday pay that is to be carried over for future use and the pulling together of this informa- tion for the very first time, which is likely to be cumbersome and time-consuming – especially for larger organisations where there is no central record kept of this information.
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FAIR VALUE ACCOUNTING
FRS 102 places an increased amount of emphasis on the use of fair values as well as introducing a number of accounting policy choices that will be available to entities reporting under the Standard. This increased emphasis affects a number of areas of the financial statements, such as:
r Biological assets – living animals and plants that can be measured using fair val- ues provided such fair values can be obtained reliably. Changes in the fair values of biological assets are taken through profit or loss. However, the fair value model is not a mandatory model and reporting entities can still carry such assets at cost.
r Business combinations – intangible assets acquired in a business combina- tion that are separate from goodwill at acquisition and whose fair value can be measured reliably are measured at fair value.
r Financial instruments – certain financial instruments, such as derivatives (for- ward foreign currency contracts, interest rate swaps and options and commod- ity contracts) and investments in certain equity shares, are carried at fair value with changes in fair value going through profit or loss.
r Investments in subsidiaries – are carried at fair value (where such fair values can be reliably estimated) with changes in fair value going through profit or loss.
Alternatively, the parent can carry the investment in the subsidiary at cost less impairment.
r Investment property – is valued at fair value when such values can be measured reliably with changes in fair value going through profit or loss (not a revalua- tion reserve).
r Property, plant and equipment – can be measured using either the revaluation model (for all assets in the same class) or under the depreciated historic cost model. On transition to FRS 102, an entity can elect to use an old UK GAAP val- uation as ‘deemed cost’ and carry the asset under the cost model going forward.
FIXED ASSETS
Old UK GAAP at FRS 15 Tangible Fixed Assets went into a lot of detail concern- ing the capitalisation criteria for ‘subsequent expenditure’. As a general rule, FRS 15 required subsequent expenditure to be written off to profit or loss unless the expenditure:
r Provided an enhancement of the economic benefits of the asset that were in excess of the previously assessed standard of performance.
r Related to a component of a tangible fixed asset that had been treated sepa- rately for depreciation purposes, which was replaced or restored.
r Related to a major inspection or overhaul of the tangible fixed asset that restored the economic benefits of the asset(s) that had been used up by the entity and that had already been reflected in the depreciation charge.
Paragraphs 34 to 41 of FRS 15 went into a lot of detail where subsequent expend- iture was concerned. FRS 102 does not specifically cover subsequent expenditure,
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but merely states at paragraph 17.15 that day-to-day servicing of property, plant and equipment must be recognised in profit or loss in the periods in which the costs are incurred. Preparers of financial statements under FRS 102 would be directed to the Concepts and Pervasive Principles in Section 2 of FRS 102 to determine whether any subsequent expenditure does, in fact, meet the definition and recognition criteria of an asset outlined in paragraphs 2.15(a) and 2.27(a) and (b).
Paragraph 17.5 of FRS 102 deals with ‘spare parts and servicing equipment’.
Under the previous UK GAAP, these would have been ordinarily carried in the finan- cial statements as inventory, with recognition taking place as and when such parts/
equipment were used in the business. FRS 102 at paragraph 17.5 requires ‘major’
spare parts and standby equipment to be included within the cost of the fixed asset(s) to which it relates when the business is expected to use them for more than one accounting period. The main difference here is that FRS 15 did not make specific ref- erence to ‘major spare parts/standby equipment’. The treatment under FRS 102 essen- tially means that the cost of major spare parts/standby equipment would be recognised within the depreciation charge rather than in profit and loss through consumption of stock (i.e. cost of sales). This would also potentially have an impact on an entity’s gross profit margins.
Where fixed assets are acquired under a deferred payment arrangement (i.e.
deferred beyond normal credit terms), the cost of the asset must be the present value of all future payments in accordance with paragraph 17.13 of FRS 102. Such issues were not specifically covered in FRS 15 and this would mean that under FRS 15, the value of assets that were capitalised would essentially be understated, giving rise to a lower depreciation charge. FRS 102 addresses this issue so that the net book value of fixed assets under FRS 102 is higher, but this would also have a consequential increase on the depreciation charge, thus reducing profitability or increasing losses.
There is a difference with regard to residual values. Under previous UK GAAP such values were based on prices prevailing at the date of acquisition and an upward adjustment was only permitted in limited circumstances. Under FRS 102, estimates are based on current prices and thus can be adjusted upwards or downwards in certain circumstances.
GOODWILL AND INTANGIBLE ASSETS
Intangible assets (other than goodwill) are dealt with in Section 18 Intangible Assets other than Goodwill with goodwill being dealt with in Section 19 Business Combinations and Goodwill. The key difference in FRS 102 as opposed to FRS 10 Goodwill and Intangible Assets is in relation to the presumed maximum life of good- will where management are unable to make a reliable estimate of such a useful life.
Old UK GAAP presumed a maximum life of 20 years, with an option to rebut this presumption if a longer or indefinite useful life could be justified. FRS 102 says that intangible assets and goodwill will always have a finite life and where no reliable estimate can be made of such intangible assets or goodwill, the presumed useful life is deemed to be a maximum of five years. At the time of writing, the Department for
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