- The latest part of the new suite of financial reporting standards which will apply in Ireland and the UK – “FRS 102” – now published
- FRS 102 – which is likely to be applied by more than 95 percent of entities in Ireland – is based heavily on “IFRS for SMEs”
- FRS 102 departs from “IFRS for SMEs” to retain a number of existing treatments allowed by existing FRSs or EU IFRS
- Many preparers will face increased measurement complexity as a result of increased use of fair value measurement for some items and a greater level of prescription generally than applies at present under Existing GAAP (Generally Accepted Accounting Principles)
- Transition will present commercial challenges which need to be considered and planned for well in advance, particularly in respect of multi-year arrangements and tax planning structures or transactions which will survive transition
- Transition will be required for periods beginning on or after 1 January 2015 but earlier adoption is permitted
- Restatement of comparatives will be required.
Time to get ready for ‘New GAAP’
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We now know the full shape of the new financial reporting framework to be applied in Ireland and the UK with the publication of FRS 102 “The Financial Reporting Standard applicable in the UK and Republic of Ireland” by the FRC in March 2013. This follows the publication of FRS 100 and FRS 101 in November 2012.
- Under the new framework, existing Irish and UK GAAP (“Existing GAAP”) preparers will generally have a choice of either:
- A. migrating to FRS 102, which is based heavily on the IASBs “IFRS for SMEs”, or
- B. voluntarily applying EU-adopted IFRS
- Qualifying entities – subsidiaries and parent companies of Groups preparing publicly available consolidated financial statements – will also have the ability to avail of reduced disclosure requirements, whether applying FRS 102 or FRS 101 (using recognition and measurement of EU-adopted IFRS), provided certain conditions are met
- Depending on the nature of their operations, entities adopting FRS 102 will face many changes in the requirements applicable to key areas of financial reporting. Undoubtedly, the most challenging issue for most will be the increased use of fair value measurement – particularly for financial instruments, all of which will now be recognised on balance sheet. Key changes to the requirements in respect of business combinations, leases and other arrangements, deferred tax and investment properties will also need detailed consideration.
- With mandatory adoption not required until accounting periods beginning on or after 1 January 2015, there is some time available before a set of financial statements prepared under FRS 102 will need to be drafted. Nonetheless, companies should begin to consider the impact the new requirements will have, particularly when entering into multi-year arrangements and structures which will survive the transition
- The transition to a new framework may pose challenges for preparers – some of which we have highlighted overleaf – but it may also provide the trigger to grasp opportunities for simplifying group structures and undertaking further tax planning strategies.
Now is the time to start tackling the financial reporting and commercial challenges which the impending change will inevitably bring!
What changes can FRS 102 bring to your financial statements?
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Financial Instruments & foreign currency
- FRS 102 introduces a distinction between “basic” and “other” financial instruments. Instruments, other than basic financial instruments, will be measured at fair value
- Monetary items denominated in foreign currencies will be carried at the current exchange rates, rather than a forward contract rate as is currently allowed. The related foreign exchange forward contracts, typically held off-balance sheet under Existing GAAP, will be recognised on balance sheet at fair value
- Hedge accounting requirements may allow for mitigation of the volatility impact on earnings but will impose significant requirements in respect of documentation and testing
- Functional currency determination, particularly in respect of special purpose entities / intermediate holding companies, will be subject to more stringent assessment
- Provisions for impairment will be made on the basis of incurred losses based on objective evidence
- Certain transactions involving purchases and / or sales of non- financial items where they are not for ‘own - use’ may need to be carried at fair value.
- Potential for significant earnings volatility, particularly for “Non-FRS 26 users”
- Items such as options, rights, warrants, futures, forward contracts, interest rate swaps, convertible instruments etc. will now need to be recognised on balance sheet at fair value where either cost or off-balance sheet treatment may have been previously applied
- Existing FRS 26 users will have some additional items recognised at fair value, with no Held-to-Maturity and no Available-for-Sale categories
- Applying hedge accounting will provide opportunities to reduce P&L volatility for many. However, entities without experience of applying fair value measurement and hedge accounting will be subject to new disciplines requiring investment in resources, systems and training
- Where existing determinations regarding functional currencies are altered, items not previously subject to retranslation – including external and intra-group debt – may now give rise to volatility. Group funding and other structures may need to be re-assessed
- Maintaining general provisions or provisions based on expected losses is not permitted, and some entities may not be able to retain existing levels of provisions.
Business combinations & goodwill
- More separately recognised intangible assets are likely to be recognised and amortised over finite useful lives
- The rebuttable presumption for the useful life of goodwill has been reduced to five years, unless evidence supports longer lives – amortised over that life
- Required to test for impairment where indicator exists
- Acquisition accounting applied to all transactions except in the case of Group reconstructions
- Transaction costs will be capitalised as part of the cost of the combination.
- Expertise required to separately identify and value acquired intangible assets is unlikely to be readily available internally in most entities
- Neither goodwill nor intangible assets are permitted to have indefinite useful lives. This, together with shorter amortisation lives generally, could negatively impact on reported earnings of acquisitive entities in the early years after acquisitions.
Leases and transactions containing embedded leases
- Agreements that transfer the right to use assets and which are not in the legal form of a lease may, for accounting purposes, be determined to be or contain leases
- Lease incentives (e.g. rent free periods) will be recognised over the life of a lease
- 90 percent “bright” line for distinguishing operating and finance leases will be removed.
- Entities will need to examine carefully arrangements they may have for procuring or providing certain services – particularly with respect to outsourcing – which are dependent on specified assets or take-or-pay arrangements
- Changes pattern of recognition of lease incentives where typically this was previously recognised up to the first break period.
- Requirements are based on the “timing differences plus” approach which looks at reported comprehensive income as compared to taxable profits similarly to what is currently required in Existing GAAP rather than the “temporary differences” or balance sheet derived approach taken under IFRS. Nonetheless, fewer exemptions are available with respect to recognition of deferred tax liabilities
- Discounting will not be permitted.
- Deferred tax will need to be recognised in respect of revalued property, regardless of any intention to sell the asset where Existing GAAP provided an exemption in this respect
- Current and deferred tax will be measured based on rates which apply to undistributed income, a consequence of which will be to recognise close company surcharges in Ireland until such time as the distribution to avoid the charge is made
- Deferred tax will be required on fair value adjustments made in a business combination.
- Definition includes properties let to and used by fellow group companies
- Recognised on balance sheet at fair value with changes in value recognised in P&L
- ‘Existing’ use valuations will not be permitted - fair value based on open-market price.
- Volatility may arise as a result in reported earnings
- Valuations will need to include “highest and best use” value.
Defined benefit pension schemes
- The deficit or surplus relating to a group defined benefit pension scheme will no longer be permitted to be recognised only in the group accounts.
- Where group companies cannot individually account for their portion of the surplus/deficit, the total must be recognised in the sponsoring company’s accounts.
What are the commercial considerations I should be considering?
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- Could there be tax implications such as additional or accelerated cash tax liabilities? (e.g. as a result of recognising fair value movements on derivatives which are taxed as part of reported earnings)
- Can existing tax planning strategies continue or might revisions be required?
- What will the impact be on existing debt agreements or facilities under negotiation, particularly with respect to covenants?
- Are there implications for other agreements or arrangements, e.g. leases, concessions, remuneration and bonus structures?
- How might distributable profits and dividend policy be affected (e.g. could a fair value loss on an out-of-the-money interest rate swap block or reduce my ability to pay dividends)?
- How might acquisition strategies be impacted?
- What are the practical implications that need to be considered to implement transition, e.g. staff training requirements, system configuration issues and conversion costs?
- Should pre-conversion restructuring of group structures or funding arrangements be considered?
- What are the commercial sensitivities arising from new disclosure requirements? (For example, disclosure of interest ratio and all terms in debt instruments)
- With iXBRL requirements being introduced for tax filings in Ireland, should early adoption be considered?
What choices will be available under the new regime?
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Who am I...?
Current position applied
Likely recommended options
shares traded on a regulated or secondary market
- Group Accounts – EU-adopted IFRS
- Irish & UK incorporated: Existing GAAP or EU-adopted IFRS
- Non-Irish & UK: EU-adopted IFRS or another local framework
- Group Accounts – EU-adopted IFRS, as before
- Qualifying subsidiaries:
- Irish & UK incorporated: Apply FRS 101 (same policies as group with reduced disclosures)
- Non-Irish & UK: No change
Large privately owned (unlisted) group
operations predominantly in Ireland and UK
- Group accounts – FRS 102
- Qualifying subsidiaries – FRS 102 with reduced disclosures
Large privately owned group
significant operations outside Ireland and UK
- Group Accounts – Existing GAAP
- Existing GAAP to Irish & UK incorporated entities
- Local framework elsewhere as required
- Key Choice for Irish & UK incorporated:
- EU-adopted IFRS for Group Accounts; FRS 101 for subsidiaries or
- FRS 102 for Group Accounts and FRS 102 with reduced disclosures for subsidiaries
- nLocal framework elsewhere as before
Irish or UK incorporated subsidiary of a listed plc headquartered overseas
A. Group Reporting under EU-adopted IFRS with statutory accounts prepared using either EU-adopted IFRS or Existing GAAP
B. Group Reporting under another framework (e.g. US GAAP) with statutory accounts prepared typically using existing GAAP or potentially EU-adopted IFRS
A. Group reporting under EU-adopted IFRS and FRS 101 for statutory accounts
B. Group Reporting as before with key choice in respect of statutory accounts: FRS 102, FRS 101 or EU-adopted IFRS. Reduced disclosures may apply under FRS 102.
Stand-alone “micro” entity
- Existing GAAP (traditionally preparing abridged accounts for filing purposes)
- The Financial Reporting Standard for Smaller Entities (“FRSSE”)
What happened to IFRS for SMEs?
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- FRS 102 has been developed using “IFRS for SMEs” as issued by the IASB at its core. However, the FRC has amended it in many respects to align the requirements of FRS 102 with many existing treatments allowed by existing FRSs or EU-adopted IFRS
- Key amendments made to “IFRS for SMEs” include retaining the provisions to electively capitalise development costs and borrowing costs in certain circumstances; retaining the revaluation model for property, plant and equipment; permitting merger accounting for group reconstruction transactions; and permitting hedge accounting in respect of net investments in foreign operations
- In addition, Government grant accounting has been re-aligned with Existing GAAP and EU-adopted IFRS while the model applied to deferred tax has been replaced with something closer to FRSs. Nonetheless, deferred tax will be a significant area of impact for many.
What are the transition rules when applying FRS 102 for the first time?
The rebuttable position for most assets and liabilities on transition is that they are restated to reflect the requirements of FRS 102 on a fully retrospective basis. However, there are a number of available exemptions from this which provide practical alternatives to potentially tortuous analysis of past transactions. These include in particular:
- exemptions from restating the treatment applied to past business combinations
- the ability to regard revalued amounts carried forward from previous GAAP or fair value at the date of transition as “deemed cost” and apply cost accounting going forward
- the ability to assess relevant facts and circumstances relating to arrangements potentially containing an embedded lease at the date of transition rather than at the inception of the arrangements
- the ability to elect to commence capitalising borrowing costs, as part of a qualifying asset, only from the date of transition.
All existing users of UK and Irish GAAP will be required to transition to the new framework for accounting periods beginning on or after 1 January 2015. Comparative information will need to be restated and a reconciliation provided in respect of the opening balance sheet position in the notes to the first set of financial statements prepared under the new framework.
Early adoption of FRS 102 is permitted.
Where can I get more information?
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More information, including the full text of the newly issued standards, which is published in one volume, is available on the FRC’s website: www.frc.org.uk
Further information is available on KPMG’s website, www.kpmg.ie/newirishukgaap
In addition, your usual KPMG contact is available to discuss the impact of conversion on your business with you, the potential impacts on your company and the transition process.