FRS 102 the transition – part 1

FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland becomes mandatory for accounting periods commencing on or after 1 January 2015.  Accountancy firms are being encouraged by many of the professional bodies to start planning for this change now and start gathering data to enable the transition process to be completed as smoothly as possible.  This article is the first article of two that considers the process for transition.  The second article will contain an illustrative set of financial statements prepared under old UK GAAP and converted to new UK GAAP so practitioners can see for themselves how the process works in real-life.

Section 35 – Transition to FRS 102

The first thing to appreciate is that the transition to a new UK GAAP is not merely a change in accounting policy. This is a whole new financial reporting framework and in some cases the work required on transition should not be under-estimated.  There will also be additional costs to consider in respect of the additional work required at the transition stage.

Section 35 in FRS 102 is the section that practitioners will use when undertaking the conversion aspect.  The underlying principle in Section 35 is retrospective application of FRS 102 to the opening balance sheet at the date of transition.  This particular section does, on first glance, seem very familiar with the procedures for a change in accounting policy (retrospective application in respect of accounting policy changes is dealt with in Section 10 Accounting Policies, Estimates and Errors), however,  Section 10 is replaced in Section 35 for the purposes of first-time adoption because Section 35 contains some mandatory exceptions and optional exemptions from retrospective application.

Section 35 will be adopted by companies moving from old UK GAAP, but in some cases a client may well be moving from EU-endorsed IFRS.

First annual financial statements

A requirement of Section 35 is for reporting entities to make an ‘explicit and unreserved statement of compliance’ with FRS 102.  This statement of compliance cannot be made by clients if their financial statements do not comply, in all respects, with FRS 102.  For the purposes of Section 35, an entity’s first annual financial statements are those which the entity:

• Did not present financial statements for previous periods; or
• Presented its most recent previous financial statements under previous UK and Republic of Ireland requirements, and so they are not consistent with FRS 102 in all respects; or
• Presented its most recent previous financial statements under IFRS.

On the assumption that a client will have a 31 December year-end, the date of transition will be 1 January 2014.  For 31 March year-ends, the date of transition will be 1 April 2014 (i.e. the start date of the earliest period reported in the financial statements).  This is the reason why professional bodies are increasingly keen on firms gathering the required data now because retrospective application of FRS 102 will be needed.

Process on transition

Having undertaken a conversion myself for the purposes of the next article and for lectures, the key advice I would offer practitioners is to ensure you tackle the conversion in a logical manner.  It’s important that technical staff are familiar with how to deal with the conversion process because the scope for error is wide, particularly if there are a lot of accounting policy changes to comply with the recognition and measurement criteria in FRS 102.  In general, Section 35 requires entities to apply the following rules:

• Recognise all assets and liabilities whose recognition is required by the standard.
• Do not recognise items as assets or liabilities if FRS 102 does not permit such recognition.
• Reclassify items that it recognised under old UK GAAP as one type of asset, liability or component of equity, but which are a different type of asset, liability or component of equity under FRS 102.
• Apply FRS 102 in measuring all recognised assets and liabilities.

Other points to consider where accounting policy alignments are concerned are:

• If the client values stock under LIFO, FRS 102 prohibits this cost flow assumption, so clients should really consider thinking about changing their stock valuation policies now to an alternative cost flow assumption (e.g. FIFO or average cost).
• Deferred tax is more onerous in FRS 102 and requires consideration for assets subjected to the revaluation model.
• Short-term employee benefits that are paid in the subsequent accounting period need calculating and accruing in accordance with paragraph 28.6 in FRS 102.
• A previous GAAP revaluation of an item of fixed assets can be used as ‘deemed cost’ at the revaluation date.  Where the valuation date is before the date of transition, the deemed cost should be depreciated from the valuation date.

A point to bear in mind where deemed costs are concerned for fixed assets that were previously carried under the revaluation model is that regardless of the fact that the entity may decide to carry the asset(s) at cost under FRS 102, the entity will still have revalued assets and so the disclosure requirements relating to the alternative accounting rules set out in Companies Act 2006 will still apply, hence the following will need disclosure:

• The amounts fixed assets held at valuation;
• The years of valuation;
• The basis adopted;
• Historical cost equivalents for those assets subjected to revaluation; and
• The amount of a revaluation reserve and any transfers from that reserve to realised reserves.

Mandatory exceptions

Paragraph 35.9 of FRS 102 provides for some mandatory exceptions from retrospective application.  By and large, some of these exceptions may not be applicable to the majority of companies, but it is important that you consider whether your client should apply the mandatory exceptions which apply to the following:

Derecognition of financial assets and liabilities

Financial assets and liabilities which were derecognised under old UK GAAP before the date of transition are not recognised on adoption of FRS 102.  In addition, an entity that has any financial assets and liabilities that would have been derecognised under FRS 102 in a transaction which took place before the date of transition but were not derecognised under old UK GAAP can choose to either derecognise them on adoption of FRS 102 or continue to recognise them until the financial assets or liabilities are disposed of or settled.

Hedge accounting

A reporting entity must not change its hedge accounting before the date of transition to FRS 102 for hedging relationships that no longer exist at the date of transition.  In respect of hedging relationships that exist at the date of transition, the entity should follow the hedge accounting requirements in Section 12 Other Financial Instruments Issues.

Accounting estimates

A client should not retrospectively change the accounting it applied in respect of estimates under old UK GAAP.  However, if additional information comes to light about the estimate, this should be treated as a non-adjusting event and accounted for in the current, not previous, accounting period, unless there is clear evidence that the accounting estimate is incorrect.

Discontinued operations

At the date of transition to FRS 102, a client should not retrospectively change the accounting it followed under old UK GAAP for discontinued operations.  Hence, there will not be any reclassification or remeasurement for discontinued operations previously accounted for.

Non-controlling interests

These are better known as ‘minority interests’ and on the date of transition, a client should not retrospectively change the accounting that it followed for measuring non-controlling interests.

Optional exemptions from full retrospective application

There are 17 optional exemptions contained in paragraph 35.10 of FRS 102 and clients can take advantage of any, all or none of the exemptions in the following:

• Business combinations, including group reconstructions
• Share-based payment transactions
• Fair value as deemed cost
• Revaluation as deemed cost
• Individual and separate financial statements
• Compound financial instruments
• Service concession arrangements
• Extractive industries
• Arrangements containing a lease
• Decommissioning liabilities included in the cost of property, plant and equipment
• Dormant companies
• Deferred development costs as deemed cost
• Borrowing costs
• Lease incentives
• Public benefit entity combinations
• Assets and liabilities of subsidiaries, associates and joint ventures
• Designation of previously recognised financial instruments.

Firms should consider whether it is advantageous for clients to take advantage of any of these optional exemptions to aid the transition process.

Disclosures at transition

Clients have to explain how the transition to FRS 102 affected its reported financial position and performance.  In order to do this, the following disclosures are necessary:

• A description of the nature of each change in accounting policy;
• Reconciliations of its equity determined in accordance with its previous financial reporting framework to its equity determined in accordance with FRS 102, for both of the following dates:
  • The date of transition to FRS 102; and
  • The end of the latest period presented in the entity’s most recent annual financial statements determined in accordance with its financial reporting framework; and
  • A reconciliation of the profit or loss determined in accordance with its previous financial reporting framework for the latest period in the entity’s most recent annual financial statements to its profit or loss determined in accordance with FRS 102 for the same period.

Disclosures are also required of the client’s equity at the date of transition and at the year-end and profit for the year-end.

A suggested format for disclosure is as follows:

Reconciliation of profit or loss for the year

Reconciliation of equity

Reconciliation of profit or loss for the year

Conclusion

This article has considered some of the more theoretical aspects that are required on transition to FRS 102.  The second article will look at a set of financial statements that have been converted to FRS 102 from old UK GAAP to offer practitioners an insight as to how to deal with the transitional issues.

Category: Accounting and standards