On 23 March 2017, the Financial Reporting Council (FRC) issued FRED 67 containing draft amendments to FRS 102 and other new UK GAAP standards. In this blog post, we consider some of the main proposals.
There is much to like in these proposals, although you may receive news of them with mixed feelings. On the plus side, the FRC who formulate and issue UK audit and accounting standards, have listened to the feedback from the profession. Concerns had been raised on practical issues in applying some of the requirements of FRS 102 and the potential lack of an appropriate balance between cost and benefit.
On the minus side, many of us have already gone through the pain (and cost) of applying these rules and might reasonably wonder why the points could not have been established earlier and been dealt with in the initial standard.
Before we go any further though, let’s see in outline, what the proposals for simplification cover (for accounting periods commencing on or after 1 January 2019, with early adoption available, but not on a cherry-picking basis):
- An option to not discount at the market rate of interest for loans from a director/shareholder to a small entity;
- No requirement to use fair value for investment properties used by other group companies;
- Further extension of which financial instruments can be treated as basic and measured at amortised cost;
- Relaxation of the requirements to split out other intangibles on a business combination;
- Fewer entities to be classed as financial institutions.
The accounting for financing transactions has been one of the most contentious in FRS 102 and is set to change to some degree.
The proposals now provide an exception to this requirement to discount the financing transaction at the market rate of interest. This applies where there is a basic financial liability of a small entity that is a loan from a director who is a natural person (so not another company or LLP) and a shareholder in the small entity (or a close member of the family of that person).
This (optional) exemption is a valuable step forward, but note its limitations –it does not apply to loans between group companies, for example and it is only available for small entities.
Under old UK GAAP properties rented to other group companies were not treated as investment properties, but as normal tangible fixed assets. FRS 102 currently requires them to be treated as investment properties in the individual entity accounts, so requiring a fair value to be established.
The proposals will permit such properties to be treated as property, plant or equipment or held as an investment property at fair value through profit and loss, as an accounting policy choice. For those entities that have already established a fair value, there is a transitional exemption to allow this to be used as deemed cost on application of these 2017 amendments. This will prevent even more work being done on getting the investment property back to cost again.
It should be noted though, that the “undue cost or effort” exemption that previously existed in Section 16, regarding obtaining a fair value for investment properties, is removed. Presumably this is because the exemption was primarily meant for group situations, which will have the option not to fair value as outlined above.
There is some rewording of the requirements regarding what is a basic debt instrument, dealt with at amortised cost in the accounts, and a non-basic one which is measured at fair value. This is still a complex area, but there has been an attempt to add an overriding principle regarding what is basic, rather than just have the rules, as currently set out in 11.9 of the standard.
This proposed revision is likely to be helpful when a complex debt instrument is nonetheless basic in principle, despite particular features that may cause it to fail the tests in the rules. It also gives an overarching description of what is meant by basic, which is likely to be helpful when initially classifying debt instruments.
The FRED proposes an amendment to the requirements in FRS 102 to recognise a separate intangible if it arises from contractual or legal rights to now also stipulate that the asset is separable. This will limit the situations in which an intangible must be recognised separately from goodwill, as previously under FRS 102 the asset only needed to be identifiable and not separable.
In practice it may be items such as customer lists, where there is no ability to separately sell these due to data restrictions, but which do arise from contractual rights, no longer have to be recognised separately on a business combination. However, there is still the flexibility to recognise such assets if desired where it is probable that there will be future benefit and the cost or value can be measured reliably.
The definition of a financial institution has been changed in the FRED, with the deletion of both retirement benefit plans and references to wealth generation or risk management through financial instruments from the requirements. This will be welcome for those entities previously caught by this part of the definition as there are significant extra disclosures required for such institutions.
There has been clarification in Section 23 of the requirements for revenue recognition when a single transaction involves the sale of multiple goods and services. This moves the standard slightly closer to IFRS 15 without yet having incorporated the model from that standard.
In addition to the headline points above, there are lots of more minor and editorial amendments proposed. Some of these aim to remove information that has proved to be of little value whilst others seek to cut clutter and improve understandability of accounts.
The FRC have also proposed minor amendments to FRS 105 that better reflect their current understanding of legal disclosure requirements under the micro-entities regime.
Before you get too excited about the proposed simplifications discussed above, remember that they are not yet available for use. The new version of the standard is proposed to be effective for accounting periods commencing on or after 1 January 2019. Early adoption will be available as long as all the amendments are applied at the same time.
In some areas the changes might just be clarifications of existing requirements so then the FRED provides useful background information which could be applied in making a judgement now. But for any substantive changes, we still have to wait until the proposals are in a final standard, so in practice early adoption is unlikely to be available until the tail end of this year when we might expect the final standard.
Details of the full consultation, which closes on 30 June 2017, can be found here.