FRS 105 versus the FRSSE

UK GAAP is currently undergoing a significant amount of change with FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland taking mandatory effect for accounting periods commencing on or after 1 January 2015 and the changes which have been made to the Companies Act 2006 due to the transposition of the EU Accounting Directive into legislation. The Financial Reporting Council (FRC) have recently issued three exposure drafts:

• FRED 58 Draft FRS 105 – The Financial Reporting Standard applicable to the Micro-entities Regime
• FRED 59 Draft Amendments to FRS 102 – Small entities and other minor amendments
• FRED 60 Draft Amendments to FRS 100 and FRS 101

Comments on these exposure drafts close on 30 April 2015 and we are expecting final standards to be issued by the FRC in July 2015.

The micro-entities regime has been the subject of much controversy within the profession, largely due to the significant disclosure reductions inherent in the regime. In addition to the significant disclosure reductions, the new regime brings about rigidity where some of the numbers that appear in the financial statements are concerned.

This article considers some of the main differences between the FRSSE (which is to be withdrawn) and the new FRS 105 which will apply to micro-entities.

Eligibility criteria

At the outset it is important to emphasise that (despite the term ‘micro-entities’) the micro-entities regime can only be applied by incorporated companies. Therefore, the following types of entity cannot apply the micro-entities legislation or FRS 105:

• Public companies
• Financial institutions including insurance companies and banking companies
• Companies that are excluded from the small companies regime
• Charities
• Limited liability partnerships
• Small parent companies that choose to prepare group accounts
• Companies that are not parent companies but whose financial statements are included in consolidated accounts

A company will qualify as a micro-entity (and hence be permitted to use FRS 105 to prepare its financial statements) if it does not exceed two, or more, of the following criteria:

• Turnover £632,000
• Balance sheet total (fixed assets plus current assets) £316,000
• 10 employees

True and fair view

One of the most commonly asked questions where the micro-entities legislation (and indeed FRS 105) is concerned is ‘how do the financial statements give a true and fair view?’ This question is asked because the legislation only provides for two disclosures and the answer to this question lies in the legislation itself.

The legislation contains ‘deeming provisions’ which say that financial statements prepared under the micro-entities legislation are presumed to give a true and fair view. As a result, the directors of a micro-entity do not have to consider any additional information to enable the financial statements to give a true and fair view.

It is important that the client’s individual circumstances are taken into consideration when determining the appropriateness of FRS 105 and not to simply adopt the standard because there are hardly any disclosure requirements. For example, if a company that would qualify to apply FRS 105 has an investment property on its balance sheet that it wishes to carry at market value (fair value), then it will not be able to apply FRS 105 and under the proposed regime, will have to apply FRS 102 for small entities as a minimum. This is because the micro-entities legislation does not recognise any of the alternative accounting rules nor does it allow any assets to be carried under the revaluation model.

In contrast, the FRSSE places a legal obligation on directors to ensure that the financial statements give a true and fair view and this will include making additional disclosure requirements where necessary (for example, going concern disclosures).

Primary financial statements

Under FRS 105 there will only be two primary financial statements produced – being the profit and loss account and the balance sheet. There is no requirement to prepare a statement of total recognised gains and losses nor is there a requirement to prepare a cash flow statement.

The profit and loss account under FRS 105 can only be a Format 2 profit and loss account whereas most companies applying the FRSSE produce a Format 1 profit loss account. The Format 2 profit and loss account comprises the following line items:

• Turnover
• Other income
• Cost of raw materials and consumables
• Staff costs
• Depreciation and other amounts written off assets
• Other charges
• Tax
• Profit or loss

Under FRS 105 principles the balance sheet can be either a Format 1 or a Format 2.

Condensed formats

The statutory formats for both the balance sheet and the Format 2 profit and loss account under FRS 105 principles are significantly condensed. For example fixed assets are not disaggregated into intangible assets, tangible assets and investment property on the face of the balance sheet; there is just one line item saying ‘Fixed assets’. Similarly, current assets are not disaggregated into the order of liquidity (stock, debtors, bank and cash); they are combined into one line item saying ‘Current assets’.

In contrast, the FRSSE disaggregates the information on the face of the balance sheet.

Disclosure reductions

As has already been mentioned, there are significantly fewer disclosure requirements under FRS 105 than the FRSSE requires and the legislation requires the following to be disclosed at the foot of the balance sheet rather than as separate notes to the financial statements:

Financial commitments, guarantees and contingencies

• The total amount of any financial commitments, guarantees or contingencies that are not included in the statement of financial position (balance sheet);
• An indication of the nature and form of any valuable security which has been provided; and
• Any commitments concerning pensions and affiliated or associated undertakings shall also be disclosed separately.

Advances and credits

• Advances and credits granted to members of the administrative, managerial and supervisory bodies with indications of the interest rates, main conditions and any amounts repaid or written off or waived.
• Any commitments entered into on their behalf by way of guarantees of any kind, with an indication of the total for each category.

In contrast, the FRSSE mandated significantly more disclosures than FRS 105.

Reduced number of accounting treatments

There are fewer options available to micro-entities in terms of accounting for certain transactions. For example, there is no option to capitalise borrowing costs as part of the cost of fixed assets; such costs will be written off to profit or loss. In addition, there is no option to revalue assets to market/fair value and therefore fixed assets will be stated at depreciated historic cost. Any assets which have been subjected to revaluation (such as investment properties) must be restated to their carrying values under normal fixed asset rules at the date of transition and going forward. No revaluation amounts are permitted and therefore it will not be possible to use a previous GAAP revaluation as deemed cost at the date of transition. In some instances this may have a detrimental impact on the company’s balance sheet and hence is an important consideration when establishing if FRS 105 is appropriate for the client.

All accounting policy choices have been removed in FRS 105 and hence the mandatory treatments will result in earlier recognition of income/expense in profit or loss as opposed to deferral in the balance sheet. Again, this is a point which will need to be carefully considered when determining the suitability of FRS 105 to your clients.

In contrast, the FRSSE permits more accounting treatments and models than FRS 105, and allows certain assets to be revalued (e.g. investment property and owned property).

Deferred tax

There is no requirement to account for deferred tax under FRS 105 and hence on transition to FRS 105 any deferred tax balances will be reversed.

The FRSSE requires deferred tax to be recognised using the timing difference approach.

Company law requirements

FRS 105 does not reproduce all the reporting requirements from the Companies Act 2006 which are applicable to micro-entities. It does, however, reproduce the requirements from the Act which relate to the financial statements themselves and hence micro-entities will have to satisfy themselves that they have met all their legal requirements.

Equity-settled share-based payment

A further simplification for micro-entities is that FRS 105 does not require a micro-entity to account for equity-settled share-based payment transactions.

Conclusion

In a lot of instances, the requirements of FRS 105 do not differ from the requirements of the FRSSE and to aid practitioners in applying and interpreting the required treatment under the new regime the FRC have included additional guidance within the standard itself.

Accountants going through FRS 105 will also see that terminology is consistent with FRS 102, for example the balance sheet is referred to as the ‘statement of financial position’. There is a Table of Equivalence included in Appendix II which can be used if needed.

Practitioners are strongly advised to consider the appropriateness of FRS 105 on a case-by-case basis taking into account the fact that the disclosure requirements are extremely negligible (although there is nothing to stop micro-entities from making additional voluntary disclosures if they so wish).

Category: Accounting and standards