This is the second of a two-part series of articles that looks at the new financial reporting regime which all companies that are not part of the small companies’ regime will have to apply mandatorily for accounting periods starting on or after 1 January 2015, followed by small and micro-entities for accounting periods starting on or after 1 January 2016.
The previous article examined the legislative changes brought about by the EU Accounting Directive which was transposed into company law in early 2015 and which primarily affects small and micro-entities. This second article will examine some of the main changes brought about by the new regime that are likely to affect all companies as they transition across to new UK GAAP.
New standards were issued by the Financial Reporting Council in the summer of 2015 for small companies and micro-entities which reflect the provisions in the revised companies’ legislation. The most notable change for small companies is the withdrawal of the Financial Reporting Standard for Smaller Entities (the FRSSE) in its entirety for accounting periods starting on or after 1 January 2016.
Retrospective application of the rules
It is important to emphasise that the rules in new UK GAAP are retrospective; that is, they must be applied as far back as the date of transition and this rule applies to all entities making the transition. The date of transition is deemed to be the start date of the comparative period reported in the financial statements. Therefore, a medium-sized business with a 31 March 2016 year-end will have a date of transition of 1 April 2014. This is because the comparative year will be 31 March 2015 and the start date of this comparative year is 1 April 2014 and hence the opening balance sheet position as at 1 April 2014 and the 31 March 2015 comparative year will have to be restated to become compliant with FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland. The same principles apply to the small companies’ and micro-entities’ regimes.
The reason that the rules are retrospective are so that the financial statements can be both comparable and consistent. It would be meaningless to prepare the current year financial statements to FRS 102 principles but have the comparative year prepared to outgoing UK GAAP as the financial statements would be incomparable and inconsistent because there are some accounting treatments which are markedly different in new UK GAAP compared with outgoing UK GAAP.
The new small companies’ regime
The new small companies’ regime has been split into two components by the introduction of ‘micro-entities’ (although the micro-entities’ regime has been with us since 2013 and is currently embedded within the FRSSE). Micro-entities are defined as a subset of small companies and are deemed to be the smallest of companies in the UK. Micro-entities can apply the rules in FRS 105 The Financial Reporting Standard applicable to the Micro-entities Regime which was issued in July 2015 if they so wish (it is to be noted that FRS 105 is optional and a micro-entity can choose a more comprehensive framework if they so wish). The thresholds for a micro-entity (of which two out of three for two consecutive years have to be met) are as follows:
1. Turnover not more than £632,000
2. Balance sheet total (fixed assets plus current assets) £316,000
3. No more than an average number of 10 employees
Please note that the eligibility criteria for the micro-entities’ regime is very restrictive and only incorporated entities can use the regime. Recently the Department for Business Innovation and Skills changed the Limited Liability Partnership Regulations and LLPs will be able to apply the micro-entities framework to their financial statements for accounting periods starting on or after 1 January 2016 (the same mandatory effective from date as FRS 105 and early-adoption is available).
FRS 105 The Financial Reporting Standard applicable to the Micro-entities Regime
FRS 105 is based on the principles found in FRS 102, but significant simplifications have been made to arrive at FRS 105. The framework is available to all entities that qualify as a micro-entity, but certain entities are exempt from the micro-entities’ regime (such as charities, financial and credit institutions, insurance institutions and micro-entities who are consolidated in with a parent). Care needs to be taken when considering the application of FRS 105 to ensure that, at the outset, the reporting entity concerned is actually eligible to use the standard.
FRS 105 has come in for an element of criticism from various commentators; however, whilst the Financial Reporting Council do advise to consider the appropriateness of FRS 105 on a case-by-case basis, it will be a suitable framework for certain micro-entities; although it will not be for others. Accountants will therefore need an awareness of the key technical points in FRS 105 so as to be able to advise clients accordingly. The table below outlines some of the most notable differences in FRS 105 in comparison to the outgoing UK GAAP although the table below is not exhaustive in terms of differences:
|Issue||Outgoing UK GAAP (the FRSSE)||FRS 105|
|True and fair view||Accounts prepared under the FRSSE are required to give a true and fair view and additional disclosures are needed in order to achieve this.||The legislation has been drafted to include ‘deeming provisions’ which say that as long as the accounts are prepared in accordance with the legally required minimum, they will be presumed to give a true and fair view.|
|Fair values and revaluation amounts||The FRSSE allows companies to carry assets in the balance sheet at fair value or at a revaluation amount. Revaluations are dealt with in the alternative accounting rules in the Companies Act 2006.||The legislation does not recognise any of the fair value or alternative accounting rules and as such no assets can be stated at fair value/revaluation. Thus on transition to FRS 105, a micro-entity will have to remove all fair value and revaluation amounts.|
|Profit and loss account||The FRSSE allows a Format 1 profit and loss account which categorises expenses by function (cost of sales, distribution costs, etc.)||Only a Format 2 profit and loss account can be prepared as follows:
|Disaggregation of the balance sheet||Fixed assets are disaggregated into their components (e.g. intangible assets, tangible assets and investment property) with further analysis in the notes. Similarly, current assets are shown in the order of liquidity (stock, debtors, bank and cash).||The statutory formats of the balance sheet for micro-entities are only preceded by letters; they are not preceded by Roman numerals and Arabic numerals hence the balance sheet will not be disaggregated.|
|Deferred tax||Deferred tax is required to be recognised in respect of all timing differences at the balance sheet date.||Deferred tax is prohibited for micro-entities on the grounds that it will not be possible to distinguish deferred tax amounts from current tax amounts due to the formats of the financial statements and lack of disclosures. Deferred tax amounts will be removed on transition with the corresponding entry going to profit and loss account reserves.|
|Disclosure notes||The FRSSE requires far more disclosures to be made in the financial statements (which has essentially lead to its demise because the disclosures it requires are incompatible with the revised Companies Act 2006 and would contravene the EU Accounting Directive).||Section 6 of FRS 105 only provides for the two legally required disclosures which relate to directors’ advances, credit and guarantees and financial commitments, guarantees and contingencies for the company. There is an appendix to this section which drills down on the actual disclosures required and micro-entities can make voluntary disclosures if they so wish.|
|Directors’ report||A directors’ report is required for small companies reporting under the FRSSE by virtue of the Companies Act.||A directors’ report is not required for a micro-entity for accounting periods starting on or after 1 January 2016.|
FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland
FRS 102 is the new reporting framework for small companies and companies not required to report under EU-adopted IFRS (as well as micro-entities not choosing to report under FRS 105). The latest edition of FRS 102 is the September 2015 edition which supersedes the August 2014 edition. It was re-issued in September 2015 because this latest version incorporates the requirements for small companies by virtue of Section 1A Small Entities which is not found in the August 2014 version of the standard.
Section 1A of FRS 102 deals only with the presentation and disclosure requirements for small companies; in terms of recognition and measurement, these are dealt with in full FRS 102. Small companies, and micro-entities that choose not to report under FRS 105, must comply with the September 2015 edition of FRS 102 for accounting periods starting on or after 1 January 2016 (although earlier adoption is permissible).
Some of the most notable differences between FRS 102 and the FRSSE are outlined in the following table (although the list below is not exhaustive):
|Issue||Outgoing GAAP (the FRSSE)||FRS 102|
|Deferred tax||Deferred tax is calculated using the timing difference approach and is to be recognised in respect of all timing differences existing at the balance sheet date where such amounts are material.||Section 29 Income Tax requires deferred tax to be calculated using the timing difference ‘plus’ approach. There are three new situations which will give rise to deferred tax under FRS 102:
|Financial instruments||Derivative financial instruments are not brought onto the balance sheet under the FRSSE as they are accounted for on settlement.||Derivative financial instruments must be brought onto the balance sheet at fair value through profit or loss (unless the entity is applying hedge accounting). Section 12 Other Financial Instruments Issues deals with the recognition and measurement requirements of such instruments.|
|Short-term employee benefits||Many entities previously did not account for unpaid holiday pay under the FRSSE (although technically they should have as FRS 12 Provisions, Contingent Liabilities and Contingent Assets did cite unpaid holiday pay as meeting the definition of a liability).||Section 28 Employee Benefits requires any short-term employee benefits accrued by employees, but not paid until the subsequent accounting period, to be accrued in the accounts. This will affect entities whose holiday year is not sequential to the financial year, or where staff are permitted to carry over holidays to the next holiday/financial year.|
|Long-term loans at non-market rates||Long-term loans at non-market rates were simply accounted for at transaction price under the FRSSE (i.e. the amount paid out of, or received in, the bank account).||Long-term loans at non-market rates may cause a problem in the form of measurement differences (the difference between the fair value and present value of the loan) as Section 11 Basic Financial Instruments uses the amortised cost method to account for such loans. Loans which are ‘on-demand’ will simply be accounted for within current assets/current liabilities at the amount immediately repayable (which will usually be at fair value of the loan made or received).|
|Investment property||Fair value gains and losses in respect of investment property are taken to a revaluation reserve in equity and reported through the statement of total recognised gains and losses. Deferred tax is generally not brought into account for such properties.||Fair value gains and losses are taken to profit or loss (as operating gains/losses) with associated deferred tax implications taken to profit or loss also. Please note fair value gains (net of deferred tax) are not distributable as a dividend to shareholders.|
|Leases||A lease is treated as a finance lease if the present value of the minimum lease payments equates to 90% or more of the fair value of the leased asset.||There is no 90% ‘bright line’ test in Section 20 Leases and the standard instead offers eight indicators that a lease is a finance lease; one of which says that if the present value of the minimum lease payments equates to ‘substantially all’ of the fair value of the leased asset, the lease is a finance lease. Hence the 90% test has been replaced by the term ‘substantially all’.|
Other applicable standards in the new suite
There are some other standards which the Financial Reporting Council have issued as part of the new UK GAAP as follows that accountants will need an awareness of:
FRS 100 Application of Financial Reporting Requirements
This standard outlines which entities can use which set of standards. For example, a micro-entity can use FRS 105, or it can use a more comprehensive framework if it so chooses. FRS 100 also says that financial statements required by the IAS Regulation or other legislation or regulation to be prepared in accordance with EU-adopted IFRS must be prepared in accordance with that regime.
FRS 101 Reduced Disclosure Framework
FRS 101 offers qualifying entities (i.e. qualifying subsidiaries) which report under EU-adopted IFRS to take advantage of reduced disclosures in their financial statements provided certain protocol is followed and certain disclosures are made. One of the qualifying criteria is that the subsidiary must be consolidated in with a parent company whose consolidated financial statements are intended to give a true and fair view and are made publicly available.
There is an equivalent reduced disclosure framework in FRS 102 for UK GAAP reporters which is contained in paragraphs 1.8 to 1.13.
FRS 103 Insurance Contracts
Reporting entities that write insurance contracts or hold reinsurance contracts will apply the provisions of FRS 103. FRS 103 will only have a limited lifespan because it will be reviewed when the International Accounting Standards Board (IASB) issue the new insurance contracts standard (which will replace IFRS 4 Insurance Contracts). The IASB have said they intend to issue this new IFRS towards the end of 2016 but in the meantime periodic amendments to FRS 103 may be made so accountants dealing with such contracts will need to keep abreast of developments in this specialist area.
FRS 104 Interim Financial Reporting
FRS 104 is not actually a Financial Reporting Standard because there is no new requirement for entities to start preparing interim financial statements. The Financial Reporting Council have issued FRS 104 for those entities that are required by law or regulations (or who voluntarily choose to prepare interim financial reports) to voluntarily apply FRS 104. It is intended for use by entities that prepare annual financial statements in accordance with FRS 102.
Some accountants may find the new regimes take some time to get used to, particularly with the revisions to the Companies Act 2006 to get to grips with and advising clients on which financial reporting framework to report under. It is always advisable to consider the impact that some of the frameworks will have on financial statements prior to transition; for example, a micro-entity that has an investment property on the balance sheet might not want to report under FRS 105 because this standard does not allow such properties to be carried at fair value. Therefore, in such situations the client will have to be advised to report under FRS 102 Section 1A as a minimum to allow the use of the fair value model for such properties.
Each regime has its advantages and disadvantages and accountants are strongly advised to gain a sound understanding of the technicalities of each standard in order that they can advise their clients/directors accordingly which will avoid the need for any further costs being incurred further down the line once the new UK GAAP has started to settle down.
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Steve Collings is the audit and technical partner at Leavitt Walmsley Associates Ltd.