FRS 102 for small companies: FAQs

The Financial Reporting Council have issued three exposure drafts which outline their intentions as to how they intend UK Generally Accepted Accounting Principles to work in the UK and Republic of Ireland for accounting periods commencing on or after 1 January 2016.  This is in response to the Department for Business, Innovation and Skills’ transposition of the EU Accounting Directive into companies legislation which was formalised on 26 March 2015 and came into effect on 6 April 2015.  Comments on the exposure drafts are open until 30 April 2015.

Over the last couple of months I have lectured across the country on the new small companies’ regime which is going to be introduced for accounting periods commencing on or after 1 January 2016. After each lecture I compile a list of the most frequently asked questions by delegates and this article considers the top 10 questions (both technical and non-technical) that I have been asked during courses, starting with the most popular question at question 1.

Question 1

Is FRS 105 The Financial Reporting Standard applicable to the Micro-entities Regime mandatory for every small businesses? I don’t like the fact that the accounts look like abbreviated accounts at the very least.

No. FRS 105 is optional and in advising a client as to whether to choose FRS 105 or FRS 102 for small entities, practitioners must carefully consider the appropriateness of FRS 105. There is only one permissible format for the profit and loss account (being Format 2) and the disclosure information is extremely negligible (in some cases there may not be any disclosures). If a micro-entity is expected to grow, then FRS 105 may not be appropriate and it might be more beneficial to use FRS 102 for small entities. In addition, if the micro-entity has any assets which have been carried at revaluation under the FRSSE (effective January 2015), such as investment property, then an impact assessment is advisable because all revaluations will have to be removed on transition to FRS 105 and the investment property restated under normal fixed asset rules which could have a detrimental impact on a company’s balance sheet. Fair valuations and revaluations are strictly prohibited in the micro-entities legislation.

Question 2

Can sole traders use the micro-entities standard?

No. Despite the title in FRS 105 referring to “micro entities”, the regime itself has strict eligibility criteria and only incorporated companies can use it. Entities such as financial and credit institutions, LLPs, charities, companies in the Republic of Ireland and companies excluded from the small companies’ regime are some of the other entities that are prohibited from using FRS 105. In assessing whether FRS 105 is appropriate for your clients, you are strongly advised to ensure that in the first instance they are eligible to apply it!

Question 3

Why have our professional bodies not done more to stop this from happening to small companies?

The change in the small companies’ regime has come about because of the EU Accounting Directive which is issued by the European Union. The professional bodies cannot stop the EU from issuing legislation and as the UK is a member of the EU, the Department for Business Innovation and Skills have had to incorporate the Directive into the Companies Act 2006. The Directive itself seeks to overhaul the way in which financial statements for small companies are prepared by reducing disclosure requirements in an attempt (by the EU) to reduce the costs for small businesses and simplifying certain accounting treatments (e.g. by reducing the number of accounting policy options which are available to micros). As a consequence, the professional bodies would not have the power to stop the legislation from hitting the UK’s statute books. The Financial Reporting Council have also had to change accounting standards for small companies as a direct result of the Accounting Directive and they, themselves, have their hands tied because accounting standards have to change because the legislation has changed. So, if anyone is to blame for this, it is the EU rather than our professional bodies and the FRC.

Question 4

Why do we have to apply the rules so far back to the ‘date of transition’? Can we not just move forward like we do when the FRSSE changes?

Unfortunately we cannot apply the new rules prospectively. Small companies reporting under FRS 102 will find the presentation and disclosure requirements contained in Section 1A Small Entities. This section only outlines the presentation and disclosure requirements. Where the recognition and measurement issues are concerned (i.e. what the numbers will look like in the financial statements) full FRS 102 principles will apply. So, for example, if your client has an investment property then you will apply the full recognition and measurement principles in Section 16 Investment Property. Where employee benefits are concerned, a small company will apply the full recognition and measurement principles in Section 28 Employee Benefits.

Because FRS 102 is a whole new financial reporting framework, it is not possible to simply apply the standard prospectively. This is because the financial statements have to be comparable and consistent (traits which would not be achieved if the 2016 year-end accounts were prepared to FRS 102 principles with the 2015 comparatives prepared under the FRSSE principles). Therefore we have to restate the financial statements as far back as the date of transition (being the start date of the comparative period in the accounts) so that the financial statements are presented as if FRS 102/FRS 105 had always been the financial reporting framework applied. This will allow the financial statements to be both comparable and consistent.

Question 5

It appears to me that we only have to comply with these new rules to satisfy our regulators. Clients are not interested and HMRC are not interested. If I were to resign my membership from my professional body could I just carry on as I am now?

I would not advise doing that. Clients expect professional accountants to prepare their accounts having a duty of care and that would mean complying with the profession’s rules, regardless of whether you agree with them or not. In the event that you do not prepare accounts in accordance with the rules you leave yourself open to a negligence claim (particularly if the non-compliance results in additional tax being paid following an investigation by HMRC into the accounts). Professional Indemnity Insurers would expect compliance with the rules in the event of a claim and if you have not prepared accounts in accordance with the rules, your claim would be jeopardised. HMRC would be interested because accounts have to be prepared in accordance with UK GAAP or EU-endorsed IFRS as well as Companies Act 2006 and will form the basis of the tax computation.

Resigning your membership of your professional body would not get around the fact that you owe a duty of care to your clients and must prepare their accounts in accordance with regulations. Even if you resigned your membership and continued practising as an accountant, by holding yourself out to be an accountant, you are holding yourself out to be a professional and a professional would be expected to abide by the rules.

Question 6

I understand that derivative financial instruments have to be brought onto the balance sheet at fair value under FRS 102 principles. What is a derivative?

A derivative is basically a contract between two (or more) parties. The price of a derivative is ‘derived’ from one or more underlying assets. The name ‘derivative’ essentially means that the instrument derives value at one or more future points in time depending on changes in the value of things like interest rates, foreign exchange rates and prices. For example, the price of a derivative in a forward foreign currency contract would be dependent on fluctuations in foreign exchange rates. Because a derivative is an underlying asset, it is recognised on the balance sheet under FRS 102 principles. The following table highlights examples of financial instruments which would meet the definition of a derivative instrument, together with the underlying variable:

Question 7

Do I have to resubmit prior year accounts to Companies House and HMRC?

No. This is because changes to prior year accounts are as a result of a new UK GAAP. For small companies, Section 1A Small Entities encourages the disclosures contained in Section 35 of FRS 102 Transition to this FRS to explain the impact that the transition has had on previously reported equity and profits and this disclosure is encouraged to help explain any changes in prior year profit and equity to authorities such as HMRC (particularly where there are tax implications of transitional adjustments made to the prior year financial statements).

Question 8

If a dividend has been declared on the accounts prepared under the FRSSE and the transition to new UK GAAP results in the reserves becoming negative at the date of transition, will the dividend now be illegal?

No. The answer to this lies in Tech 02/10 Guidance on Realised and Distributable Profits under the Companies Act 2006. Paragraphs 3/28 and 3.29 outlines the reasons and says:

‘Although the effect of these changes may be to reduce or even eliminate a company’s net realised profits, that would not render unlawful a distribution already made out of realised profits determined by reference to “relevant accounts” which had been prepared in accordance with generally accepted accounting principles applicable to those accounts (this is subject to paragraph 3.30 and 3.31 below). This is because the Act defines realised profits and losses for determining the unlawfulness of a distribution as ‘such profits and losses of the company as fall to be treated as realised in accordance with principles generally accepted at the time when the accounts are prepared, with respect to the determination for accounting purposes of realised profits or losses.’

Question 9

How can micro-entity accounts possibly give a ‘true and fair view’ given the fact that there are hardly any disclosures in the accounts and in some cases there are no disclosures?

Financial statements prepared to the micro-entities legislation are ‘presumed’ to give a true and fair view. This presumption is often referred to as the ‘deeming provisions’. As a result, the directors of a micro-entity are not required to consider any additional information that would be required to give a true and fair view.

Question 10

When does all this new regime come into effect?

The new small companies regime was formally approved by Parliament on 26 March 2015 and came into effect on 6 April 2015. It is mandatorily effective for accounting periods commencing on or after 1 January 2016 and for accounting periods commencing on or after 1 January 2015 but before 1 January 2016 if the directors so wish.

Category: Accounting and standards