Small company reporting set for sweeping changes

In light of the legislative changes occurring in the UK which were announced by the Department for Business, Innovation and Skills (BIS) on 29 August 2014, the Financial Reporting Council (FRC) has published a consultation document outlining their proposals on the implementation of the EU accounting directive.

The most significant changes arising from the EU Accounting Directive is the change in the small companies’ regime and this affects current accounting standards because they may not specify disclosure requirements in addition to the limited number of disclosures contained within the new Accounting Directive.  A point worth noting is that under the new Accounting Directive a company must still make additional disclosures over and above those contained in the proposed legislation if the minimum disclosures imposed do not enable the financial statements to give a true and fair view.  This is a concern of the FRC who view the determination of those additional disclosures to be a greater burden on company directors (and those charged with governance) and for the majority of practitioners they will need to work with their clients to ensure that their financial statements do give a true and fair view.

The FRC proposals

The FRC have outlined their proposed framework as follows:

• Micro-entities will apply the Financial Reporting Standard for Micro-Entities (FRSME).
• Small entities which are not micro-entities will apply FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland. The FRC are proposing to insert a new section in FRS 102 which will outline the presentation and disclosure requirements which will apply to small companies and will be based on the new legal provisions.  In all other respects FRS 102 will remain unchanged.
• Entities which apply EU-endorsed IFRS in the preparation of their financial statements will continue to do so.
• Qualifying entities will continue to have the option to prepare financial statements in accordance with the provisions in FRS 101 Reduced Disclosure Framework.
• An entity can still have the option to apply a more comprehensive accounting standard if they so wish. For example a micro-entity could choose between the new FRSME, FRS 102 applying the small companies’ regime, full FRS 102 or EU-endorsed IFRS.

The FRSSE is proposed to be withdrawn with small companies being brought under the scope of FRS 102 (as in (b) above).

The proposals are anticipated to take effect for accounting periods commencing on or after 1 January 2016.

The consultation document contains a table outlining the revised framework which is as follows:

The FRSME

The FRSME is going to be based on the recognition and measurement requirements of FRS 102.  As a consequence, regardless of whether small companies apply the FRSME or the simplified FRS 102 regime they will apply accounting treatments which are consistent with the new UK GAAP (ie full FRS 102).  For example, currently within the FRSSE if a company has investment property fair value fluctuations are taken to the revaluation reserve within equity and reported through the statement of total recognised gains and losses.  Under FRS 102, fair value fluctuations are taken to profit or loss so there is a disparity between the accounting treatment under the FRSSE versus FRS 102 (although under the FRSME, reporting entities would not be able to revalue investment properties at each balance sheet date as they would have to be carried at cost less depreciation).

The FRC have acknowledged that the consistency within accounting treatments will result in a reduction in the number of accounting changes necessary as entities grow.

The definition of a micro-entity is contained in sections 384A and 384B of the Companies Act 2006 and the qualifying conditions are met by an entity in a year which it does not exceed two, or more, of the following criteria:

• Turnover £632,000
• Balance sheet total £316,000
• Number of employees 10

The micro-entities regime is optional and a company that would otherwise qualify to apply the FRSME could choose not to and apply the simplified FRS 102, full FRS 102 or EU-endorsed IFRS (although it is highly unlikely a micro-entity would choose full FRS 102 or EU-endorsed IFRS to prepare its financial statements).  Companies in the Republic of Ireland cannot use the micro-entities regime because no legislation currently exists, but this has been consulted on as part of the DJEI Consultation Document.

The FRSME will be developed from FRS 102 and will be adapted so as to reflect the requirements of the micro-entities legislation but with further simplifications.

The FRC are planning to simplify the accounting framework for micro-entities in the new FRSME as follows:

• Presentation and disclosure requirements as set out in legislation.
• FRS 102-specific recognition and measurement requirements except for:
• Financial instruments which will only be measured at amortised or historical cost;
• No requirement to account for deferred tax (many accountants will rhapsodise this simplification);
• No requirement to account for equity-settled share-based payments prior to the issue of shares;
• Simplified accounting for post-employment benefits. A micro-entity will be able to account for a defined benefit pension plan as a defined contribution plan.
• Withdrawal of the option to capitalise borrowing costs.
• No requirement to apply sections of FRS 102 which will not generally apply to micro-entities (eg Section 19 Business Combinations and Goodwill, Section 31 Hyperinflation and most of Section 34 Specialised Activities (although the sub-section Agriculture will be retained)).

If a micro-entity has derivative financial instruments, the FRSME will not be able to allow these to be accounted for at fair value or require disclosure of the existence and nature of such instruments because the legislation prohibits this (the micro-entities regime does not recognise any provisions of the alternative accounting rules).  However, the FRC have mentioned that the FRSME will clarify when a derivative instrument becomes onerous and hence the obligation will be recognised at present value.

Conclusion

Clearly financial reporting is undergoing a significant amount of change and accountants are encouraged to submit their comments – particularly if there are any areas of the consultation document which they are concerned.  The invitation to comment on the proposals is open until 30 November 2014.  After this date the FRC will develop the proposals further and issue Exposure Drafts for which comments will also be encouraged.  The FRC are planning to issue final standards on the small companies regime in the summer of 2015.

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