The new UK GAAP framework means that all current UK accounting standards are withdrawn and a new financial reporting regime is introduced in their place. Transition to this new framework is a major change for UK businesses.
There will be implications beyond the accounting. Practical and resourcing issues will also need to be considered. Particularly where there are long-term arrangements such as bank loans which could be affected.
The FRC's project to replace UK GAAP with a new suite of standards went through many draft proposals and consultations and the three main replacement standards have been issued:
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- FRS 100: Application of Financial Reporting Requirements
- FRS 101: Reduced Disclosure Framework
- FRS 102: The Financial Reporting Standard applicable in the UK and Republic of Ireland
All extant FRSs, SSAPs and UITF Abstracts are withdrawn and these new standards are effective for accounting periods beginning on or after 1 January 2015. Currently the FRSSE (the Financial Reporting Standard for Smaller Entities) remains effective until 2016 after which it will be replaced with a new standard for micro-entities and a new Section 1A in FRS 102 applicable to eligible small entities.
As FRS 100-102 is effective from 1 January 2015, 31 December 2015 year end accounts will be the first prepared under the new regime. Comparatives and the opening balance sheet need to be restated and so the first balance sheets prepared using the new requirements will be as at 1 January 2014.
The standards are available for early adoption, which may benefit some companies.
Which standard should my entity apply?
The three main standards are structured as follows; one sets out which accounting standards different types of entity can apply (FRS 100: Application of Financial Reporting Requirements), one sets out an option of EU- adopted IFRS (IFRS) with reduced disclosures for qualifying parent company and subsidiary individual accounts (FRS 101: Reduced Disclosure Framework) and then there is financial reporting standard which will be applied by the majority of entities currently using UK GAAP (FRS 102: The Financial Reporting Standard applicable in the UK and Republic of Ireland).
Since the original publication of these standards, further developments in the framework have resulted in a new standard 'FRS 105: The Financial Reporting Standard applicable to the Micro-entities Regime' as well as amendments to FRSs 100-102 to align the new framework with the changes to UK law arising from implementation of the new EU Accounting Directive. These changes include withdrawal of the FRSSE (the Financial Reporting Standard for Smaller Entities) which is replaced from 2016 with a new Section 1A within FRS 102 applicable to eligible small companies.
FRS 100 sets out where an entity falls within this structure. Firstly, companies look to company law and other regulations to determine whether the adoption of IFRS is required. For example, the group accounts of companies listed on the London Stock Exchange and other EU-regulated markets are required by law to be prepared under IFRS, while the AIM rules require the use of IFRS for the group accounts of AIM-listed companies. Where entities are eligible for the small companies' regime under company law, the FRSSE will continue to be available for periods beginning before 1 January 2016 after which they will apply Section 1A of FRS 102. Entities eligible for the micro-entities regime under company law will be able to apply FRS 105. Until then, the FRSSE has been amended to be applicable to micro-entities.
All other entities will apply FRS 102. Disclosure exemptions are available from both FRS 102 and from IFRS for parent company and subsidiary individual accounts, provided that certain qualifying conditions are met.
The new structure of UK accounting standards is therefore set to look like this:
FRSSE/FRS 102 Section 1A
Eligible small entities
Eligible micro entities
Option to adopt FRS 101: Reduced Disclosure Framework for qualifying parent/subsidiary
Disclosure exemptions for qualifying parent/subsidiary
Within this structure all companies will be able to elect to 'move up', essentially moving to the left in the table.
Overview of FRS 102: The Financial Reporting Standard applicable in the UK and Republic of Ireland
FRS 102 has gone through a number of different incarnations to reach the final standard. The original draft of the standard was based on the IFRS for SMEs (the International Financial Reporting Standard for Small and Medium-sized Entities) which was designed by the International Accounting Standards Board (the IASB) to be a simplified standard suitable for use by the majority of privately held businesses.
In developing FRS 102, the FRC modified the IFRS for SMEs significantly. In particular, the IFRS for SMEs contains few accounting treatment choices, for example it does not permit the capitalisation of development expenditure. Where such options exist in current UK accounting standards and are aligned with the full version of IFRS, they have been included in FRS 102. These changes reduce the amount of discrepancy between old UK accounting standards and FRS 102, but a significant number of differences remain.
FRS 102 includes some disclosure exemptions for subsidiary and parent company individual accounts, which principally mirror those in old UK GAAP. The main exemptions are from preparing a cash flow statement, disclosing related party transactions with and between wholly-owned subsidiaries and disclosures relating to financial instruments. A qualifying entity is a subsidiary or parent company which is included in publicly available consolidated accounts that are intended to give a true and fair view, provided that there is no objection from shareholders.
Overview of FRS 101: Reduced Disclosure Framework
FRS 101 sets out an option of applying IFRS, but with a number of disclosure exemptions. It was designed to meet the needs of groups where the group accounts are prepared in accordance with IFRS and for foreign-owned companies where the group reporting is on an IFRS basis or similar. The aim is to continue to provide information which is useful for users of subsidiary and parent company accounts, while providing exemptions from disclosures which duplicate information given in the group accounts or which are otherwise not useful in the context of a subsidiary or parent company on an individual basis.
Although FRS 102 is based on an IFRS framework, there are significant differences to IFRS, for example financial instruments and the useful lives of intangible assets. This means that if parent and subsidiary individual accounts are prepared using FRS 102, consolidation adjustments may be needed in the preparation of IFRS group accounts. This will be exacerbated when the new IFRSs on lease accounting and revenue recognition come into effect, since there is likely to be a time delay before these changes are introduced into FRS 102.
FRS 101 is available to any 'qualifying entity'. This has the same definition as a qualifying entity within FRS 102 except FRS 101 is not available to charities. Importantly, there is no minimum percentage ownership for a subsidiary to qualify, no requirement for the parent company to be registered in the UK or EU and no restriction on the GAAP used to prepare the consolidated accounts.
What are the business implications?
Transition from old UK GAAP to either FRS 102, FRS 101 or FRS 105 is likely to alter some of the reported numbers for most businesses. This could affect the accounting profit and the assets and liabilities reported on the balance sheet. These changes could have a number of important business implications.
Loan covenant tests are frequently based on profit or balance sheet measures, and transition may affect the headroom on these covenants. For example, interest rate swaps will need to be recognised on the balance sheet at fair value, which could alter balance sheet measures such as the current ratio. Alterations in accounting policies may affect measures such as profit before tax, used to calculate a bonus or determine the vesting of share options and could reduce the effectiveness of employee incentive schemes.
As all companies within a group will need to undergo transition at the same time (other than dormant companies which are exempt), this may be a good time to think about simplifying the structure and reducing the number of companies within the group.
Our experience of assisting companies with transition to IFRS is that transition usually takes longer than anticipated, but that careful planning and control of the process can minimise the disruption.
What does it mean for privately-held businesses?
All privately-held businesses currently using UK GAAP will need to transition to a new set of accounting standards. Most are likely to move to FRS 102 but for some there may be an advantage to applying 'full' IFRS instead. This could be the case if, for example, a group were planning to list in the next few years since it would avoid the need for two transition exercises, first to FRS 102, then to 'full' IFRS.
For privately-held groups, it should also be considered whether the parent company and subsidiaries meet the criteria for being a 'qualifying entity' and the associated disclosure exemptions. The most notable disclosure exemptions in FRS 102 for qualifying entities are from preparing a cash flow statement and financial instrument disclosures. Alternatively FRS 101, essentially 'full' IFRS with reduced disclosure requirements, is available to qualifying entities.
The effective date for transition is accounting periods beginning on or after 1 January 2015, so 31 December 2015 year ends onwards. From this date, all old UK GAAP users will be required to apply the new standards.
Early adoption of the new standards is permitted. Particularly where current IFRS users or subsidiaries of IFRS groups are considering applying FRS 101, early adoption may be beneficial.
What are the implications for listed businesses?
The new standards will not affect which accounts must be prepared using 'full' IFRS. This means that, as now, the only accounts which must be prepared under IFRS are the consolidated accounts of groups listed on the full-list of the LSE, other EU-regulated markets or on AIM.
For listed single entities, groups listed on markets such as ISDX Growth Market which are not EU-regulated and parent and subsidiary individual accounts, there will be a choice of GAAP. It will be possible to apply FRS 102, but in some cases it may be beneficial to transition to 'full' IFRS. For example, for a listed single entity investors may respond better to IFRS accounts which provide increased comparability to peer companies and increased disclosure of information useful to them. Voluntarily adopting IFRS could also avoid a second transition exercise in future if the company acquires a subsidiary and is then required to prepare IFRS group accounts.
In group situations, the parent company and subsidiaries are likely to qualify for disclosure exemptions both from FRS 102 and 'full' IFRS. Applying IFRS with disclosure exemptions (FRS 101) could simplify the group reporting and consolidation process by avoiding the need for 'IFRS adjustments' where there are recognition and measurement differences between FRS 102 and IFRS.
What choices are there for foreign-owned companies?
UK companies that are subsidiaries of an overseas parent will be able to apply FRS 102 or could voluntarily adopt 'full' IFRS. Many will also meet the criteria for applying FRS 101.
The 'publically available' consolidated accounts criteria for use of FRS 101 is not necessarily restricted to accounts filed on the public record; it is likely also to mean available on a company's website or by post on request. There is no restriction on the percentage ownership, and no restriction on the location of the parent which is preparing the consolidated accounts. There is also no restriction on the GAAP used to prepare the consolidated accounts as long as they show a true and fair view, although this may affect whether all of the disclosure exemptions can be taken.
The main advantage of FRS 101 is to align the recognition and measurement with the group reporting where this is on an IFRS or similar basis, but to reduce the length of the UK statutory accounts compared to full IFRS.
An issue to note is that there are many significant differences between FRS 102 and the IFRS for SMEs and compliance with the IFRS for SMEs is unlikely to result in compliance with FRS 102, not least due to differences in the required format for the primary statements. Unless the IFRS for SMEs is endorsed by the EU, and there is currently no indication that this will happen, it will not be available for use by UK companies.
How will not for profit entities be affected?
The original proposal was for a supplementary standard to be issued for 'public benefit entities'. However, the FRC received feedback that this approach was too complex. The solution was to include the relevant requirements in the appropriate sections of FRS 102, identified as being specifically applicable to public benefit entities.
A public benefit entity is defined as one whose primary objective is to provide goods or services for the general public, community or social benefit and where any equity is provided with a view to supporting the primary objectives rather than with a view to providing a financial return to equity providers, shareholders or members. This definition may encompass entities which would not previously have been considered as 'not for profit'.
The three 'not for profit' SORPs (Charities, Registered Social Housing Providers and Further and Higher Education) have been retained and updated to align with FRS 102.
What are the changes for small companies?
There are significant changes for small companies. Small companies which are eligible will continue to be able to use the FRSSE (the Financial Reporting Standard for Smaller Entities) for periods beginning before 1 January 2016. There is also a new standard for micro-entities 'FRS 105: The Financial Reporting Standard applicable to the Micro-entities Regime' which is a cut-down and simplified version of FRS 102.
For small entities that are not micro-entities, from 2016 the new Section 1A in FRS 102 will apply which sets out the reduced disclosure and presentation requirements for small companies to align with the changes to company law arising from implementing the new EU Accounting Directive, and which will disapply all other FRS 102 disclosure and presentation requirements. However, FRS 102 accounting will apply to small companies, including, for example, carrying derivatives and some other financial instruments at fair value.