Undeniably, many first-time adopters of FRS 102 are nervous about the transition because, in many cases, this is the first-time a transition has been undertaken.
Lessons from those that have already adopted FRS 102 can be learnt in order to aid a smooth transition, particularly for small companies that may not have experienced a transition previously.
In this week's blog we look into detail at three of the accounting treatments have changed in FRS 102 when compared to previous UK GAAP. It is worth flagging these up to help those that are adopting new UK GAAP in 2017.
1. Transitional adjustments
On first-time adoption of FRS 102, the rules must be applied as far back as the date of transition. The date of transition is the start date of the comparative period reported in the accounts; hence a 31 December 2016 year-end will invariably have a 1 January 2015 date of transition because the comparative year in the accounts will be 31 December 2015 and this year starts on 1 January 2015.
Some entities have experienced difficulty in interpreting the rules correctly and have only applied the standard to the end of the comparative year. This results in the opening balance sheet position in the comparative year being incompatible with FRS 102, where transitional adjustments are needed (for example to recognise unpaid holiday pay accruals or investment property revaluation surpluses). Care needs to be taken to ensure a sound understanding of the requirements in Section 35 Transition to this FRS and always apply the rules to both the opening balance sheet position as at the date of transition and to the end of the comparative period. This will ensure that the financial statements are both comparable and consistent.
2. Financing transactions
Where an entity has entered into a loan that is below market rate (or interest-free), or has agreed credit terms which are beyond those normally granted; a financing transaction arises. Section 11 Basic Financial Instruments in FRS 102 requires a financing transaction to be initially recognised at the present value of the future payments, hence is recognised at present value; thus the future payments are discounted using a market rate of interest for a similar debt instrument. This accounting treatment arises because Section 11 uses the amortised cost method, which in turn uses the effective interest method.
This accounting treatment has caused a number of difficulties in practice, particularly where a group situation is involved because intra-group loans are often entered into a below market rates and are usually unstructured (i.e. contain no formal loan terms).
When an off-rate loan does not contain any loan terms, FRS 102 would treat the loan as repayable 'on-demand'. An on-demand loan would be recognised at transaction price (i.e. at cost) and hence no present value calculation would be performed, which is clearly a distinct advantage. The disadvantage would be, for example, where a group member has received a loan from another group member and it has been classed as a long-term liability in the borrowing group member's financial statements under previous UK GAAP (FRS 4 Capital instruments or the FRSSE). Under FRS 102, the on-demand treatment would mean that the loan would have to be moved into current liabilities, which would reduce net current assets, turn net current assets into net current liabilities or increase net current liabilities.
The other 'workaround' to discounting such loans to present value is treating the loan as a 53-week loan term. Technically, the 53rd week would require discounting to present value but it is likely to be immaterial (reporting entities are always advised to check the materiality of the 53rd week to ensure it is immaterial). This option is also proving quite popular; however, invariably auditors will ask questions as to what the arrangement is actually about if the 53-week loan term is renewed year-on-year, so care needs to be taken where this arrangement is concerned.
3. Residual values of fixed assets
In order to calculate 'depreciable amount', the anticipated sales proceeds on disposal of the asset are deducted from the asset's cost and the balance is then depreciated on a systematic basis over the asset's useful economic life.
Some entities are unaware of the difference under FRS 102 where residual values are concerned. Under FRS 102, such residual values are based on current prices, not historical prices. Therefore, under FRS 102, depreciation charges could fluctuate upwards or downwards depending on what happens with the residual value, whereas this was not the case under FRS 15 Tangible fixed assets and the FRSSE because residual values were always historic values. In some instances, it may be that the residual value has changed to such an extent that depreciation may be materially misstated so care needs to be taken where this is concerned.
You can find out more about UK GAAP and transitional issues in 2017-18 Update: UK GAAP.
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