What do the changes mean for UK businesses?
Companies of all sizes often complain that financial reporting regulation always seems to be changing. Not surprisingly, many of our clients turn to us in understanding what these amendments mean, and more importantly, how we can help them to prepare for these changes.
When FRS 102 was originally introduced in 2015, many firms hoped that it heralded a period of stability for the vast majority of UK businesses who prepare under FRS 102 (and who had a lot of work to do to get themselves ready for FRS 102).
Despite that optimism, it wasn’t really the case. During its first triennial review, the Financial Reporting Council (FRC) made further changes to FRS 102 that will impact on UK companies.
The full text of the Triennial Review can be found on the FRC website, which is here.
When do the changes to FRS 102 come into effect?
The amendments take mandatory effect for periods starting on or after 1 January 2019, which means that for any business which has a 31 December 2019 year-end, your next accounts will need to be compliant.
This article doesn’t highlight all the changes introduced, but reviews the key issues which are going to most affect those preparing their financial statements.
Intangibles Acquired in Business Combinations
The FRC has amended Section 18 of FRS 102 on intangible assets acquired in a business combination. The requirements have now been changed so that businesses are only required to recognise such intangible assets separately from goodwill if they meet the recognition criteria, are separable and arise from contractual or other legal rights.
Companies are still given the choice to separately recognise additional intangible assets, though this is now a policy option rather than a requirement.
In practical terms, this should result in fewer intangible assets being separated from goodwill in business combinations.
Removal of ‘Undue Cost or Effort’ Exemptions
The FRC has removed the exemption of ‘undue cost or effort’ which they felt was being abused by many companies. Prior to the review, companies were required to measure all investment property at fair value, unless there was undue cost or effort in determining such a fair value.
This exemption has now been removed, so all investment property (with the exception of investment property rented to another group entity) must now be measured at fair value. Many companies were interpreting ‘undue cost or effort’ as an accounting policy choice, rather than an exemption to measure investment properties at cost, so for this reason the FRC decided to remove it altogether.
The change means that all investment properties must be valued at fair value, with gains or losses hitting the Profit and Loss account and deferred tax calculated. For those companies that previously measured at cost using this exemption, they must now assess a fair value.
It’s worth noting that the valuation does not necessarily need to be undertaken by an expert valuer, and directors could possibly value the investment property, although full FRS 102 adopters will need to disclose in the financial statements the methods and major assumptions made by management in determining fair value.
Investment Properties within Groups
For investment property rented out to another group entity, a new accounting policy choice has been introduced. Under previous GAAP these properties were measured at cost less depreciation, although this choice was removed when FRS 102 was first introduced.
After some feedback, the FRC have now decided to allow companies a choice: they can measure such investment properties rented out to group members either at cost (less depreciation and impairment) or at fair value.
If the company decides to choose this cost model for such properties, then on transition to the new reporting policy, a company is permitted to use the fair value of such an investment property as its deemed cost at the date of transition to the Triennial Review (i.e. the start of the comparative period).
It is worth noting, however, that all other investment properties rented out to third parties (i.e. not to group members) must be measured at fair value and there is no cost model choice.
Director/Shareholder Loans Exemption
For many small companies, directors or shareholders will often enter into loans with the company at lower than market (or zero) interest. FRS 102 initially stated that these loans were ‘financing transactions’ and the present value should be measured on initial recognition, with the difference being a capital contribution.
Changes made in May 2017 and subsequently by the triennial amendments have simplified this area for small businesses. They are now allowed an option to measure loans from a director (or their group of close family members when that group contains at least one shareholder) at transaction price, rather than present value. In short, it simplifies things.
Companies previously avoided having to make the present value calculations by making these type of loans legally repayable by demand and classifying them as short term liabilities. The changes mean that they can now think about the way this debt is structured without having to complete the present value calculations.
Key Management Personnel Compensation
FRS 102 requires the disclosure of the aggregate compensation paid to key management personnel. The Triennial Review introduces an exemption from disclosing key management personnel compensation where:
- The company is subject to a legal or regulatory requirement to disclose directors’ remuneration in its financial statements; and
- The key management personnel and directors are the same.
This removes duplication where key management personnel and the directors are the same, and disclosure of the compensation paid to both is required in the financial statements.
Classification of Financial Instruments
Under FRS 102 financial instruments are classified as either ‘basic’ or ‘other’, with the classification determining the accounting treatment for the instrument. The Triennial Review introduces an additional description of debt instruments which should be treated as basic financial instruments when the specific conditions set out in FRS 102 to account for them as basic are not otherwise met.
This change will result in a small number of financial instruments, which currently fail to meet the conditions for classification as basic instruments, now being classified as basic instruments and therefore measured at amortised cost, rather than their fair value.
Statement of Cash Flows – Net Debt Reconciliation introduced
The FRC has introduced the requirement to disclose a net debt reconciliation. This disclosure is based on, but not identical to, the requirements of “old UK GAAP”, FRS 1 – Cash Flow Statements.
FRS 102 – The Final Word
While the changes brought about by the Triennial Review are quite narrowly focused, the effects may be significant for some businesses. It’s therefore important that affected clients are fully prepared for the changes, especially as we approach year-end and think about closing out this year’s accounts. If you’re not sure whether and how the changes affect your business, feel free to get in touch with us.