ICAS responds to the FRC’s proposed changes to UK GAAP
ICAS has responded to the FRC’s proposed changes to UK GAAP following its periodic review.
The Financial Reporting Council (FRC) published Financial Reporting Exposure Draft (FRED 82) in December 2022 with the consultation closing on 30 April 2023.
About the consultation
FRED 82, Draft amendments to FRS 102, The Financial Reporting Standard applicable in the UK and Republic of Ireland, and other FRSs contains the FRC’s proposed changes to UK GAAP following its latest periodic review. The other FRSs referred to include FRS 105 The Financial Reporting Standard applicable to the Micro-entities’ regime.
ICAS has responded to the FRC’s proposed changes to UK GAAP, which we broadly support.
We also comment on additional changes that we would like to see introduced now and on other matters we would like to see covered in a future periodic review.
For those with an interest in pension scheme financial statements and charity financial statements, our response includes sector-specific comments.
Principal amendments and our views
The principal amendments proposed by the FRC arise from decisions taken on how to reflect significant changes made in recent years to IFRS Accounting Standards in UK GAAP:
- Changes to accounting requirements for revenue in FRS 102 and FRS 105 are based on the five-step model for revenue recognition from IFRS 15 Revenue from Contracts with Customers, with simplifications.
The extent of any impact on an entity’s recognition of revenue will depend on the form of its contracts with customers.
In our response, we recommend that the proposed practical expedient for group entities, to apply IFRS 16 Leases to promote efficiency within groups, is made available in the same circumstances to the application of IFRS 15.
On a point of detail, we have pushed back on the substitution of the term ‘performance obligation’ with the word ‘promise’. ‘Performance obligation’ is a well-understood term used in IFRS 15. By using the term ‘performance obligation’ in UK GAAP, financial statements’ preparers will have access to third-party GAAP guides which use consistent terminology on the recognition of revenue from contracts with customers.
- Changes to the lease accounting requirements in FRS 102 are based on the on-balance sheet model from IFRS 16, with simplifications.
This is expected to result in an impact on the financial statements of most entities which are currently lessees under one or more operating leases. There are new requirements on the treatment of leases provided at a rental that is significantly below market value.
The practical expedient permitting group entities preparing their financial statements in accordance with FRS 102 to apply IFRS 16 is something that we welcome.
We recommend that the definition of a lease incentive in FRS 102 is revised to align with the IFRS 16 definition. The current definition within FRS 102 has not been updated and continues to refer to ‘an operating lease’.
We also comment on the potential challenges which may exist for entities, particularly smaller entities, including charities, in identifying market rents for leases provided at below market rent.
The FRC has no current plans to align FRS 102 with the expected credit loss model of financial asset impairment from IFRS 9 Financial Instruments. We are supportive of the FRC’s position.
Timing of implementation
The revised FRSs are expected to apply to financial statements with accounting periods commencing on or after 1 January 2025, although the timing is subject to consultation.
We highlight that revised FRSs would need to be published no later than September 2023 to give entities sufficient time to address transitional matters. Entities with banking or loan covenants referring to EBITDA (Earnings before interest, taxes, depreciation and amortisation) or other key performance measures will need time to renegotiate contracts, so the proposed implementation timing may be challenging for some.
Another suggestion made by us, calls for the FRC to consider a short implementation delay perhaps to periods commencing on or after 1 April 2025. This will enable the accountancy profession to better serve its clients. This short delay would avoid a six-month overlap, from April 2026 to September 2026, where financial statements’ preparers would be working on both 31 December 2025 and 31 March 2026 year-ends, until the filing deadline for 31 December 2025 year-ends had passed.
We believe there is scope in the medium term to consider reviewing UK GAAP’s sized-based reporting requirements to reduce complexity and better meet the needs of both financial statements’ preparers and users.
An alternative to the current arrangements whereby small entities can choose to apply Section 1A of FRS 102 and micro entities can choose to apply FRS 105, could be the replacement of both with an enhanced FRS 105 which would apply to entities below the Companies Act 2006 audit threshold.
FRS 102 could then become a standard primarily designed to fit the needs of the financial statements’ users of entities above the Companies Act 2006 audit threshold.
This would help to remove some of the tension that exists between trying to create a proportionate financial reporting standard intended to serve the needs of exceptionally large entities as well as smaller entities.
This would require amending the accounting regulations, which is beyond the power of the FRC and would require the support and proactive involvement of the Department for Business and Trade.
Our response to the FRC is available here