Many of us still talk about ‘new UK GAAP’. But the truth is that it isn’t really all that new anymore as FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland – the standard that forms the cornerstone of the ‘new’ regime – was issued back in March 2013 and became effective for accounting periods beginning on or after 1 January 2015.
Just over four years since FRS 102 was issued, it’s time for a bit of a refresh. For some time now the FRC have been reaching out to stakeholders asking them to suggest ways in which the standard could be improved or to highlight areas where implementation was challenging. On the back of this feedback, the FRC recently published FRED 67, an exposure draft setting out a number of proposed improvements and clarifications.
The press release accompanying the exposure draft describes these proposed changes to FRS 102 as ‘simplifications’ and promises that they will make it ‘easier’ and ‘more cost-effective’ to apply the standard. So, at first glance, this sounds like a good news story. On second glance, however, there’s a danger that you’ll feel a little overwhelmed by the sheer volume of changes being proposed. But delve a little deeper and it quickly becomes apparent that many of them will have very little effect in practice.
Helpfully, the FRC has highlighted the five proposals that are likely to have the biggest impact. It doesn’t mean that these are the only proposed changes you need to think about. But they’re certainly a good place to start. Which is what we’re going to do in this blog.
Accounting for directors’ loans provided to the company interest-free or at below market interest rates has – for many - been one of the biggest challenges in applying FRS 102, which typically requires such loans to be treated as financing transactions. This means that in many instances directors’ loans have to be initially measured at the present value of the future payments discounted at a market rate of interest for a similar debt instrument, and subsequently accounted for at amortised cost.
A particular challenge for small entities is that identifying a market rate of interest for a similar debt instrument can be highly problematic when the borrower would struggle to obtain alternative finance in the open market. This may be the case when an entity has no collateral to offer, is a start-up or is experiencing financial difficulties. Similarly, it may be difficult to establish a market rate of interest for loans with a term that is significantly longer than the period for which an entity typically borrows.
The exposure draft therefore proposes introducing an option that would allow small entities to initially measure loans from directors who are also shareholders – or from their close family members –at the transaction price rather than at present value. At a stroke this would fix one of the biggest bugbears of many practitioners. As such, this proposal is likely to be widely welcomed.
Another area that has caused concern is the requirement under FRS 102 to recognise more intangible assets acquired in a business combination separately from goodwill than used to be the case under old UK GAAP. Some have argued that ascertaining the value of these additional intangibles involves significant additional cost and effort but reaps little if any benefits for users of the financial statements.
The FRC has acknowledged that in some instances the costs of complying with this requirement can be disproportionate. However, they also accept that some entities may wish to provide this information in order to afford users with additional useful information about the business combination. The FRC have therefore reached something of compromise position. On the one hand they are proposing that entities will be required to recognise no more intangibles than they did under old UK GAAP. But on the other hand, they are also proposing that entities may, on an asset-by-asset basis, choose to separately recognise additional intangibles.
So in other words, if the proposals are accepted, entities will be able to separately recognise very few intangibles just as they did under old UK GAAP, lots of intangibles as they did under the original version of FRS 102 or somewhere in between the two. While some many bemoan the lack of consistency, others are likely to welcome the added flexibility – and the cost savings – that this will bring.
Under old UK GAAP, property let to and occupied by another group company was excluded from the definition of an investment property. This exemption was removed when FRS 102 was introduced, meaning that on transition many properties that were previously classified as property, plant and equipment had to be reclassified as investment properties and measured at fair value through profit or loss rather than being measured at cost less accumulated depreciation and impairment. The only way around this was where the entity could show that determining fair value would require ‘undue cost or effort’. In practice this exemption could seldom be applied.
Under the proposals, entities would be able to choose to measure these investment properties at cost less depreciation and impairment instead of fair value, with the undue cost or effort exemption removed for all investment property. These proposed changes will remove what many see as an unnecessary burden and as such they are – again – likely to be widely welcomed.
The requirements relating to ‘basic’ and ‘other’ financial instruments set out in Sections 11 and 12 of FRS 102 respectively have also proved contentious, especially for those entities that discovered that some of their debt instruments unexpectedly failed to qualify as ‘basic’ and therefore had to be measured at fair value through profit or loss.
The proposals would retain the current prescriptive conditions for determining whether an instrument qualifies as ‘basic’ or ‘other’ but would also add a new overarching principle-based description that is likely to see additional financial instruments classified as basic. But before anyone gets over-excited, this isn’t a carte blanche that would allow entities to classify any instrument they like as ‘basic’. It will, however, allow a little more wriggle room in some marginal cases.
The final big change being proposed relates to the definition of a financial institution.
While it has always been very clear that certain entities – such as banks, building societies and credit unions – are within the scope of this definition, there has been some confusion about whether it also captures a number of organisations – including some group treasury functions – that many would not normally consider to be financial institutions. Making the additional disclosures that financial institutions are required to give can be quite onerous, so finding that you unexpectedly meet the definition of such an entity can be not only bewildering but also burdensome.
The proposed changes to the wording of the standard should mean that a smaller number of entities meet the definition of a financial institution.
The FRC have requested that comments on the exposure draft by 30 June 2017. The aim is to finalise the amendments in December 2017, with an effective date of accounting periods beginning on or after 1 January 2019. Early application will be permitted.
A second exposure draft looking at how to incorporate recent major changes to IFRSs into UK GAAP is expected in the autumn. Any amendments arising from this phase of the triennial review will be effective for accounting periods beginning on or after 1 January 2022.
ICAEW will be responding to this consultation in due course. If you have any views or comments on the proposals please drop me an email.
If you’d like to find out more about these proposals, the faculty is hosting an event at Chartered Accountants’ Hall on 19 April and a webinar on 18 May. Both are free to ICAEW members.