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The Financial Reporting Council in the UK has published three Financial Reporting Standards (FRS), which will replace generally accepted accounting principles (GAAP) in the UK and Republic of Ireland. These are contained in three FRSs:
- 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. This will be the new FRS for UK GAAP reporters.
There were a number of concerns with current UK standards, including:
- Consistency. The current standards were a mix of Statements of Standard Accounting Practice (SSAP) issued by CCAB, FRS developed and issued by the Accounting Standards Board (ASB) and IFRS-based standards issued by the ASB to converge with international standards
- The current standards permitted certain relevant transactions to remain unrecognised
- The standards had not kept pace with evolving business transactions and in some areas are out of date.
FRS 100 sets out the overall financial reporting requirements, giving many entities a choice of detailed accounting requirements depending on factors such as size and whether or not they are part of a listed group. FRS 100 provides companies with an opportunity to take advantage of reduced disclosures, and identifies whether entities need to produce their consolidated or individual financial statements in accordance with EU IFRS, FRS 102 or the Financial Reporting Standard for Smaller Entities (FRSSE).
FRS 100 does not extend the mandatory application of EU-adopted IFRS. In the absence of a requirement to prepare EU IFRS financial statements, the individual accounts or consolidated accounts of any qualifying entity is prepared in accordance with one of the following:
- EU IFRS
- FRS 101 for the individual accounts of a qualifying entity
- FRS 102
The last three options above are all 'Companies Act' accounts. FRS 100 provides companies with an opportunity to take advantage of reduced disclosures. However, companies should consider the advantages and disadvantages of the options before making a decision as to which regime to adopt. There are transitional arrangements for entities that change the basis of preparation of their financial statements.
Entities that are not required to use IFRS but wish to use its recognition and measurement requirements can choose to apply FRS 101 in their individual financial statements, benefiting from reduced disclosures, as long as they are qualifying entities. FRS 101 permits UK subsidiaries to adopt EU IFRS for their individual financial statements but within the reduced disclosure framework (RDF). This option is also available for the parent company's individual financial statements. The disclosure exemptions do not apply to consolidated financial statements of intermediate groups, as they are only available for individual financial statements of qualifying entities.
A qualifying entity for these purposes is one that is a member of a group where the parent of that group prepares publicly available consolidated financial statements, and that member is included in the consolidation.
In order to use RDF, the shareholders should have been notified in writing and those holding a certain percentage of shares have not objected, EU-adopted IFRS have been applied, and the financial statements make specified disclosures relating to the exemptions.
A shareholder may object to the use of the disclosure exemptions only if the shareholder is the immediate parent of the entity, if the shareholder or shareholders hold more than half of the allotted shares in the entity that are not held by the immediate parent, or if the shareholder or shareholders hold 5 percent or more of the total allotted shares in the entity.
FRS 101 contains various exemptions from IFRS disclosures. Some of these require that equivalent disclosures are included in the consolidated financial statements of the group in which the entity is consolidated. There are exemptions from providing some comparative information for property, plant and equipment, intangibles, investment property and biological assets. There is an exemption from the requirement in IAS 24, Related Party Disclosures to disclose related-party transactions entered into between two or more members of a group, provided that any subsidiary that is a party to the transaction is wholly owned by such a member. Other exemptions include:
- IFRS 2, Share-based Payment, regarding arrangements using equity instruments of another group entity.
- IFRS 3, Business Combinations, regarding acquisitions of unincorporated businesses.
- IFRS 7, Financial Instruments: Disclosures, and IFRS 13, Fair Value Measurement, regarding disclosure of financial instruments and fair values but not for financial instruments held by financial institutions
- IAS 7, Statement of Cash Flows - a cashflow statement is not required.
- IAS 36, regarding some disclosures relating to cash generating units.
FRS 102 replaces the majority of current UK accounting standards; it adopts an IFRS-based framework with proportionate disclosure requirements and improves the accounting and reporting for financial instruments. It is based on the IFRS for SMEs but with significant changes in order to address company law and to include extra accounting options. It includes guidance for public benefit entities and eventually most Statements of Recommended Practice will be updated to be consistent with FRS 102.
FRS 102 differs from the existing UK GAAP in several ways. Complex financial instruments will now come on balance sheet and will be measured at fair value through profit or loss. This could affect earnings and lead to some volatility and tax effects. The entity has the option within FRS 102 to adopt EU IAS 39, Financial Instruments: Recognition and Measurement or IFRS 9, Financial Instruments.
Additionally, intangibles and goodwill cannot have indefinite lives under FRS102.They must be amortised and their life is deemed to be at a maximum of five years unless a reliable estimate can be obtained. This is significantly shorter than the 20-years-or-less presumption in UK GAAP. IFRS will seem attractive in this area to some entities as goodwill and intangible assets are impairment tested rather than amortised. However, accelerated tax allowances may sway other entities. The multi-employer exemption for defined benefit schemes will disappear under FRS 102.Currently no obligation is shown on individual balance sheets of group entities as defined contribution accounting is used. The allocation of these balances to group entities under FRS102 or IFRS will significantly change the balance sheets of group entities.
Entities reporting under UK GAAP will be affected, as they will have to decide whether to apply IFRS, FRS 102 or, if eligible, the FRSSE. Qualifying entities will need to consider whether they wish to use the reduced disclosure framework. This may be attractive to subsidiaries in IFRS groups that wish to have statutory accounts prepared on a consistent basis with the IFRS consolidation, but with reduced disclosures. It will allow many subsidiaries of entities applying EU-adopted IFRS to use accounting policies consistent with those of their parent, without needing to apply the full requirements of EU-IFRS.
When to adopt?
IFRS groups in particular may be interested in early adoption of the IFRS reduced disclosure framework if this eases their statutory reporting burden. Although the ASB is pushing ahead with moving UK GAAP onto an IFRS-based framework, it has decided to defer the mandatory effective date of the revised framework to 1 January 2015. This is because of the interaction with the potential effective dates of new IFRSs, including revenue recognition, leases and financial instruments projects, which could have resulted in companies making several accounting changes in the short term. The revised date effectively allows entities a choice to either undertake the accounting changes in a single period, or to adopt a more gradual approach over a longer period if early adoption is chosen.
Some entities will delay moving away from current UK GAAP until 2015. The ASB's drive towards an IFRS framework is supported by the majority of finance leaders as they will see benefits in global consistency of accounting and reporting.
The choice of reporting approach and timing for an entity needs to take account of numerous factors, including the tax impacts of conversion; the impact of GAAP differences and how these could affect key performance indicators and distributable reserves; whether the options available under one particular GAAP may align better with the business; the opportunities afforded by first-time adoption; the benefit of avoiding dual reporting by groups; and the size and complexity of the entity as the fewer requirements may be attractive.
Complex groups with large numbers of subsidiaries could benefit particularly from early planning. This is especially true of tax planning. Moving from the UK GAAP to the new framework could have a significant impact on tax payable. For each GAAP difference, consideration needs to be given to whether there is an impact on tax payable, which may be subject to transitional rules or specific exemption. If the tax treatment follows the new accounting treatment, there could be tax effects. The IASB's project on leasing where most leases will appear on the balance sheet could make IFRS less appealing. The new framework will undoubtedly affect distributable profits and possibly banking covenants. Remuneration schemes may be impacted by the new treatments and reporting systems will need preparing for the new regime.
The timetable for the new financial reporting regime is that it should apply to accounting periods commencing on or after 1 January 2015, requiring a transitional balance sheet at 1 January 2014. Companies will be able to early adopt these proposals for periods ending on or after 31 December 2012. It seems as though the transitional problems of 2005 are here again!
Graham Holt is an ACCA examiner, and associate dean and head of the accounting, finance and economics department at Manchester Metropolitan University Business School