The new accounting standards: What you need to know
Amy Hutchinson, ICAS Assistant Director, Technical Policy, answers common questions about the new accounting standards for small and micro-entities.
The Financial Reporting Council (FRC) recently issued new accounting standards for small and micro-entities, which will apply for accounting periods beginning on or after 1 January 2016. In this article, we answer some of the most common questions about the new standards and their implementation.
I have a number of client companies who qualify as micro-entities and who currently use the Financial Reporting Standard for Smaller Entities (FRSSE) with the micro-entity amendments. What are the options for these companies under the new accounting regime?
The FRC has recently published a new standard for entities applying the micro-entities regime – Financial Reporting Standard (FRS) 105. This is a stand-alone standard which incorporates the specific legal requirements relating to the financial statements of micro-entities, including:
- Financial statements prepared in accordance with the legal requirements of the micro-entiies regime are presumed to give a true and fair view, therefore directors are not required to consider what additional information is required for the financial statements of the entity to give a true and fair view.
- The statutory formats for the balance sheet and profit and loss accounts are significantly condensed, and only two note disclosures are legally required.
- Micro-entities are not permitted to fair value or revalue any assets or liabilities.
In addition, the FRC has made further simplifications for micro-entities; removing the requirement to recognise deferred tax and removing accounting policy options.
Entities who qualify as a micro-entity under the Companies Act and who choose to adopt the micro-entities accounting provisions must prepare their accounts in compliance with FRS 105 for accounting periods beginning on or after 1 January 2016 with early adoption available for accounting periods commencing on or after 1 January 2015.
Micro-entities can also choose to provide additional disclosures within FRS 105 accounts, or of course may decide to use another accounting framework (e.g. FRS 102 or indeed IFRS), if it is more appropriate to their circumstances. Care also has to be exercised by directors of such entities to ensure that the micro-entity framework is fit for the purposes of the entity concerned.
My small company has prepared its accounts under the FRSSE for a number of years. I had understood that the new accounting standard, FRS 102, was only to apply to medium and large companies. It now appears that I will have to apply FRS 102 after all, is this correct? Will this be more complex than using the FRSSE?
FRS 102 replaces full UK GAAP for accounting periods beginning on or after 1 January 2015, with the FRSSE remaining in force for small entities for a further year. From 1 January 2016, you are correct that small entities will be required to adopt a version of FRS 102 – section 1A small entities.
This sets out the specific presentation and disclosure requirements applicable to small entities, while recognition and measurement must be in accordance with the main body of FRS 102. Changes to company law made to implement the requirements of the EU Accounting Directive have reduced the number of disclosure notes that can be mandated for small companies, therefore the disclosures under section 1A may seem more straightforward than under the FRSSE. However, directors are still required to ensure the financial statements give a true and fair view, therefore must consider what additional information is necessary to achieve this.
In terms of recognition and measurement, much of FRS 102 is similar to the FRSSE, although there are a few key areas where new accounting treatment is introduced: the recognition of more financial instruments such as interest rate swaps and foreign exchange contracts, and the additional recognition of deferred taxation on the revaluation of fixed assets.
What are the new size criteria for small companies?
The small company thresholds will increase for accounting periods beginning on or after 1 January 2016 to:
- Turnover £10.2 million
- Balance sheet total £5.1 million
- No. of employees 50
The micro-entity thresholds remain at:
- Turnover £632,000
- Balance sheet total £316,000
- No. of employees 10
Please remember that the 2 year still applies and certain entities are specifically prohibited from using either financial reporting regime.
I have a client which is currently a medium-sized company, but which would qualify as small under the new thresholds recently announced by the government, taking effect from 1 January 2016. Does this mean my client will be required to apply full FRS 102 for its 2015 accounts and then be eligible to use FRS 102 – section 1A small entities from 2016 onwards?
The government has permitted early adoption of the new accounting thresholds in the Companies Act, and when this option is taken, section 1A of FRS 102 can also be adopted early. This means that the situation you have described above can be avoided – the company can move straight to FRS 102 – section 1A for its 2015 accounts. It should be noted that the although the definition for audit exemption remains aligned with the small company definition for financial reporting purposes, the revised thresholds cannot be adopted early for audit exemption purposes and therefore would only apply from 1 January 2016.
We are expecting BIS to comment on its plans for audit exemption in its forthcoming consultation on its proposals for implementing the EU Audit legislation. This consultation is expected to be published in late September/early October. If BIS does not alter the legislation as curently implemented then the audit thresholds will rise to a turnover of £10.2 million and a balance sheet total of £5.1 million for accounting periods commencin on or after 1 January 2016.
I act for a number of clients that will be adopting FRS 102 – section 1A small entities. What are the key areas of difference from the FRSSE that they should be focussing on?
As noted above, there are many similarities between the FRSSE and FRS 102 – section 1A small entities, but there are some areas where the accounting will change, and those applying the new standard should ensure they fully understand the impact of these on their accounts. The three areas below may have an impact for many small entities:
The FRSSE does not really address accounting for financial instruments, while FRS 102 requires the recognition and measurement of a wide range of financial assets and liabilities. Basic financial instruments, such as straightforward loans and investments, may be measured at amortised cost, whilst 'other' instruments such as derivatives require to be fair valued.
Small entities could be tempted to think that fair value will not apply to them, but in fact many could hold interest rate swaps or foreign exchange forward contracts which are treated as derivatives. Another common area that may become more complex is that of inter-company loans which are made at zero interest, or a below market rate of interest. Under the FRSSE, such loans would be recognised at their face value, but FRS 102 requires them to be treated as financing transactions, to be measured at the present value of the future payments discounted at a market rate of interest for a similar debt instrument.
Under FRS 102, gains or losses on the revaluation of an investment property will be required to be included in the profit or loss for the year. This is in contrast to the current treatment for such gains or losses being posted via the Statement of Recognised Gains and Losses to the Revaluation Reserve.
This change will therefore have an impact on the reported bottom line in the profit and loss account without any change in the economic substance of the entity's activities. Such changes will end up in the profit and loss account reserve although entities may decide to transfer such amounts to a separate reserve, as these profits or losses will not be realised and hence do not impact on the level of profits that may be distributed.
The method of determining deferred tax under FRS 102 has been changed to a "timing differences plus" approach. This is likely to have a significant impact in practice as more companies are going to be required to include provisions in respect of deferred tax. Currently, companies which revalue fixed assets do not recognise the related deferred tax aspects of that revaluation but merely provide information of such in the notes to the accounts. However, FRS 102 requires the deferred tax on such gains or losses to be provided for in the primary financial statements and discounting of any such balance is not permitted.