Changes to financial reporting standards for small businesses: FRS102 Section 1A and FRS105

22nd March 2017

The Financial Reporting Council (FRC) has published a suite of updated reporting standards that will drastically change the face of small and micro-entity financial reporting. These new standards are applicable for periods commencing on or after 1 January 2016 for companies qualifying as small and will impact future reporting for all businesses falling within these categories.
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We take a look at some of the key areas and implications of the new accounting standards and which actions you should take if you are affected.

What has changed?

All small entities previously adhering to financial reporting standard FRSSE 2015 (Financial Reporting Standard for Smaller Entities) will now automatically fall within the scope of FRS102, however, they will be entitled to a number of financial reporting exemptions as laid out in the new Section 1A of the standard.

In addition to this, a new standard (FRS105) has also been introduced for the smallest of entities, which qualify for and can choose to apply the micro-entities regime.

These new standards will apply for all accounting periods commencing on or after 1st January 2016.

Will my business be affected?

 SMALL ENTITIES

If you have previously followed the FRSSE 2015 standards and qualify as a small entity, you will certainly be impacted.

A small entity is defined as….

A company that qualifies as small under sections 382 to 384 of the Companies Act 2006 (or would do had it been incorporated under company law) or an LLP qualifying as small under the LLP regulations.”

These are the current thresholds for qualification as a small entity.

Qualifying Threshold
Turnover £10.2m
Balance Sheet Total £5.1m
Number of Employees 50

Previous qualifying thresholds prior to the changes were as follows: Turnover: £6.5m Balance Sheet Total: £3.26m Number of Employees: 50

 LLPs

The small company thresholds highlighted above also apply to LLPs when deciding whether to follow FRS 102 Section 1A or full FRS 102.

MICRO-ENTITIES

Your business may qualify as a micro-entity, meaning that you are able to apply FRS105 instead of FRS102 if it suits your business.

A micro-entity is defined as….

Any small entity that meets at least two out of three of the following thresholds“:

Qualifying Threshold
Turnover Not more than £632,000
Balance Sheet Total Not more than £316,000
Number of Employees Not more than 10

*The turnover limit is adjusted proportionately if the financial year is longer or shorter than twelve months. The rules for qualifying in the first and subsequent financial year are the same as those under the small companies regime.

frs102cThere is more to qualifying as a micro-entity than being very small. Aside from the size criteria, a number of entities are specifically excluded from the micro-entities regime including charities, investment undertakings, financial holding and insurance undertakings, credit institutions, overseas companies, unregistered companies and companies authorised to register pursuant to s1040 of the Companies Act 2006.

If your business qualifies as a micro-entity, you will need to understand which of the new standards are best for you, which you should be following; FRS102 Section 1A or FRS105. This will depend on your individual business circumstances.

FRS102 Section 1A: Key Features and Changes to previous standards

We have taken the key areas of change of Section 1A of FRS102 and broken down where they may impact or have changed from previous GAAP standards.

HOLIDAY PAY ACCRUALS

Key changes:

  • Historically there has been no reason to provide for a holiday pay accrual.
  • FRS102 requires the inclusion of a holiday pay accrual to include the liability for any unused employee holidays and benefits the employee is entitled to as at the balance sheet date.

What this will mean:

Upon preparation of the accounts you will need to provide details of the company’s holiday year period, details of holiday allowances, and details of holidays taken from the start of the holiday year to the year end. There will however, be the benefit of Corporation Tax relief on the holiday pay accrual.

HIRE PURCHASE LIABILITIES

Key changes:

  • Historically interest on hire purchase liabilities has been calculated on a straight line basis, by which the total interest charged on the hire purchase has been charged in equal monthly instalments over the duration of the agreement.
  • Under FRS102 hire purchase interest is to be calculated using the ‘sum-of-digits’ method, meaning it is charged in relation to the outstanding balance (more at the start of the agreement, and less at the end of the agreement).

What this will mean:

Upon preparation of the first year on FRS102 you may need to provide copies of historical hire purchase agreements still in the financial statements. Any adjustment made to the hire purchase interest in previous years will be subject to Corporation Tax relief.

OPERATING LEASES

Key changes:

  • Historically only the annual lease payments due have been disclosed in the financial statements.
  • However, under FRS102 you will need to disclose the total future minimum lease payments to the end of the lease.

What this will mean:

In order to make these disclosures you will need to provide details of any current leases in the financial statements, along with the expiry date of the lease to be able to calculate this.

GOODWILL

Key changes:

  • Purchased goodwill has historically been amortised over a useful life that the directors consider to be appropriate (usually around 20 years).
  • However, under FRS102, goodwill should only be amortised over five years, unless a reasonable explanation can be given to justify an extended useful life.

What this will mean:

If there is no real justification to the useful life of purchased goodwill, you may have to reduce the useful life to only five years.frs102b

RELATED PARTY DISCLOSURES

Key changes:

  • Historically directors’ remuneration has been disclosed, along with any transactions with a related party, including details of the related party’s name and outstanding balances.
  • Under FRS 102, remuneration of ‘key management personnel’* must be disclosed.
  • Any remuneration received by close family members of key personnel should also be disclosed.
  • Related party transactions do not need to be disclosed (under Section 1A) if the transactions occurred under normal market conditions.

What this will mean:

Possible reduced disclosure of related party transactions, if in normal market conditions. You will also need to provide details of ‘key management personnel’, along with their salaries for the current and comparative year.

* Key management personnel are those persons having authority and responsibility for planning, directing and controlling the activities of the entity, directly or indirectly, including any director (whether executive or otherwise) of that entity. 

INVESTMENT PROPERTIES

Key changes:

  • Investment properties are to be held in the financial statements at open market value – meaning they should be revalued each financial year.
  • Gains and losses have historically been recognised in the statement of total recognised gains and losses, and a distinction made between permanent and temporary falls in value.
  • Under FRS102, any changes in the investment property value are to be shown in the profit and loss account, and all reductions are deemed to be permanent.
  • The definition of an investment property has also been extended to include properties leased to other members of the same group within the individual company accounts.
  • Finally, properties under finance leases can now be treated as ‘investment properties’ if they are held by the lessee for rentals and / or capital appreciation.

What this will mean:

Companies holding investment properties will be required to obtain a valuation at the year end, unless this would cause undue cost or effort.

DEFERRED TAX

Key points to note:

  • Transition to FRS102 may result in fair value revaluations to investment properties and other tangible fixed assets. This will also result in a corresponding adjustment to the deferred tax calculation.

FOREIGN EXCHANGE HEDGING TRANSACTIONS

Key changes:

  • Historically where derivative contracts have been used, the transactions have been translated at the contracted / agreed rate rather than the spot / transaction rate.
  • Under FRS102, all foreign transactions must be recorded at the spot / transaction rate, and any derivative contracts must be recognised at fair value in the balance sheet, with any foreign gains or losses on revaluation going to the profit and loss.

 

I qualify as a micro-entity – should I adopt FRS105 reporting standard?

If your business qualifies as a micro-entity, you will need to decide if it makes more sense to apply FRS105.

Main features of the micro-entities regime

  • A simpler balance sheet and profit and loss account. There are two formats for the balance sheet and one format for the profit and loss account.
  • A micro-entity is not required to prepare a directors’ report.
  • No notes to the accounts are required. Instead, where applicable, details of any advances, credit and guarantees with directors (companies only), and details of any financial commitments, guarantees and contingencies should be disclosed at the foot of the balance sheet. This reduced information is referred to as the ‘minimum accounting items’.
  • If a micro-entity chooses to disclose information in addition to the minimum accounting items it must, in respect of that item, follow the disclosure requirements of the relevant accounting standard.
  • The fair value accounting and alternative accounting rules cannot be applied in micro-entity accounts. This means that no revaluations or subsequent measurement at fair value is permitted under the micro-entities regime. For example, a micro-entity with an investment property, choosing to adopt the micro-entities regime, would be required to measure the property at cost and not fair value.
  • Accounts prepared in accordance with the regulations are presumed by law to give a true and fair view.
  • Only the balance sheet, including the information disclosed at the foot, needs to be filed at Companies House. It is not necessary to file the Profit and Loss account, or where relevant, the Directors’ report.

The adoption of FRS105 by micro-entities is entirely optional. A micro-entity may just as easily choose to follow the standard FRS102 Section 1A required for small entities and the decision will depend on the individual circumstances of the reporting entity. For example, current and potential creditors and lenders to a business may require more information than micro-entity accounts provide. On the other hand, a micro-entity with an investment property and little or no borrowings may be attracted by the fact that, under the micro-entities regime, investment properties will not need to be revalued each year. 

As is often the case, the decision about which regime to apply will depend on the circumstances of the individual entity, such as the following.

  • The users of the financial statements: the information required in micro-entity accounts is significantly less than in accounts prepared under the small companies regime. Current and potential lenders, amongst others, may require more information than is provided by micro-entity accounts.
  • Future growth plans: a company that qualifies as a micro entity but is growing and close to the size limits may decide that it does not make sense to adopt the micro-entities regime for just a year or two.
  • Minimum accounting items: the micro-entities regime sets out “minimum accounting items” to be included, when relevant, in micro-entity accounts. However, if a micro entity chooses to include additional information in the accounts it must refer to the relevant requirements of Section 1A of FRS102. If a micro entity expects to disclose extra information it may decide that it makes more sense to apply the small companies regime instead.
  • Accounting differences: while there are different presentation and disclosure requirements for small entities applying FRS102, there are no simplifications to the recognition and measurements requirements. On the other hand, FRS105 is based on FRS102 but with significant simplifications and may prove an attractive option for the smallest entities not keen to apply the more complex accounting treatments found in FRS 102. For example, under FRS105 the accounting for financial instruments (including intra-group and directors’ loans) is simpler and accounting for deferred tax is not permitted.
  • Account formats: micro-entity accounts are simpler than “full” accounts prepared under the small companies regime. However, there are fewer formats available and less flexibility.
  • True and fair: although the recent changes to UK company law limit the number of disclosures that can be required by law in small company accounts, those accounts are still required to give a true and fair view. Judgment will therefore be needed when deciding whether additional information is required. In contrast, micro-entity accounts are presumed by law to give a true and fair view.

Entities should consider carefully the various implications before deciding whether or not to take advantage of the micro-entity exemptions.frs102d

Summary

There are a number of ways in which these changes could impact you and your business, including; existing loan arrangements, which may be impacted by language used; company profits could be impacted in your transitional year, which may impact dividends due to lowered distributable reserves; tax liabilities or tax savings opportunities may differ; and lower reserves and net current assets may affect credit ratings and relationships with suppliers and lenders.

However, this need not be as difficult as it sounds. With effective planning and thought, the negative impact of the changes can be reduced. In addition, there are also ways in which these changes can be used to your benefit, by reducing tax liabilities or improving the appearance of company balance sheets.

At TTR Barnes, we have been planning for these changes for some time and can help in a number of ways:

  • Assisting with conversion to FRS102/FRS105
  • Pre-emptive reviews in order to identify areas of potential impact/benefit
  • Preparing statutory accounts under FRS102 where independence issues prevent the incumbent auditor from assisting
  • Tax reviews to identify areas of potential saving

To find out more about how we can help, please speak to one of our Account & Auditing Team or contact us.

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