FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland (September 2015) becomes mandatory for small companies if the accounting period starts on or after 1 January 2016.
Therefore, small companies with 31 December 2016 year-ends are going to be some of the first small entities to apply the standard for the first time. The FRSSE (effective January 2015) is withdrawn in its entirety and micro-entities may choose to apply FRS 105 The Financial Reporting Standard applicable to the Micro-entities Regime if they wish.
A small company reporting under FRS 102 will apply the provisions in Section 1A Small Entities. This section, which was first introduced into the September 2015 edition of FRS 102, outlines the presentation and disclosure requirements that a small company must apply in the preparation of its financial statements. Please note that Section 1A only outlines the presentation and disclosure requirements; in terms of recognition and measurement of amounts in the small entity’s financial statements, these will be based on the provisions in full FRS 102.
Related party disclosures
The issue concerning related party disclosures has often caused problems for accountants, largely because of their subjective nature. Related party disclosures for small entities are outlined in Appendix C Disclosure requirements for small entities at paragraphs 1AC.34 to 1AC.36. These disclosure requirements reflect the provisions in the EU Accounting Directive which restricts the disclosures to only limited related party disclosures.
The fact that related party disclosures have been reduced in company law will, at first, seem quite a welcome change as in some cases there may be no related party disclosures made in the small entity’s financial statements. However, in some situations, the circumstances of related party transactions in a small company might mean that applying Section 1A is not quite as straightforward as in another small company.
As the size thresholds which determine whether a company is small, and hence eligible to apply Section 1A of FRS 102, have been increased significantly (from £6.5m turnover to £10.2m and £3.26 balance sheet total to £5.1m), this means that many more companies that would have been medium-sized under the old thresholds will now drop into the small companies’ regime and hence these companies will be eligible to apply Section 1A provisions when preparing their financial statements. Some of the companies that will now be part of the small companies’ regime might have some fairly complex related party transactions to consider and therefore care needs to be taken in applying the provisions of paragraphs 1AC.34 to 1AC.36 correctly and taking the necessary steps to document any decisions reached.
Paragraph 1AC.35 says that particulars must be given of transactions which the small entity has entered into ‘… that have not been concluded under normal market conditions.’ The phrase in italics can be taken to mean that the related party transactions have not been undertaken on an arm’s length basis, even though FRS 102 does not use this terminology. The particulars which must be given in respect of related party transactions which have not been carried out on an arm’s length basis include:
- the amount of such transactions;
- the nature of the related party relationships; and
- other information about the transactions necessary for an understanding of the financial position of the entity.
It is worth noting that Section 1A does not require the names of the transacting related parties; however, some companies might choose to disclose the names for reasons of clarity and/or completeness.
The requirement to disclose directors’ remuneration in the financial statements of a small company was repealed in SI 2015/980. SI 2015/980 amended the Companies Act 2006 to reflect the provisions in the EU Accounting Directive and these amendments apply mandatorily for accounting periods starting on or after 1 January 2016 (with early adoption as far back as periods starting on or after 1 January 2015, but before 1 January 2016, permissible).
One of the emerging issues which is beginning to come to the surface is the question as to whether directors’ remuneration in some small companies is actually being concluded under normal market conditions and therefore not disclosable, or whether such remuneration is not being concluded under normal market conditions and hence is caught under the disclosure requirements. Certainly what may be regarded as normal market conditions for one company might not be regarded as such in another company. This is where professional judgement is going to be needed to be applied.
For many small companies, it is not uncommon to organise directors’ remuneration and dividends in a tax-efficient manner; for example, small company directors that are also the shareholders are often paid a salary up to the PAYE threshold, with any additional remuneration being taken in the form of dividends.
Directors’ remuneration would require disclosure under Section 1A of FRS 102 when it is concluded that such remuneration has not been undertaken under normal market conditions. Views differ on what ‘normal market conditions’ in this context means.
The upshot of the removal of the requirement in law to disclose directors’ remuneration and only to disclose it as a related party transaction if such remuneration has not been concluded under normal market conditions essentially means that professional judgement will have to be applied, both on the part of the small company directors and of the accountant. Reliance on accounts production software systems should not be a reason for deliberately leaving out the disclosure as most systems will have functionality allowing directors’ remuneration to be disclosed.
When uncertainties present themselves, particularly with regard to the issue of directors’ remuneration and disclosure versus non-disclosure, the advice is to document any decisions or conclusions reached. It might well be that the directors of the small company view a mix of salary and dividends in combination to be normal market conditions for their remuneration, and hence no disclosure would be needed if this is concluded.
AAT Licensed Accountants are strongly advised to make a professional judgement call on whether the directors’ remuneration issue is concluded under normal market conditions. Some commentators argue that normal market conditions are not the same as ‘market rate’ whilst some commentators bring in the market rate test to see if the transaction is being carried out under normal market conditions. Documenting decisions reached on this, or any other issue which requires professional judgement, will be invaluable in case any of the judgements are questioned further down the line.
Paragraph 1AC.35 of FRS 102 does try to steer the accountant into making the disclosures by saying that small companies which choose to disclose all transactions with related parties (including those concluded under normal market conditions) would still be compliant with the law. However, the advice is to proceed with caution and to document any decisions that are reached. Over time, there might be some guidance issued where this is concerned; however, as the Financial Reporting Council is not allowed to require small and micro-entities to make mandatory disclosures beyond the requirements of the EU Accounting Directive, there are likely to be different levels of related party disclosures under the new reporting regime where small companies are concerned.
Other directors’ transactions
Directors’ transactions include directors’ remuneration and dividends paid to directors. However, any advances and credits granted by the small entity to the director(s), together with guarantees of any kind entered into by the small company on behalf of the directors, must be shown in the financial statements. This is a Companies Act 2006 requirement and hence will be needed where advances, credits and guarantees have been entered into.
In respect of an advance or a credit, the details required are:
- its amount;
- an indication of the interest rate;
- its main conditions;
- any amounts repaid;
- any amounts written off; and
- any amounts waived.
Monetary totals must be stated in respect of items a, d, e and f.
In respect of a guarantee, the details required are:
- its main terms;
- the amount of the maximum liability that may be incurred by the small entity; and
- any amount paid and any liability incurred by the small entity for the purpose of fulfilling the guarantee (including any loss incurred by reason of enforcement of the guarantee).
Monetary totals are required to be stated in respect of items b) and c).
FRS 102, as a whole, is proving to be a challenge in many areas for many accountants and there are lots of subjective areas which will need the accountant and the directors to exercise professional judgement.
Further technical articles will be published on AAT Comment which will examine some of these subjective areas. In addition, certain technical provisions of FRS 102 are examined in the Staff Education Notes which are available from the Financial Reporting Council’s website in the New UK GAAP section of the website.
Steve Collings is the audit and technical partner at Leavitt Walmsley Associates Ltd.