FRS 105 The Financial Reporting Standard applicable to the Micro-entities Regime is a new standard issued by the Financial Reporting Council (FRC) in July 2015.
The scope of the standard is quite restrictive and only incorporated entities can apply the framework (i.e. limited companies and limited liability partnerships). The standard itself is based around the legal framework on which FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland is based; however, FRS 105 contains significant simplifications and disclosure reductions.
FRS 105 is mandatory for accounting periods which start on or after 1 January 2016, although early adoption is permissible.
AAT Licensed Accountants should ensure that they consider the suitability of FRS 105 to their micro-entity clients on a case-by-case basis. This is because while the standard may be appropriate for some micro-entities, it will not be appropriate for them all. This article considers some of the main issues which practitioners and AAT Licensed Accountants working for micro-entities need to consider when establishing whether, or not, FRS 105 is appropriate.
One of the most notable features of FRS 105 are the ‘deeming provisions’. The micro-entities’ legislation has been drafted to say that if a micro-entity prepares its financial statements in accordance with the basic legal requirements, then those financial statements are presumed in law to give a true and fair view.
This means that the directors of the micro-entity need not consider any additional disclosures that may be needed in order to achieve a true and fair view, which was not the same approach a micro-entity could take under the outgoing Financial Reporting Standard for Smaller Entities (the FRSSE). This does not, however, mean that the micro-entity cannot make additional disclosures voluntarily if it wishes; although where the micro-entity chooses to make additional voluntary disclosures it must do so in accordance with FRS 102, Section 1A Small Entities.
Micro-entities are defined as being a ‘subset of the small companies’ regime’ in FRS 105. As mentioned in the introductory section of this article, despite the term ‘micro-entities’ only incorporated entities can use it (i.e. it is only available to limited companies and limited liability partnerships). The following types of entity are not eligible to use FRS 105:
- – charities
- – any companies excluded from the small companies’ regime
- – financial institutions
- – credit institutions
- – insurance institutions
- – small parent companies that choose to prepare group accounts (thus if a micro-entity’s financial statements are consolidated in with those of a parent, that micro-entity cannot apply (FRS 105); and
- – public companies.
If the micro-entity is a type of business which is eligible to use the standard, the next issue to consider is the size thresholds. A micro-entity qualifies to use FRS 105 if it does not exceed two, or more, of the following criteria
- – Turnover of not more than £632,00
- – Balance sheet total (i.e. fixed assets plus current assets) of not more than £316,00
- – Not more than an average number of employees
If the micro-entity has a short accounting period, then the turnover figure is pro-rata’d accordingly. For example, if a new start-up business has been trading for nine months of the year and wants to use FRS 105, then the turnover figure of £632,000 will be substituted for £474,000 (being £632,000 x 9/12).
It is important to clarify that the term ‘balance sheet total’ is fixed assets plus current assets. The net assets figure must not be used because this is, of course, after the deduction of the micro-entity’s liabilities. The term ‘balance sheet total’ is also referred to as ‘gross assets’ and is a Companies Act requirement. Also, the employee headcount total is based on the average number of employees during the year; it is not the actual number of employees at the year-end. Again, the employee headcount criteria is a Companies Act requirement.
Prohibition of the fair value and alternative accounting rules
The micro-entities’ legislation does not recognise any of the fair value or alternative accounting rules provided in the Companies Act 2006. As a consequence, a micro-entity cannot carry any assets at fair value or at revaluation. Where assets have been carried at fair value, or at revaluation under, say, the FRSSE (effective January 2015), then the micro-entity must remove all fair value and revaluation amounts on transition and in the comparative year. There is a detailed article on AAT Comment which examines this issue in more detail in respect of investment properties that were carried at open market value under the FRSSE (effective January 2015).
In addition, it is worth noting that previous revaluations for GAAP purposes cannot be used as a deemed cost because FRS 105 requires all assets to be stated under the historical cost model which means assets will be carried at cost, less accumulated depreciation and less any amounts recognised in respect of impairment.
Lack of accounting policy options
FRS 105 does not allow a micro-entity to have accounting policy options because the Corporate Reporting Council (previously known as the Accounting Council) of the FRC concluded that to allow a micro-entity the ability to apply different accounting policy options would confuse users. Therefore, the standard is very prescriptive and hence for a micro-entity that perhaps capitalised development costs as an accounting policy option under the FRSSE, they will not have this option under FRS 105 and all such development costs must be expensed to profit or loss.
Significant disclosure reductions
The disclosure reductions under the micro-entities’ regime are significant in comparison to outgoing UK GAAP. Section 6 Notes to the Financial Statements in FRS 105 outlines the legally required disclosures but there is also an Appendix to Section 6 which is considered to be an integral part of FRS 105 which ‘drills down’ in more detail as to what these disclosure requirements actually are. This is because the disclosure requirements in Section 6 cover different parts of the Companies Act 2006 and the disclosures relate to:
- – advances, credit and guarantees to directors and
- – financial commitments, guarantees and contingencies in respect of the company.
The disclosures above are included at the foot of the balance sheet in the micro-entity’s financial statements rather than as a separate entity in the financial statements themselves.
Production of non-statutory information
The disclosure reductions above essentially mean that the scope for the preparer producing additional non-statutory information will be greater. This is an issue that should be considered by practitioners particularly because additional costs may be incurred in preparing non-statutory financial information to complement the financial statements or because lenders and/or creditors have requested such information.
Rigidity of the financial statements format
The first point to emphasise where the financial statements themselves are concerned is that a micro-entity can only prepare a Format 2 profit and loss account which classifies expenses by nature, rather than a Format 1 profit and loss account which classifies expenses by function (cost of sales, distribution costs, administrative expenses and so forth). The structure of a Format 2 profit and loss account for a micro-entity is as follows
- – Turnover
- – Other income
- – Cost of raw materials and consumable
- – Staff cost
- – Depreciation and other amounts written off asset
- – Other charges
- – Tax
- – Profit or loss
It is important to bear in mind that none of the item descriptors can be changed and hence if ‘other charges’ simply consisted of motor expenses, the line item descriptor must stay as ‘other charges’.
A micro-entity can prepare a Format 1 or a Format 2 balance sheet, provided of course they are consistent from one reporting period to the next. However, a notable feature of FRS 105 is that there is no disaggregation of the balance sheet. For example, fixed assets are not split between intangible fixed assets, tangible fixed assets and investments with additional breakdowns of these figures in the notes to the financial statements – there is simply one line item on the face of the balance sheet as ‘Fixed assets’. Similarly, current assets are not split according to the order of liquidity (i.e. stocks and work in progress, debtors, bank and cash) – again there is simply one line item ‘Current assets’ on the face of the balance sheet (although prepayments and accrued income are shown separately). This is potentially where the micro-entity’s directors or other interested parties might ask for a breakdown as to what is in each category on the balance sheet.
No deferred tax
Micro-entities are prohibited from accounting for deferred tax. This is on the grounds that it would not be possible to distinguish deferred tax and current tax and hence the Corporate Reporting Council decided to prohibit micro-entities from accounting for deferred tax. Therefore, on transition to FRS 105, a micro-entity will remove all deferred tax provisions and take the corresponding entry to profit and loss reserves (retained earnings). The entity must then remove deferred tax in the prior year and ignore deferred going forward whilst reporting under FRS 105.
Filing requirements at Companies House
Micro-entity financial statements must still be lodged with the Registrar of Companies within nine months of the financial year; there are no special concessions in respect of the filing requirements where micro-entities are concerned. As a minimum, the micro-entity must file the balance sheet with the related balance sheet notes at the foot of the balance sheet. Micro-entities need not file the Format 2 profit and loss account if they do not wish. In addition, the directors’ report for a micro-entity is no longer needed for accounting periods starting on or after 1 January 2016 and hence this will not be filed as micro-entities will not be preparing such a directors’ report.
Pace of growth of the micro-entity
If a new start-up business is expected to grow at a rapid rate, it might not be advisable to use FRS 105 as the financial reporting framework because this may mean undertaking a transition to FRS 102, Section 1A as a minimum in a relatively short period of time if the micro-entity outgrows FRS 105. To reduce the scope for additional costs being incurred by the client or the practitioner, in such situations it might be advisable to bypass FRS 105 and report under FRS 102, Section 1A.
The FRC are keen to emphasise that FRS 105 is an optional standard and a micro-entity can choose to apply a more comprehensive framework in the preparation of their financial statements if they so wish. The standard itself will be appropriate for some micro-entities but not necessarily for others and hence some of the factors that should be considered are:
- – the lack of accounting policy options
- – prohibition of carrying assets at fair value or under the revaluation model
- – the scope for producing non-statutory information
- – pace of growth of the micro-entity
- – the client’s wishes and
- – the views of banks or other lenders and creditors who may need additional information (this links into the production of non-statutory information).
Where a micro-entity has got assets carried at revaluation, it is important that the adviser carries out an impact assessment and advises the client as soon as possible as to the likely impact of applying FRS 105 because the client may wish to continue measuring assets at fair value or revaluation and hence in this situation the only possible means of doing this is by applying FRS 102, Section 1A as a minimum.
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Steve Collings is the audit and technical partner at Leavitt Walmsley Associates Ltd.