FRS 102: Frequently asked questions so far

During recent lectures on the application of FRS 102 The Financial Reporting Standard applicable in the United Kingdom and Republic of Ireland, there appears to have been a pattern emerging with commonly asked questions about the new UK standard.  This article has been put together to put all these ‘FAQs’ in one place and further ‘FAQ-style’ articles will be written over the coming months to assist practitioners in the run up to the implementation date.

Is it true that all FRSs/SSAPs/UITFs will be consigned to history?

It is, but with the exception of FRS 27 Life Assurance.  At present the Financial Reporting Council (FRC) are currently dealing with preparing FRS 103 Insurance Contracts which will deal separately with these issues.

I have heard that fair value gains and losses on investment property will hit the profit and loss account.  Why have the FRC agreed to this treatment and what will happen to revaluation surpluses on my clients’ balance sheets?

FRS 102 is essentially based on IFRS For SMEs which in turn is a scaled-down version of full IFRS.  In IAS 40 Investment Property and IFRS for SMEs, gains and losses on the fair value fluctuations of investment properties are also taken directly to profit and loss.  The rationale behind this is because investment properties are neither depreciated nor tested for impairment as they are carried at fair value at each reporting date.  Any revaluation surplus on your revaluation reserve account will be transferred to profit and loss reserves on transition to FRS 102.  However, transitional adjustments can also be recognised in another appropriate category of reserves, if appropriate (FRS 102 paragraph 35.8).

If a client has a revaluation gain on an investment property which is taken directly to profit and loss which in turn increases profit to what it would have been under SSAP 19, can this gain be distributed as a dividend?

No.  This is because the profit has not been realised.  This is an area where there is much confusion and clients with investment properties in their balance sheet need to understand the consequences of this transaction.  The gain on investment property will, of course, increase accounting profit, however it will not be distributable in the form of a dividend to the shareholders.  There has been mention of taking such gains directly to an ‘undistributable reserve’ account in the equity section of the balance sheet.  However, if this is done the treatment itself will not technically comply with the requirements in paragraph 16.7 to FRS 102.

I have a client that carries freehold property that it occupies under the  revaluation model.  Do fair value gains on these also have to go to the profit and loss account?

No.  Fair value gains and losses for investment property only are taken directly to profit or loss.  Investment property is dealt with in Section 16 Investment Property, whereas freehold property will fall under the scope of Section 17 Property, Plant and Equipment (PPE).  You can still carry PPE at fair value in accordance with paragraph 17.15B and any fair value gain can be reported in equity and reported via other comprehensive income in accordance with paragraph 17.15E.  However, fair value gains on such property can be taken directly to profit and loss to the extent that it reverses a revaluation decrease of the same asset which was previously recognised in profit or loss.

I have been told that lease classification is going to be ‘more subjective’ under the new FRS.  How is this?

In the current SSAP 21 Accounting for leases and hire purchase contracts there is a 90% threshold (see the Guidance Notes to SSAP 21 at paragraph 22) whereby if the fair value of the minimum lease payments is equivalent to 90% or more of the fair value of the leased asset then the presumption is that the lease is a finance lease. Section 20 Leases is more subjective in that it removes the numeric benchmark. However, having said that, paragraph 20.5 (d) essentially replaces ‘90%’ with the words ‘substantially all’ so whilst judgement as to what ‘substantially all’ means, I doubt there will be many misinterpretations.  Also, don’t forget that both paragraphs 20.5 and 20.6 offer additional indicators of leases that would normally lead to classification as a finance lease which may even prove more conclusive than the minimum lease payments versus the fair value of the leased asset calculation.

What does the word ‘plus’ in the timing difference ‘plus’ approach for deferred tax mean?

Deferred tax is a controversial subject, but it is still a concept that is still with us.  However, the FRC have tried their best to ensure that deferred tax is not made any more complicated than it has to be and they have to be commended for the way they handled the criticism in the first round of exposure drafts (EDs).  In the previous ED’s, deferred tax would have had to be calculated under a ‘temporary’ difference approach which is the way IAS 12 Income Taxes and IFRS for SMEs requires deferred tax to be calculated.  This was met with criticism during the comment period because it would have meant potentially more deferred tax balances would be recognised because the temporary difference approach is focussed on the balance sheet, whereas our ‘timing difference’ approach is focussed on when items are recognised in the profit and loss account.  Therefore the FRC took on board that feedback and came up with the timing difference ‘plus’ approach.  The ‘plus’ part brings in additional situations that will trigger deferred tax in addition to the current requirements in FRS 19 Deferred tax.  This was done to bring deferred tax recognition more in line with the international regime and which will result in a deferred tax answer which would be similar to IAS 12 under the new regime, except in rare circumstances.  The additional circumstances that will trigger deferred tax (i.e. the ‘plus’ parts) are:

• Revaluations on non-monetary assets (such as investment property revaluations and freehold property revaluations);
• Business combinations; and
• Certain unremitted earnings on overseas subsidiaries or associates.

Will my software be able to handle the conversion process?

Software providers are working on the issues that are likely to affect practitioners during the conversion process.  However, the practitioner will have to do the bulk of the work as the software will not be able to identify whether your client’s accounting policies are FRS 102-compliant or not.  It is envisaged that software providers will be making sure their software is as ‘conversion-friendly’ as possible.

Why do we have to go back as far as 2013 in order to convert to FRS 102 for a December 2015 year-end client?

The reason is because you have to review your client’s accounting policies at the date of transition (in your case, your client’s date of transition will be 1 January 2014 as this is the start date of the earliest period presented in the financial statements).  You then have to restate the 2013 figures to arrive at an opening FRS 102-compliant balance sheet at the date of transition so that the opening position recognises accounting policies that are permitted in FRS 102 and does not include accounting policies that are not permitted in FRS 102.  Such policy changes will more than likely include (among others) restatement of goodwill values to accord with the five-year useful economic life presumption, stock values to recognise the prohibition of valuation under LIFO and deferred tax implications.

My client is a housing association that constructs their own assets?  What are the rules relating to interest my client incurs on loans to construct their own houses?

The interest that your client will incur will be covered in Section 25 Borrowing Costs.  This Section is very similar to current requirements in FRS 15 Tangible fixed assets at paragraphs 19 and 20.  Section 25 will allow your client the option to capitalise borrowing costs as part of the cost of a qualifying asset provided the policy your client adopts is applied consistently. The term ‘qualifying asset’ is defined in the Glossary and in the broadest terms is taken to mean an asset that takes a substantial period of time to get ready for its intended use or sale.  The term ‘substantial period’ will generally be taken to mean a period longer than 12 months.

I work on my own as a sole-practitioner and don’t have the time to deal with all these issues just yet.  What advice can you give me?

I am advising all practitioners to start to think about these issues now, particularly if you have several clients that are going to be affected by the proposals.  My advice, in the first instance, would be to understand the main differences between FRS 102 and the current UK GAAP.  Once you understand where the differences lie, you can then gauge an idea as to how much work will be involved with your client portfolio who are likely to be affected by FRS 102.  I do not advise any practitioners that are affected by these proposals to wait until they MUST adopt FRS 102 to start to think about the impact it will have on their practice.

Professional bodies are also producing resources to help firms assess the impact and deal with the conversion process.  The good news for us all in the UK is that the FRC has always foreseen such changes to an international-based regime and hence has tried, as far as possible, to align current standards more or less to their international counterparts.  For many clients there may only be a couple of transitional adjustments (although there will have to be additional disclosures which will be covered in future articles nearer the time) and for other clients there may be several transitional adjustments.  The key is to identify which clients are going to be affected and how they are going to be affected.  I would also advise practitioners who are short of time to attend at least one course that specifically deals with the conversion aspect so you can gain an understanding as to the issues you will face.

Category: Accounting and standards