FRS 102 – What is it and what does it mean to your business?
FRS 102, or to give its correct title, Financial Reporting Standard 102, is the main new UK accounting standard which replaces all of the previous reporting standards. Financial reporting standards are the rules which we have to follow when preparing accounts, setting out what and how a company’s financial information has to be shown. FRS 102 sets out the new rules which we now have to follow.
Virtually all UK companies will be affected in some way by the changes. FRS102 came into effect on a mandatory basis for accounting periods beginning on or after 1 January 2015, although earlier adoption is permitted, for larger & medium companies.
For small entities (turnover <£10.2m, balance sheet <£5.1m and <50 employees), FRS 102 applies to accounting periods beginning on after 1 January 2016. This means that, the first accounts that we will see adopting the new standard will be those with a 31 December 2016 year ends, hence the reason for it being the subject of our January 2017 newsletter. As will be seen below, although FRS 102 is a reporting standard it may have a tax and commercial impact for some companies.
Micro entities (turnover <£632,000, balance sheet <£316,000 and <10 employees) can adopt FRS102 if they wish, however micro’s have an opt out and can use a much simpler set of rules.
What are the changes?
You may ask “why do I care, I am the client and you are the accountants, a reporting standard is your issue?”. However the changes may have a substantial effect on your reportable profits, tax charges and distributable reserves.
The new standard means that your 2016 accounts will take longer for us to complete, as apart from getting up to speed with the new rules, we have to adjust the prior year (2015) to match for comparative purposes. You will recall that when you review your company accounts it shows the results of two trading years.
The language used is also different, so you will see for example reference to receivables and payables; not debtors and creditors. Property, plant and equipment, rather than fixed assets and a number of other changes. The standard consists of 335 pages, which we can not cover in detail here, but below we have covered some of the key points, which we believe to be the most important as they could impact businesses significantly.
For those clients with goodwill on the balance sheet, we write this down annually under the previous rules, known as amortisation. Currently there is a default maximum amortisation period of 20 years if a reliable estimate of useful life cannot be made. Under the new standard this is shortened to ten years. Consequently, where there are no reliable estimates of useful life, the effect will be higher charges set against profits than currently, resulting in lower profits available for distribution as dividends. There is also a potential implication for the business’s credit rating and banking covenants.
A further point to note, is that although the distributable profits are lower as a result of the accelerated amortisation, following the change announced in the summer Budget of July 2015, there is no tax relief for the amortisation charged on goodwill acquired after the Budget announcement. The accounting standard change and the tax change means a double hit, lower profits and no tax relief for the deduction.
Property revaluations (Freehold/Long Leases)
Presently any revaluation gain or loss goes to a separate revaluation reserve on the balance sheet. This has no impact, as nothing is charged to the profit and loss account, unless the revaluation reserve has been fully extinguished.
Under FRS 102, the revaluation gain or loss on a property will go to the profit and loss account. This may have a dramatic effect on the accounting profit or loss for the period depending on the revaluation.
Some trading companies may hold investments (e.g. offshore or onshore bonds, investment bonds, unit trusts etc.). We advise our clients not to do this as it generally has adverse tax implications. Such investments will now have to be accounted for on a fair value basis. Under the old rules, investments were valued using the historical cost basis.
As with property, the gain or loss has to go to the profit and loss account, which could have a dramatic effect on the profit.
On the basis that these types of investment may not be good for tax purposes (potentially resulting in the shareholders failing to qualifying for entrepreneurs’ relief or business property relief for inheritance tax), together with the potential tax impacts of a revaluation, a review of investments held by a company should be considered.
Deferred tax is an account on a company’s balance sheet that represents the temporary differences between the company’s accounting and tax carrying values of fixed assets and timing differences caused by the tax treatment of revenue items not matching the accounting treatment. We refer to it as a “pretend tax” as opposed to the real tax you pay HMRC and it added to the tax charge in the profit and loss account and also shown as a long term liability on the balance sheet. Sometimes the deferred tax provision is an asset but more often it is a liability..
Presently, deferred tax is not accounted for on revaluations unless there is an intention to sell the re-valued asset (usually a property). The changes under the new standard means that deferred tax is accounted for in full on all revaluations.
Inter-company loan balances
Many company group structures or companies connected by common ownership enter into intra-group loans for a variety of reasons. For example, we have clients who make loans from their trading company to a property investment company. Problems will emerge under the new accounting standard where “soft” loans that are not repayable on demand are lent interest-free or at interest rates which are below market rates.
These soft loans will need to be discounted to their present value. Not only is such a calculation potentially complex, but it will also impact upon profits and distributable reserves.
Overdrawn directors loan accounts
These will be treated as soft loans, as explained above for inter-company loans, unless a market rate of interest is charged.
As with inter-company loans these will be discounted to their present value..
Summary for your company
So, what does this mean to you and your business?
- It is possible that there may be an impact on your company’s profits in the year of transition which will impact on the reserves available for distribution.
- As dividends can only be paid from realised distributable reserves, this reduction in profit could affect your ability to pay dividends or staff bonus arrangements.
- Lower reserves and net current assets may affect credit ratings and relationships with suppliers/lenders, and affect banking covenants.
- The tax treatment will largely follow the new standards which could give rise to additional tax liabilities or, if timed properly, tax savings.
FRS 102 – What is it and what does it mean to your business – This new accounting standard, for companies which do not qualify as micro entities will, for some businesses, have both tax and commercial implications which will need to be factored into cash flow forecasts and budgeting.
We would ask clients to bear with us, as the new standard is implemented and its effects are understood.
Should you have any queries, please do not hesitate to contact us.
Harbour Key Limited
09 January 2017