Moving between accounting frameworks
The two ‘main’ accounting standards in UK GAAP are FRS 102 The Financial Reporting Framework applicable in the UK and Republic of Ireland and FRS 105 The Financial Reporting Standard applicable to the Micro-entities Regime. It is worth noting that the Financial Reporting Council (FRC) recently issued new editions of these standards (being the January 2022 editions) which consolidate all amendments made to them since March 2018. FRS 100 Application of Financial Reporting Standards has not been reissued as yet but is expected to be issued later in 2022.
UK GAAP is fairly flexible in its approach. An entity that qualifies as a micro-entity and is eligible to report under the micro-entities’ framework can apply FRS 105, or it can use FRS 102 if it wishes. A company that is classed as small (but not micro) uses FRS 102 and can apply the presentation and disclosure requirements in Section 1A Small Entities if it wishes, or it can report under full FRS 102 or even UK-adopted IFRS (although very few private entities that are small companies report under UK-adopted IFRS).
It is important that clients select an appropriate financial reporting framework (i.e. FRS 102 or FRS 105) at the outset. While FRS 105 will be appropriate for many micro-entities, it will not be appropriate for them all and hence it may be that the practitioner advises the client to bypass FRS 105 and go onto FRS 102. Factors that may influence this decision-making process include the following (note the list below is not comprehensive):
- Information on the public record. There will be less information published at Companies House where the micro-entity files a micro-entity balance sheet than under the small companies’ filing regime where the entity may choose to file ‘filleted’ or ‘filleted abridged’ accounts.
- Pace of growth. The micro-entity may be planning to expand at a rapid rate, hence may outgrow FRS 105 in a relatively short timescale, therefore it may be advisable to bypass FRS 105 and go straight into FRS 102 (including applying the presentation and disclosure requirements of Section 1A) to avoid a transition up to FRS 102 in a relatively short timescale.
- Access to finance and credit. There have been concerns that the limited disclosures made in micro-entity financial statements have had an impact on the credit-rating of the business (although this has not been substantiated with actual cases). In addition, lenders may require additional non-statutory information to base their lending decisions on or require such information as a matter of course to ensure the micro-entity remains creditworthy.
- Effect on distributable profit. The lack of accounting policy options in FRS 105 will mean that most transactions are recognised in profit or loss. For example, there is no option to capitalise borrowing and development costs under the standard – all such costs must be written off to profit or loss.
- Effect on balance sheet. The prohibition on the use of fair values and revaluation amounts means that all assets will be measured under the cost model (cost less depreciation less impairment). This will reduce micro-entities’ balance sheet positions (especially those with an investment property on the balance sheet). This is an issue which should be carefully considered when advising a micro-entity on using FRS 105.
- Client expectations. The client may require more detailed information to be presented in the financial statements on which to aid the decision-making process. FRS 105 will only provide minimal information.
- Ease of use. FRS 105 is the least complex framework in UK GAAP and hence this, in itself, may be the deciding factor when choosing the relevant framework for a micro-entity.
Can an entity switch from FRS 102 to FRS 105 and vice versa on a regular basis?
As noted earlier in the article, it is important that the client chooses the most appropriate financial reporting framework at the outset. While it is possible to move between financial reporting frameworks, a transition from FRS 102 to FRS 105 and vice versa should not be done on a regular basis. Transitioning on a regular basis will be expensive because on transition to another framework, the financial statements will need to be restated so they are compliant with that framework. As will be examined later in the article, a transition must be carried out from the date of transition which is the start date of the earliest period reported in the financial statements.
Consider a company that is planning to transition from FRS 105 to FRS 102 and is currently preparing its financial statements for the year ended 31 December 2021. The date of transition in this case will be 1 January 2020, which is the start date of the earliest period reported in the financial statements. The transition date balance sheet will need to be restated to comply with FRS 102 as will the closing comparative year, so there may be several transitional and prior year adjustments that need to be effected to enable the comparative year’s financial statements to be FRS 102-compliant.
The example above highlights why an entity would be ill-advised to make regular transitions from one framework to another. Regular transitioning to another framework can be costly and an inefficient use of time.
‘Cherry picking’ from another standard
A micro-entity does not necessarily have to report under FRS 105 if it does not wish to. It can choose to report under FRS 102, including applying the presentation and disclosure requirements of Section 1A.
If an entity is eligible to use both FRS 102 and FRS 105 it cannot ‘cherry pick’ from another standard. For example, an entity that would qualify as a micro-entity and be eligible to use FRS 105 but chooses instead to report under FRS 102 cannot ignore deferred tax. If the entity were to report under FRS 105 then it would not be able to account for deferred tax because that standard prohibits it. However, because it has chosen to report under FRS 102 then it is subject to the same recognition and measurement requirements as any other entity reporting under FRS 102 and hence must account for deferred tax.
Similarly, an entity that could use FRS 105 but chooses to report under FRS 102 must fair value its investment property at each balance sheet date. The fact that the Fair Value Accounting Rules in company law cannot be applied by a micro-entity reporting under FRS 105 is irrelevant. If the entity chooses to report under FRS 102 it must comply with the requirements of that standard.
Transitioning between the frameworks
Some micro-entities do outgrow FRS 105 and hence will need to transition to FRS 102 (including applying the presentation and disclosure requirements of Section 1A, if applicable). Conversely, some small entities may contract and become eligible to use FRS 105.
Whenever there is a switch between financial reporting frameworks, a transition must be carried out. This involves restating the transition date balance sheet (i.e. the opening balance sheet position as at the start date of the comparative year) and then restating the closing comparative year so that the financial statements comply with the requirements of FRS 102 or FRS 105. Remember, the entity must prepare financial statements which are comparable hence the financial statements would be meaningless if the current year was prepared under, say, FRS 102 and the prior year under FRS 105. This is why the transition exercise is essential.
The table below provides some non-comprehensive factors to consider when switching between frameworks:
| From FRS 102 to FRS 105 | From FRS 105 to FRS 102 |
| Remove any fair values and revalued amounts (a revaluation reserve should never be seen on a micro-entity’s balance sheet) | Consider additional accounting policies that are permitted under FRS 102, such as revaluing property, plant and equipment and capitalising development expenditure. Also, FRS 102 requires all investment property (except intra-group investment property) to be measured at fair value through profit or loss with associated deferred tax consequences accounted for as well |
| Remove all deferred tax balances | Recognise deferred tax balances |
| Apply the disclosure requirements per FRS 105 (which do not include issues such as related party transactions and transitional information) | Consider whether the entity will apply the presentation and disclosure requirements of Section 1A, or whether full FRS 102 disclosures are to be made. Related party disclosures are limited under Section 1A but are more comprehensive under Section 33 Related Party Disclosures and the disclosure of transitional information for small entities is encouraged |
| Restate foreign exchange assets and liabilities to contract rate where applicable | Only use the closing rate for such assets and liabilities – contracted rates are not allowed under FRS 102 and hence a derivative financial instrument is likely to be recognised under FRS 102 |
| Remove additional statements such as the statement of changes in equity and other comprehensive income statement | Small entities are encouraged to present a statement of changes in equity and other comprehensive income statement |
| Restate basic financial instruments as the amortised cost method which uses an effective interest rate is not permitted | Basic financial instruments are measured at amortised cost using the effective interest method. A small entity can apply the simplification in FRS 102, para 11.13A(a) for directors’ loans to the entity at below market rate |
| Remove transactions related to equity-settled share-based payment transactions that have not yet been issued | Recognise equity-settled share-based payment transactions even if the shares have not yet been issued |
| Remove the defined benefit pension liability and account for the defined benefit pension plan as a defined contribution pension plan but recognise a liability in respect of an agreement to fund a deficit in the form of a schedule of contributions | Remove the liability in respect of an agreement to fund a deficit in the form of a schedule of contributions and apply defined benefit accounting (i.e. bring the defined benefit obligation onto the small entity’s balance sheet) |
Conclusion
This article has considered some of the more notable issues relating to FRS 102 and FRS 105 and how they interact with each other – especially when it comes to transitioning between the frameworks. The article has not covered every eventuality and preparers must, therefore, have a sound understanding of the differences of each framework to be able to provide sound advice to their client in respect of the most appropriate financial reporting framework to adopt in the preparation of the entity’s financial statements.
Category: Accounting and standards
