The changing face of accounting:

FRS 102

Tessa Park and Tim Gonzaga 4 June 2015

What we will be covering

An overview of the new Framework

Who needs to adopt and when

Key differences from current UK GAAP

The implications for you and your business

Managing the transition

What happens with the tax?

Overview of the new framework

All existing FRS, UITF, SSAP going

Replaced by a small suite of standards:

– FRS 100 (an overview standard)

– FRS 101 (reduced disclosures for some entities

otherwise adopting IFRS)

– FRS 103 /104 (don’t worry about these!)

FRS 102 – all the accounting and disclosure requirements

FRS 105 (draft) same, only for ‘micro entities’

How will this affect me?

Do I need to adopt?

Applies to all entities preparing

accounts under UK GAAP except

FRSSE companies

However, FRSSE to be withdrawn

with effect from 2016

So unless you elect to use IFRS/

FRS 101 – yes!

When do I need to adopt?

Applies for accounting periods beginning on or after

1/1/2015

Small companies: from 1/1/ 2016

Key dates – first accounting period under FRS 102: and

Date of transition (point at which everything gets

retrospectively restated)

Some useful one off exemptions on transition (see later)

Can early adopt – but adds time pressure

What do I need to do?

Default position is full retrospective restatement

This means:

– Take account of all differences at date of transition – however far

back they go

– Restate all balance sheet items where this is necessary

– May involve recognition and measurement changes

– Changes that affect brought forward P&L – adjust retained

earnings at date of transition

What do I need to do? (2)

First year of preparing financial statements under FRS 102

– prepare reconciliations:

– Balance sheet at date of transition

– Balance sheet at date of last financial statements published under

old UK GAAP

– Profit and loss account ditto

Disclose the reconciliations in the notes to the accounts

What will my accounts look

like?

Some new requirements – statement of

changes in equity

Statement of comprehensive income – one part

or two?

Cash flow statement – totally different format

Statement of compliance with FRS 102

Disclosure of significant judgements and

sources of estimation uncertainty

PYA for all material errors in prior year, not just

those that are fundamental

What else will I need to think

about?

The numbers are likely to change – profits may well go

down (or possibly up)

This may have an effect on

– Bonus policy

– Dividend policy

– Banking covenants

– Tax payable

Best to think about this now rather than later

Key changes

Key changes

Intercompany/ other long term loan balances

Media write backs

Property

Deferred tax

Holiday pay accruals

Financial instruments & foreign exchange

Goodwill and intangible assets

Business combinations and other group issues

Health warning - these are not the only

differences!

Long term loan balances

Issues arise where loan balances are at zero or a below

market rate of interest and are long term (i.e. more than

one year)

This is common with intercompany loans or loans from / to

related parties

FRS 102 requires them to be treated as ‘financing

transactions’

Logic – company getting a benefit from not paying a

market rate

Long term loans (2)

On initial recognition – show at present value of

eventual amount of repayment

Discount over term of loan using a market rate of

interest on a similar debt instrument (need to

impute/ estimate/ guess)?

Then unwind discount over the term

Potentially significant differences between

repayment amount and amount initially recognised –

how to account for difference?

Issues to consider

What is a comparable market rate? What rate could the

loan have been obtained from a bank?

What is the expected time frame (realistically) for

repayment? Is there an agreed term?

Should terms of loan be formalised (or changed?)

Should a market rate be charged? (possible tax

consequences?)

Issues to consider (2)

If on demand – no issue

However, reclassification as current could have serious

effect on liquidity of balance sheet

May need to renegotiate covenants with external lenders?

If no explicit terms, this would usually be default position

Media write backs

Big issue for media where accrual recognised but invoice

never received – though could apply to any uninvoiced

accrual

FRS 102 (unlike old UK GAAP) contains explicit guidance

on derecognition of liabilities

Liabilities can only be derecognised when settled, released

by the creditor, or expires

Media write backs (2)

In the case of media write backs – unlikely to either be

settled or released by creditor

Can be said to have expired when statute of limitations has

passed

6 years from date the liability was initially incurred

Not permissible to write back any earlier under FRS 102 –

so may require accounting policy change/ adjustment at

DoT

Property, plant and equipment

Major difference is treatment of

revaluations – cost model is

basically the same

Gains on revaluation go through

other comprehensive income –

again basically same as now

Losses go to profit or loss – unless

previously recognised gain on same

asset – can no longer offset

Investment property

Valued at fair value – unless FV cannot be

obtained without ‘undue cost or effort’

Term is not defined – but if were able to

obtain sensible valuations in the past,

exemption unlikely to be available

All gains and losses on investment property

are shown in profit or loss

Not realised so not distributable – need to

keep track!

Leases

Overall 2 main points of difference

No ’90% test’ for determining whether lease

is finance or operating

Lease incentives spread over lease term

rather than period to first rent review

Lease term is the non-cancellable period plus

any further periods which are highly probable

to be entered into at the inception of the

lease

Deferred tax

Nobody’s favourite area of accounting!

Generally – more ‘timing differences’

under FRS 102 than current UK GAAP

Therefore – more deferred tax balances

recognised – with consequential effects

on profits

In addition – discounting of deferred tax

balances prohibited

Deferred tax (2)

Recognised on all revaluation gains

even if no binding agreement to sell

BIG difference – main impact where

property held– consider effects on b/s

ratios/ covenants?

Other big difference - recognised on

fair value adjustments on a business

combination (with balancing

adjustment to goodwill on

acquisitions)

Holiday pay accruals

Explicit requirement to accrue for

‘accumulating compensated absences’

Holiday pay and any similar entitlements

where there is an ability to carry forward

Not an issue where policy is ‘use it or lose

it’ (and enforced)

Holiday pay accruals (2)

If entitlement to c/f holiday – recognise accrual at o/s

holiday x average daily rate of pay

Particular problem where holiday year not the same as

accounting year, or where holiday entitlement depends on

when an individual joined

May be constructive obligation if in practice allow c/f even

though policy doesn’t technically permit

Full retrospective restatement required – so best to do DoT

calculation ASAP

Financial instruments

Key principle – financial instruments are

split between ‘basic’ and ‘other’

Most (though not all) basic are at cost or

amortised cost

This includes bank loans with

straightforward terms

‘Other’ are at fair value

Financial instruments (2)

Derivatives (forward currency contracts, interest rate

swaps taken out separately from loan) – bring on

balance sheet at fair value and re-measure at each

reporting date

Investments in other entities – show at fair value,

unless unquoted equity instruments and fair value

cannot be reliably measured

Financial instruments (3)

Main implications:

– Terms of loans will need to be reviewed carefully to determine if

basic or not

– Cannot just assume bank loan will be basic

– Consider renegotiation? (Bank may not agree!)

– How do you fair value anyway? (talk to the bank)

– Listed, and many unlisted, investments will have to be fair valued

(easy if listed, less so if not)

Foreign exchange

Need to disclose functional currency – may not always be

Sterling

Currency of primary economic environment in which

company operates

Can choose a different presentation currency

Use of a contracted rate or closing rate to translate

transactions is not permitted – need to use spot rate. FX

contracts may be accounted for as hedges

Cannot use closing rate to translate P&L of foreign

operation

Goodwill and intangible assets

Under current UK GAAP – 20 years for

goodwill, though can have longer/

indefinite life

Under FRS 102 – use UEL of max 10 years,

if a reliable estimate of UEL cannot be

made

Indefinite life UEL/ intangibles not

permitted

Goodwill (2)

On transition – need to consider carefully whether a

reliable estimate of UEL can genuinely be made

(and if so, is it same as it was before?)

If yes – don’t need to do anything (except disclose)

If no – put through additional amortisation (increased

hits to consolidated profits)

Ditto company profits if goodwill from purchase of

unincorporated business

How to account will depend on why it’s changed

Business combinations

Need to determine whether any intangibles should

be recognised separately from goodwill

This could include brand names, databases or

customer relationships

Deferred tax provisions on FV adjustments

Need to factor in contingent liabilities, if FV can be

reliably measured

So potentially significantly different goodwill

balances

Negative goodwill same treatment as currently

Business combinations (2)

Piecemeal acquisitions – goodwill only calculated at the

point control obtained (none recognised subsequently if

changes in MI)

Merger accounting banned (except group reconstructions/

some charity combinations)

Fair value adjustments – one year from date of the

combination (not the subsequent year end date)

Contingent consideration – substance of earn out

arrangements?

JVs – equity accounting not gross equity

Business combinations (3)

Main implications:

– Goodwill balances may be significantly different

– Part acquisitions and part disposals will be accounted for

differently

– More intangibles – how to value? Could be quite difficult to do

– Accounting for JVs – arguably simpler?

Managing the transition

Transitional exemptions

A number of areas where there are optional exemptions

from full retrospective restatement on transition

Also some instances where full retrospective restatement

is actually prohibited

Some exemptions are more useful than others

Optional exemptions

Business combinations – exemption from restating

combinations before date of transition

However – will still need to restate deferred tax on fair

value adjustments

Since cannot adjust goodwill if taking exemption – adjust

brought forward consolidated reserves instead

Really useful exemption as removes need to unpick old

acquisitions

Optional exemptions (2)

Fair value or revaluation as deemed cost

Most useful for own use property

Can fix valuation under current UK GAAP as deemed cost

at date of transition – then apply (less depreciation) going

forward

So no need for future valuations

Can also do as a one-off if item not previously held at

valuation

Optional exemptions (3)

Lease incentives for leases commencing prior to DoT – can

use old treatment for spreading (quite useful)

Dormant companies – basically exempt from any

restatements unless balances change i.e. ceases to be

dormant (useful given intercompany balance issue)

A few other exemptions which are less useful – see section

35 of FRS 102

Prohibitions from retrospective

restatement

Can’t ‘lose’ prior year errors as transition differences

Accounting estimates not to be retrospectively

adjusted

For instance – legal case – provision for £50k in the

31/12/13 accounts. By the time the 31/12/15

accounts are prepared under FRS 102, case has

settled for £75k.

In FRS 102 numbers at DoT the provision is shown at

£50k – prevents the creative use of hindsight when

preparing the transitional numbers

Only exception is where accounting policies change

due to adoption or if material error

Tax aspects of FRS 102

Michael Haig

Corporation tax

Three areas to cover:

– General trading income

– Intangible assets

– Financial instruments

Two situations

– Transition

– Operating under FRS102

Corporation tax

General position

Change from one valid basis to another

Compare years up to 31/12/2014 (old); with 31/12/2015

(new)

Need to ensure

– Receipts taxed once

– Expenses allowed once

Adjustment on first day of new basis

Applies to trading and property business

General trading

Transition

Most transitional adjustments will be tax effective

– Property impairments/revaluations

– Disallowable/capital costs eg entertaining

Trading/property will follow FRS102 accounts

Accounts do not determine tax status eg revenue/capital,

wholly/exclusively

General trading

Media writebacks

Period over which media writebacks may be made

extended

May result PY adjustment in accounts

“Receipts…brought into account before the

change…[that]… would not have been…if the profits had

been calculated on the new basis.”

Deduction on first day of first period

Intangible assets

Transition

Only for “new” intangibles (1 April 2002)

Compare accounting value:

– End of last “old” period; and

– Start of first “new” period

Difference arises on 1st day of new basis

Not applicable if 4% election made

Intangible assets

Look out for

Research & development

– If enhanced deduction – no amortisation of intangible

Software

– Treated as Plant & Machinery – not affected

– Future expenditure – election for P&M treatment

Financial instruments

General

FRS102 has some profound effects

– “proper” Amortised Cost accounting

– Fair value accounting

– Recognition of derivatives

In addition, Loan Relationship Rules are changing!

– FRS102 from 1 January 2015

– Loan Relationships from 1 January 2016

Financial instruments

Transition

A number of interacting parts

– Legislation

– Change of Accounting Practice Regs

– Disregard Regs

A very complex area

Financial instruments

Transition

Basic rule

– Difference between closing and opening value

– Irrelevant how treated in accounts

– Includes derivatives

Change of Accounting Practice Regs

– Transition adjustments spread over 10 years

– Unless realised in first AP under new basis

Financial instruments

Living with FRS102

Loan Relationship rules tax all movements (for now…)

Some FIs “Fair Valued” but;

– connected parties always taxed under Amortised Cost

Amortised Cost or Fair Value accounting will result in gains

and losses

Initial recognition may give day 1 credit or debit

– Gaining clarity on where “spare” debit/credit goes; but

– Little guidance from HMRC

Financial instruments

Hedging

Derivatives recognised under FRS102

FV movements will be tax effective (for now…)

So hedges would not be effective for tax purposes

Disregard Regulations

– Attempts to restore pre-FRS26 UK GAAP

– Applies to certain hedging instruments

– FV movements disregarded until realisation

Will need to elect in to Regs

Financial instruments

New Loan Relationships

New loan relationship rules from 1 January 2016

Main changes

– Only tax P&L entries

– “Perpetual debt” – not a Loan Relationship

– Consultation on amendment to connected party rules

– Some changes to Disregard Regulations

Draft legislation in December?

Income Tax

Income Tax?

Companies must use FRS102

And so must LLPs

– Trading/property income similar to Corporation Tax

– P&L movements for intangibles not taxable/allowable

– Interest/discounts taxed on receipt/realisation

Taxable and accounts could be very different

Capital Gains Tax

Capital Gains Tax?!

HMRC Statement of Practice D12

Revaluation of, say, investment property;

Change in capital sharing ratios;

Chargeable disposal!

Conclusion

Tax issues separate but associated with accounting issues

Don’t assume accounting adjustments will be same as tax

Watch this space on FIs

Questions