FRS 102: IN PRACTICE

SEMINAR – 17 FEBRUARY 2016 PRESENTER: Paula Galloway

TIMETABLE FOR CHANGE 31 December Reporter 31 March Reporter Opening balance sheet (1 January 2014) Comparative year balance sheet (31 December 2014) Financial statements for the year ended 31 December 2015 31 December Reporter Opening balance sheet (1 April 2014) Comparative year balance sheet (31 March 2015) Financial statements for the year ended 31 March 2016 31 March Reporter FRSSE - ONE YEAR LATER

MY CLIENT Manufacturing Rents additional space 31-Dec-15 £'000 Fixed Assets 10,550 Investment Properties 2,500 Intangible Assets 150 Current Assets 8,160 Current Liabilities (3,820) Net Current Assets 4,340 17,540 Creditors (over 1 year) (4,600) Provisions and deferred income (500) Deferred Tax (530) Pension Scheme Deficit (1,000) Net Assets 10,910 Equity Capital 30 Revaluation reserve 2,000 Profit and Loss account 8,800 Manufacturing Rents additional space Holds investment property Sells overseas

CURRENT ASSETS / LIABILITIES - STOCKS LIFO no longer allowed (13.18) Spares (higher value) reclassified as fixed assets (17.5)

CURRENT ASSETS / LIABILITIES – DEBTORS/ FOREIGN EXCHANGE Year end rate – not contract rate Forward contracts are financial instruments Hedge accounting

CURRENT ASSETS / LIABILITIES – DEBTORS/FOREIGN EXCHANGE Example My Client sells goods to a US customer on 1 November 2015. The invoice is for $100,000 for settlement in 3 months ie 31 January 2016. On 1 November 2015, My Client enters into a forward contract to sell $100,000 on 31 January 2016 at a contracted rate of $1.62:£1. Details of GBP to USD exchange rates are below: Date Spot rate Forward Rate 1 November 2015 1.6 1.62 31 December 2015 1.57 1.59 31 January 2016 1.55 n/a

CURRENT ASSETS / LIABILITIES – FOREIGN EXCHANGE Summary of impact on financial statements Year ended 31 Dec 2015 SSAP 20 £ FRS 102 £ Profit and Loss Sales 61,728 62,500 FX Gain - 1,194 Loss on derivative (1,165) 62,529 Balance Sheet Debtors 63,694 Derivative liability

CURRENT ASSETS / LIABILITIES - DEBTORS Financing arrangements Discounting

FINANCIAL INSTRUMENTS BASIC Cash and bank accounts Trade and other accounts receivable/payable Loans from banks or other third parties Loans to and from group companies OTHER Options and forward contracts Interest rate swaps Investments in convertible debt Rights, warrants and future contracts AMORTISED COST FAIR VALUE INVOICE PRICE/NPV HEDGE ACCOUNTING PROVISIONS

FINANCIAL INSTRUMENTS Taxation follows Accounting, with exceptions FOREX Gains and Losses Example Direct impact on profits chargeable to Corporation Tax Timing of charge to Corporation Tax Transitional deferred tax position

CURRENT ASSETS / LIABILITIES – HOLIDAY PAY Example: Facts Employees of My Client are permitted 24 days annual leave which must be taken in the holiday year which commences on 1 April. My Client’s financial year end is 31 December. At 31 December an employee, pro-rata is entitled to have taken 18 days holiday. My Client calculates from holiday records that outstanding holiday (i.e. holiday not taken from an allowance of 18 days) is 56 days for all employees at the same grade. My Client considers that it is appropriate to make an accrual for the 56 days outstanding holiday measured at the average salary per day. Overall impact On the date of transition to FRS 102, a new provision would be recognised for short-term employee benefits with a corresponding adjustment to opening retained earnings. In future years, assuming the annual holiday allowance, the pattern of holidays taken and holiday year remain constant, the movement in the provision from one year to the next will probably be limited.

CURRENT ASSETS / LIABILITIES - LEASES Operating lease incentives Straight line Period (lease term) – non cancellable period Operating lease disclosures – total future lease payments by years

CURRENT ASSETS / LIABILITIES - LEASES Lease Incentives Example: Facts My Client leases a property for 10 years from 1 January 2014 with a market rent review at the end of year 5. At the outset of the lease the landlord agreed to a 2 year rent free period. The annual rental year 3 to 10 is £100,000 per annum. UITF 28 The lease incentive is allocated over the lease term on a shorter period ending on the date from which a market rental is payable – normally the first break period/rent review in this case 5 years – annual charge of £60,000 in year 1 to 5 and £100,000 thereafter. [At 31 December 2015 a creditor of £120,000] FRS 102 The incentive should be amortised over the period of the lease – annual charge of £80,000 over 10 years. [At 31 December 2015 a creditor of £160,000]

MY CLIENT Current Assets Current Liabilities Stock: Spares Debtors: Financial instruments /financing arrangements Current Liabilities Creditors: Holiday Pay, lease incentives

FIXED ASSETS – PROPERTY, PLANT & EQUIPMENT Changes Residual Values – assess on current values Transitional arrangements (valuation) Revaluation (sufficient regularity) Deferred taxation Reminder Capitalisation policy Depreciation – component approach Subsequent expenditure

FIXED ASSETS Transition Example – Facts Property A acquired on 31 December 1980 for £100,000. Revalued regularly, current value £150,000. Decision – not to continue with a policy of revaluation Options: Elect to use the most recent revaluation (£150,000) as deemed cost Restate to original cost £100,000

FIXED ASSETS – PROPERTY, PLANT & EQUIPMENT UK tax legislation departs from the accounting standards – no Corporation Tax impact Deemed Cost revaluation & Revaluation model – significant deferred tax implications Current UK GAAP – taxable profits vs. accounting profit FRS 102 – taxable profits vs. other comprehensive income Example Property acquired 1 January 2006 for £1,000,000 valued on 31 December 2015 at £1,500,000. Assuming indexation of £100,000 there is a potential capital gain of £400,000. If disposed of at that point in time there would be a corporation tax liability at 20% of £80,000. This equates to the deferred tax liability which would be recognised in the accounts. The gain will be charged to corporation tax only when the gain is realised on disposal.

FIXED ASSETS - LEASES Classification - (90% test) – present value of minimum lease payments - Substantially all the risks and rewards of ownership

FIXED ASSETS - LEASES Classification Example: Facts (specialist plant) My Client leases a bespoke piece of machinery from Company A. The machinery was constructed for use in My Client’s business, to its specification and is used in producing an item for which My Client holds the patent, so a third party would not legally be able to use the machinery without significant alteration. The lease is for a period of seven years and the expected useful life of the machinery is at least 10 years. The present value of the minimum future lease payments is 70% of the asset’s fair value at inception. SSAP 21 The present value of the minimum lease payments is only 70% of the fair value of the asset at the inception of the lease, therefore, it may be classified as an operating lease. FRS 102 Under FRS 102, the lease would pass the condition set out in paragraph 20.5(e) (assets of specialised nature) and so would be classified as a finance lease.

FIXED ASSETS – INVESTMENT PROPERTIES Gains / losses on revaluation – through P&L Provision for deferred tax Group properties (individual company accounts)

KEY CHANGES – INVESTMENT PROPERTIES Revaluation Example – Facts On 1 January 2015, the carrying amount of an investment property was £2m. An updated valuation of £2.5m is received on 31 December 2015. SSAP 19 Under SSAP 19, the gain of £0.5m would be recognised as follows: Dr: Investment property £0.5m Cr: Investment property revaluation reserve (STRGL) £0.5m The revaluation is transferred to a revaluation reserve FRS 102 Under FRS 102, the gain of £0.5m would be recognised as follows: DR: Investment property £0.5m Cr: Profit and loss £0.5m (not reserves)

FIXED ASSETS - GOODWILL No indefinite useful life UEL not to exceed 10 years if no reliable estimate Goodwill / intangibles /Acquisitions

MY CLIENT Fixed Assets Property, Plant and Equipment: Valuation Policy, Residual Values, Deferred Tax Investment Property: Valuation, Profit/Loss, Deferred Tax Intangible Assets: Goodwill amortisation

CREDITORS DUE OUTWITH ONE YEAR – INTERCOMPANY LOANS/OTHER LOANS Included within scope of section 11 (Basic Financial Instruments) Valued at the present value of the future payments discounted at a market rate of interest for a similar debt instrument (fixed repayment date)

KEY CHANGES – INTERCOMPANY LOANS Example: Facts 1 January 2014 an inter group loan of £10,000 is received, repayable on 31 December 2015. Interest at 5%, market interest 10%. NPV of loan at 1 January is: Discount Cash flow NPV Year 2014 0.9091 £500 £454 Year 2015 0.8264 £10,500 £8,678 £9,132 Amortised cost Interest (10%) Cash flow 31 December 2014 £9,132 £913 (£500) £9,545 £9,545 £954 (£10,500) - Accounting treatment

PROVISIONS AND DEFERRED INCOME – GOVERNMENT GRANTS Performance model/accrual model SSAP 4 (Accrual model) The grant is deferred and shown as a liability. It is then released to the profit and loss account over the expected useful life of the related asset. Recognition of depreciation charge on the factory (£600,000 / 50 years) Dr Depreciation (P&L) £12,000 Cr Fixed assets £12,000 Release the grant to the P&L (£200,000 / 50 years) Dr Deferred grants £4,000 Cr P&L (grant income) £4,000 FRS 102 Performance model or accrual model Where the entity elects to apply the performance model, the whole grant is recognised in profit or loss immediately where there are no provisions requiring deferral of the grant received.

PENSIONS Defined benefit obligations - on one balance sheet in group scheme - independent actuary/annual valuation - profit/loss charge Multi employer schemes (funding agreement liability)

PENSIONS Tax legislation departs from accounting standards Restated accruals will have no tax impact – Only pension payments made in the accounting period attract Corporation Tax relief Changes to the profit and loss charge for defined benefit pension schemes may impact on the deferred tax position however the materiality would need to be assessed on a case by case basis

MY CLIENT Financial Instruments: Creditors due outwith one year Intercompany loans Interest rate hedge Creditors due outwith one year Government Grants Performance/accrual model Provisions and deferred income Pension Impact on profit/loss charge Pensions scheme accounting

OTHER AREAS TO CONSIDER FRSSE Disclosures Terminology (practice/ learning) Impact on Auditors/ audit requirements

FRS 102 – THE BUSINESS IMPLICATIONS Loan covenant tests Bonus/share schemes Acquisition criteria/assessment Resource (Training) \ Cost (Group Structure) Financial instruments Distributable Reserves (revaluations)

QUESTIONS

CONCLUSION In summary -