Mar

14

FRS 102: Dealing with the numbers

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calculatorFRS 102 The Financial Reporting Standard Applicable in the UK and Republic of Ireland is getting closer to mandatory implementation (accounting periods commencing on or after 1 January 2015).  Professional bodies are advising member firms to start gathering data this year to aid the transition process as there will be changes to figures that have already been finalised some time prior to the implementation of FRS 102.

The previous two articles have focused on the theoretical aspects concerning FRS 102 as well as the additional disclosures that are required to be made in the first financial statements of a company reporting under FRS 102.  This article will consider the accounting policy alignments for a fictitious company that need to be made to comply with FRS 102.  There is no substitute for understanding FRS 102 and whilst articles and other reference material will help that understanding, it is important that firms now start to get to grips with the detailed content in FRS 102 rather than leave it until the last minute and risk getting the transition wrong.

The transition across

Section 35 Transition to this FRS deals with first-time adoption of FRS 102.  Many practitioners have commented during lectures where I have carried out a transition using a fictitious company that this is markedly similar to a change in accounting policy – i.e. that the transition is applied retrospectively.  Whilst the manner in which a transition is carried out is similar to what would happen when a client changes an accounting policy, it is not a change in accounting policy.  This is because Section 35 contains some mandatory and optional exemptions that companies are mandated to apply or may apply when transitioning across to FRS 102.  There are also additional disclosure requirements which are needed in the first set of FRS 102 financial statements which go over and above those required when a company changes accounting policy so in this respect, do not apply the provisions in Section 10 Accounting Policies, Estimates and Errors when moving over to FRS 102 – be sure to use Section 35.

Step 1 – The date of transition

The first step is to work out the date of transition to FRS 102.  The date of transition is the start date of the earliest period reported in the financial statements.  For a year-end 31 December 2015, the date of transition will be 1 January 2014. This is because the 2014 financial statements will be the comparative period reported in the current year financial statements and hence the start date of that comparative period is 1 January 2014. Using quarter-end periods, the following will help work out the date of transition:

Year-End:

Date of Transition:

31 December 2015

1 January 2014

31 March 2016

1 April 2014

30 June 2016

1 July 2014

30 September 2016

1 October 2014

 

The fact that the date of transition is the 2014 year is the reason why professional bodies are strongly advising their member firms to start gathering the data and considering the impact on their clients now.

Step 2 – Align the accounting policies at the date of transition

Once you have worked out your date of transition, you will then need to consider the client’s accounting policies and whether these accounting policies are compliant with FRS 102.  Where policies are not compliant with FRS 102 they will need to be changed to comply and this will result in transitional adjustments being made.  For example, consider a company that has a year-end of 31 December 2015 and thus a transitional date of 1 January 2014 and a policy is not compliant with FRS 102.  The figures will need to be restated from old UK GAAP to FRS 102 to comply with FRS 102.  Essentially this may mean going back into the 2013 trial balance, and re-stating the figures so you can roll the 2013 trial balance into the 2014 financial year to arrive at an opening position at 1 January 2014.  Alternatively, some automated accounts production systems may allow postings directly into the 1 January 2014 opening trial balance as transitional adjustments, but if this is not the case, the 2013 trial balance will have to be restated so that the closing balances at 31 December 2013 agree to the opening balances at 1 January 2014 as otherwise you will have exceptions reported by your accounts production system.  Consider the following simple example:

Example – accounting policy alignment

Company A Limited has a 31 December 2015 year-end and falls under the scope of FRS 102.  Under old UK GAAP the following opening balances as at 1 January 2014 have been generated by the company’s bookkeeping system (which also agree to the financial statements as at 31 December 2013):

Opening balances – 1 January 2014 (old GAAP)

DR

CR

Plant and machinery – cost

100,000

Plant and machinery – depreciation

30,000

Computer equipment – cost

30,000

Computer equipment – depreciation

20,000

Investment property (fair value)

140,000

Stock

45,000

Trade and other debtors

85,000

Cash at bank and in hand

60,000

Trade and other creditors

50,000

Corporation tax

17,000

Ordinary share capital

10,000

Revaluation reserve (Note 1)

25,000

Profit and loss reserves

308,000

460,000

460,000

 

Note 1

The revaluation reserve account is in relation to the investment property which is carried at market value in accordance with SSAP 19 Accounting for Investment Properties.  This was the only revaluation in respect of this investment property and was carried out on 31 December 2013.

For the purposes of this article, and to keep things relatively straightforward, there are only a couple of issues that need to be dealt with in order to arrive at an FRS 102-compliant opening balance sheet as at 1 January 2014.  The first issue relates to the investment property.  We are told that this is currently accounted for under the provisions in SSAP 19 which requires all fair value gains and losses to be taken to the revaluation reserve unless a deficit (or its reversal) on an individual investment property is expected to be permanent, in which case it is charged (or credited) to the profit and loss account of the period (SSAP 19.13).  However, paragraph 17.15 effectively extinguishes the use of the revaluation reserve account for investment properties and fair value gains and losses are taken directly to profit or loss (this treatment is consistent with IFRS for SMEs and the international equivalent, IAS 40 Investment Properties).  This treatment must be reflected in the opening trial balance on the date of transition and therefore at the transition date we must:

 

DR revaluation reserve

£25,000

CR profit and loss reserves*

£25,000
Being reallocation of investment property revaluation reserve on transition to FRS 102

 

Please note, that any revaluation reserve in respect of property which is not investment property may not need adjustment on transition to FRS 102 as the concept of the revaluation reserve is still in existence in FRS 102 for property, plant and equipment accounted for under the revaluation model permitted in Section 17 Property, Plant and Equipment (see paragraph 17.15B).

* The £25,000 credit to profit and loss reserves in respect of the revaluation of the investment property will not be distributable as a dividend to shareholders because it is not a realised gain.  It is therefore advisable for reporting entities to keep a record of the value of undistributable reserves in order to prevent such reserves being distributed as a dividend inappropriately.

Section 35 does permit, where considered appropriate, an alternative category of equity to take transitional adjustments at the date of transition to FRS 102.

The next issue to consider is the deferred tax implications relating to this investment property.  Under FRS 19 Deferred Tax, provision for deferred tax in respect of non-monetary assets subject to revaluation would only be made if:

  • The asset is revalued to fair value each period with changes in fair value being recognised in the profit and loss account; or
  • The entity has entered into a binding agreement to sell the revalued asset, has revalued the asset to its selling price and does not expect to obtain rollover relief.

Section 29 to FRS 102 Income Tax deals with the issue relating to investment property in paragraph 29.16.  This particular paragraph says:

‘Deferred tax relating to investment property that is measured at fair value in accordance with Section 16 Investment Property shall be measured using the tax rates and allowances that apply to sale of the asset, except for investment property that has a limited useful life and is held within a business model whose objective is to consume substantially all of the economic benefits embodied in the property over time.’

Section 35 is silent on the treatment of deferred tax but the transitional procedures in FRS 102 will apply to deferred tax to comply with paragraph 35.7 (i.e. FRS 102 assets and liabilities will be recognised, reclassified and measured according to FRS 102 in an entity’s opening balance sheet).  Therefore to arrive at the FRS 102-compliant trial balance, deferred tax will need to be recognised on the investment property gain at the date of transition.  If we assume that the company pays corporation tax at the rate of 20% (and this rate of tax will essentially apply to the sale of the asset), deferred tax in respect of this investment property gain at the date of transition (ignoring the effects of issues such as indexation) will be £5,000 (£25,000 x 20%).  Therefore the transitional adjustment will be:

DR profit and loss reserves

£5,000

CR deferred tax provision

£5,000
Being deferred tax on fair value of investment property at transition date

The effects of the transition can be illustrated as follows:

Opening balances – 1 January 2014 (effect of transition to FRS 102)

DR

CR

Transitional Adjustments

DR

CR

Plant and machinery – cost

100,000

100,000

Plant and machinery – depreciation

30,000

30,000

Computer equipment – cost

30,000

30,000

Computer equipment – depreciation

20,000

20,000

Investment property (fair value)

140,000

140,000

Stock

45,000

45,000

Trade and other debtors

85,000

85,000

Cash at bank and in hand

60,000

60,000

Trade and other creditors

50,000

50,000

Corporation tax

17,000

17,000

Deferred taxation

5,000

5,000

Ordinary share capital

10,000

10,000

Revaluation reserve

25,000

25,000

Profit and loss reserves

308,000

20,000

328,000

460,000

460,000

25,000

25,000

460,000

460,000

 

Step 3 – Deal with the accounting policy changes in the 2014 year-end accounts

Once you have dealt with the opening position at the date of transition and have got the opening trial balance to be FRS 102-compliant, the next step is to consider the effect of the accounting policy alignments on the 2014 year-end financial statements.  For the purposes of this step, if we assume that as at 31 December 2014 the market value of the investment property had risen to £160,000 (i.e. a £20,000 gain during the year), then under SSAP 19 the entries would have been:

DR investment property (balance sheet)

£20,000

CR revaluation reserve (equity section)

£20,000
Being fair value gain on investment property at 31 December 2014

 

This accounting treatment is inconsistent with the requirements of FRS 102 and, therefore, the 2014 year-end accounts will need restating to become FRS 102-compliant.  At 31 December 2014, the financial statements will be adjusted as follows:

 

DR revaluation reserve (equity section)

£20,000

CR profit and loss account

£20,000

Being fair value gain on investment property at 31 December 2014

 

The next step is to provide for the additional deferred tax on the revaluation gain (paragraph 29.16 to FRS 102).  Again, ignoring the effects of indexation and assuming the company continues to pay corporation tax at the rate of 20%, the deferred tax will be calculated as follows:

Deferred tax on revaluation gains (£45k x 20%)

£9,000

Deferred tax balance on 1 January 2014

(£5,000)
Deferred tax expense to 31 December 2014 (or 20% of the £20k gain in 2014) £4,000

Being deferred tax on investment property movement to 31 December 2014

 

Step 4 – Disclosure requirements

The disclosure requirements relating to first-time adoption of FRS 102 are set out in paragraphs 35.12 to 35.15 and have been covered in a previous article on transitional issues.  In some cases the disclosure requirements for first-time adoption may be relatively straightforward – however, some companies may require quite vast transitional disclosures depending on the number of accounting policy alignments needed for the accounts to become FRS 102-compliant.

Step 5 – Apply FRS 102 going forward

Once the transitional issue are complete and the previous year’s financial statements have been restated to become FRS 102-compliant, the company will then apply FRS 102 going forward to all assets, liabilities, income, equity and expenses to its 2015 financial statements.

Mandatory and optional exemptions

Practitioners must not forget that Section 35 prescribes some mandatory exemptions from full retrospective application of FRS 102 at paragraph 35.9 (note not all of these will apply to every client).  In addition, optional exemptions are contained at paragraph 35.10 and a client can take advantage of all, some or none of these exemptions in paragraph 35.10.

Other issues

This article has considered the transitional aspects relating to a relatively straightforward scenario where the only accounting policy alignment was in respect of investment property and the associated deferred tax implications.  Not every client will be as straightforward as this example, and some other considerations that practitioners need to keep in mind are:

  • Issues relating to financial instruments (more recognition of such instruments on the balance sheet in FRS 102 as opposed to disclosure only);
  • Deemed cost valuations for items of property, plant and equipment subjected to revaluation under FRS 15 (note you can use previous revaluations under current GAAP for ‘deemed cost’ but if this valuation was not done on the date of transition, you must depreciate from the date of valuation to the date of transition);
  • Goodwill (reduction of presumed useful economic lives from 20 years to five years);
  • Stock valuations (LIFO is prohibited under FRS 102);
  • Cash flow statement (fewer cash flow classifications in FRS 102 as opposed to FRS 1);
  • Deferred tax (more onerous in FRS 102);
  • Employee benefits (unpaid holiday pay, sick pay and other short-term employee benefits that remain unpaid at the year-end should be accrued under FRS 102);
  • Fair value accounting more prominent in FRS 102;
  • Classification of leases more subjective in FRS 102 (no 90% benchmark for finance leases);
  • Correction of errors by way of prior-year adjustments (‘material’ errors are corrected by way of a prior-year adjustment in FRS 102; ‘fundamental’ errors are only corrected by way of a prior-year adjustment in FRS 3).

As a closing point, it is also worth mentioning that if errors are discovered in prior year accounts during the transitional process, these must be distinguished from transitional adjustments in the disclosures (FRS 102 paragraph 35.14).

Conclusion

There are many considerations that practitioners need to look at when it comes to the transitional process and this article has merely touched on one of the accounting policy alignments that are needed (relating to investment property) but the reality is that some companies will face many more accounting policy alignments to enable their financial statements to be FRS 102-compliant.  Financial statements prepared to FRS 102 also need to contain an ‘explicit and unreserved statement of compliance’ and therefore in order to be able to make this statement, the accounts must comply in all respects with FRS 102 so this emphasises the need to ensure the transition is carried out with great care and attention to detail.  Accounts production systems usually have the facility to run ‘exception reports’ which flag up any errors in closing v opening balances and this facility should be run regularly during the transitional process to ensure that these are spotted and corrected as quickly as possible.

 

Category: Accounting and standards, Audit

About the Author ()

Steve Collings is the audit and technical director at Leavitt Walmsley Associates Ltd and the author of 'Interpretation and Application of International Standards on Auditing'. He is also the author of 'IFRS For Dummies' and 'The AccountingWEB Guide to IFRS'. More about Steve's publications can be found by clicking on the 'Published Work' tab on the homepage. Steve is also a regular contributor of articles to www.accountingweb.co.uk, the UK's largest resource for professional accountants on a free subscription basis and is a member of the Society of Authors. Steve is an Editorial Board member for Wiley Insight IFRS and sits on the AAT's Financial Reporting Technical Panel. In 2011 Steve was named 'Accounting Technician of the Year' at the British Accountancy Awards and won 'Outstanding Contribution to the Accountancy Profession' by the Association of International Accountants in 2013. Follow Steve on Twitter - @stecollings

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