FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland deals with financial instruments in two sections: Section 11 Basic Financial Instruments and Section 12 Other Financial Instruments Issues.
Most, if not all, reporting entities will have some financial instruments which are treated as basic financial instruments, such as:
- trade debtors and creditors;
- intra-group loans;
- directors’ loans; and
- straightforward bank loans.
Effect of the triennial review
The triennial review, which was completed by the Financial Reporting Council (FRC) in December 2017 gave rise to new FRSs being issued in March 2018. The March 2018 editions of UK GAAP are mandatory for accounting periods commencing on or after 1 January 2019. Early adoption of the triennial review amendments is permissible, provided all of the amendments are applied at the same time. There two exceptions in respect of the directors’ loan account amendment (see FRS 102 (March 2018) paragraph 11.13A) and the gift aid amendments (see FRS 102 (March 2018) paragraph 29.14A) which can be early adopted separately without having to early adopt FRS 102 (March 2018).
The FRC included an additional paragraph 11.9A which provides a description of a basic financial instrument. Prior to the introduction of paragraph 11.9A, a financial instrument could only be classed as basic if it met all the detailed conditions in paragraph 11.9. The inclusion of a description of a basic financial instrument in paragraph 11.9A means that if the financial instrument fails to meet the detailed conditions in paragraph 11.9, but meets the description of a basic financial instrument, the instrument can still be classed as basic. This will result in a small number of financial instruments now being eligible to be treated as basic and accounted for under the amortised cost method rather than non-basic at fair value under Section 12.
Accounting for a straightforward bank loan under FRS 102
One of the challenges faced by AAT Licensed Accountants is how to account for financial instruments such as bank loans under FRS 102. The amortised cost method was a new method for most accountants and the way it works in practice was initially unfamiliar. The ‘amortised cost (of a financial asset or financial liability)’ is defined in the Glossary to FRS 102 as:
‘The amount at which the financial asset or financial liability is measured at initial recognition minus principal repayments, plus or minus the cumulative amortisation using the effective interest method of any difference between that initial amount and the maturity amount, and minus any reduction (directly or through the use of an allowance account) for impairment or uncollectability.’
A straight forward bank loan will fall under the scope of Section 11 and hence be accounted for at amortised cost. The accounting for this loan can be done using Microsoft Excel; in particular, the ‘Goal Seek’ function to calculate the interest in the loan which will be charged to the profit and loss account over the life of the loan.
Using the Goal Seek function in Microsoft Excel can be an efficient use of time as (provided the payments or receipts do not change throughout the life of the loan), the same schedule can be used each year in the working papers file. Do watch out for loans which have a variable interest rate, which will be examined in a future article. FRS 102, paragraph 11.20 states:
‘If an entity revises its estimates of payments or receipts, the entity shall adjust the carrying amount of the financial asset or financial liability (or group of financial instruments) to reflect actual and revised estimated cash flows. The entity shall recalculate the carrying amount by computing the present value of estimated future cash flows at the financial instrument’s original effective interest rate. The entity shall recognise the adjustment as income or expense in profit or loss at the date of the revision.’
Accounting for basic financial instruments can be complex under FRS 102 and it is important that AAT Licensed Accountants fully understand how the amortised cost method works. This will ensure that (a) the financial instrument is carried in the balance sheet at an appropriate amount and (b) the interest income or expense is reflected in the profit and loss account correctly.
Steve Collings is the audit and technical partner at Leavitt Walmsley Associates Ltd.