1 Purpose of chapter
The P2 UK paper
This chapter contains the additional syllabus content required for those who are sitting the P2 UK paper.
If you are sitting the P2 INT paper then you do not need to study this chapter.
2 UK GAAP
UK standards
Guidance about the accounting standards that UK companies should apply is found within FRS 100 Application of Financial Reporting Requirements. The rules are as follows:
- Listed groups must prepare their accounts under IFRS.
– However, the companies within the group can take advantage of disclosure exemptions outlined in FRS 101 when preparing their individual (non-consolidated) financial statements.
- Other UK companies will apply FRS 102 The Financial Reporting Standard Applicable in the UK and the Republic of Ireland unless:
– they voluntarily choose to apply IFRS, or
– they are a micro-entity and choose to apply FRS 105 The Financial Reporting Standard Applicable to the Micro-Entities Regime.
Purpose of chapter
The P2 UK paper
This chapter contains the additional syllabus content required for those who are sitting the P2 UK paper.
If you are sitting the P2 INT paper then you do not need to study this chapter.
2 UK GAAP
UK standards
Guidance about the accounting standards that UK companies should apply is found within FRS 100 Application of Financial Reporting Requirements. The rules are as follows:
- Listed groups must prepare their accounts under IFRS.
– However, the companies within the group can take advantage of disclosure exemptions outlined in FRS 101 when preparing their individual (non-consolidated) financial statements.
- Other UK companies will apply FRS 102 The Financial Reporting Standard Applicable in the UK and the Republic of Ireland unless:
– they voluntarily choose to apply IFRS, or
– they are a micro-entity and choose to apply FRS 105 The Financial Reporting Standard Applicable to the Micro-Entities Regime.
- A small entity that applies FRS 102:
– does not have to show other comprehensive income
– does not have to produce a statement of cash flows
– is exempt from many of the disclosure requirements of FRS 102.
FRS 101
FRS 101 Reduced Disclosure Framework applies to the individual financial statements of subsidiaries and ultimate parent companies. It provides exemptions from disclosure requirements that will result in cost savings when producing individual financial statements. FRS 101 does not apply to consolidated financial statements.
To apply FRS 101, the shareholders of a qualifying entity must have been notified about its use and they must not object.
FRS 102
FRS 102 is a single standard that is organised by topic.
Although FRS 102 is based on IFRS for Small and Medium Entities (the SMEs Standard), there are differences. The differences that are examinable in the P2 UK syllabus are outlined later in this chapter.
FRS 105
The Financial Reporting Council has withdrawn the Financial Reporting Standard for Smaller Entities (FRSSE). Micro-entities can now choose to prepare their financial statements in accordance with FRS 105 The Financial Reporting Standard Applicable to the Micro-entities Regime.
An entity qualifies as a micro-entity if it satisfies two of the following three requirements:
- Turnover of not more than £632,000 a year
- Gross assets of not more than £316,000
- An average number of employees of 10 or less.
FRS 105 is based on FRS 102 but with some amendments to satisfy legal requirements and to reflect the simpler nature of micro-entities. For example, FRS 105:
- Prohibits accounting for deferred tax
- Prohibits accounting for equity-settled share-based payments prior to the issue of the shares
- Prohibits the revaluation model for property, plant and equipment, intangible assets and investment properties
- Prohibits the capitalisation of borrowing costs
- Prohibits the capitalisation of development expenditure as an intangible asset
- Simplifies the rules around classifying a financial instrument as debt or equity
- Removes the distinction between functional and presentation currencies.
There are very few disclosure requirements in FRS 105.
3 Examinable differences between International and UK standards
Examinable differences between FRS 102 and the SMEs Standard
Although FRS 102 is based on IFRS for Small and Medium Entities (the SMEs Standard), there are differences. Some of these differences are included in the UK P2 syllabus.
Financial statement presentation
To comply with Companies Act, FRS 102 allows a ‘true and fair over-ride’. If compliance with FRS 102 is inconsistent with the requirement to give a true and fair view, the directors must depart from FRS 102 to the extent necessary to give a true and fair view. Particulars of any such departure, the reasons for it and its effect are disclosed.
Statement of cash flows
Under FRS 102, small entities, mutual life assurance companies, pension funds and certain investment funds are not required to produce a statement of cash flows. This exemption does not exist under the SMEs Standard.
Consolidated and separate financial statements
Under the SMEs Standard, a parent need not present consolidated financial statements if the parent is itself a subsidiary, and its ultimate parent (or any intermediate parent) produces consolidated general purpose financial statements that comply with full IFRS and IAS Standards or the SMEs Standard.
FRS 102 makes some slight amendments to the above to comply with Companies Act. In particular, consolidated financial statements do not need to be produced if the parent, and group headed by it, qualifies as small. The requirements of Companies Act are dealt with in more detail later in this chapter.
Inventories
FRS 102 specifies that the cost of inventories acquired through a non-exchange transaction (such as a donation or legacy) should be measured at the fair value of the inventories at the acquisition date. The SMEs Standard does not mention this issue.
Investments in associates
FRS 102 explicitly clarifies that an investment in an associate cannot be equity accounted in the individual financial statements of a company that is a parent. Instead, the investment in associate can be held at cost or fair value.
Under FRS 102, the cost of an associate should include transaction costs. These are excluded from the cost of the associate under the SMEs Standard.
Investments in joint ventures
FRS 102 explicitly clarifies that an investment in a jointly controlled entity cannot be equity accounted in the individual financial statements of a company that is a parent. Instead, the investment can be held at cost or fair value.
Under FRS 102, the cost of a joint venture should include transaction costs. These are excluded from the cost of the joint venture under the SMEs Standard.
Intangible assets
Under FRS 102, an intangible asset arising from development activity can be recognised if certain criteria are met. These criteria are broadly the same as under IAS 38. According to the SMEs Standard, research and development expenditure is always written off to profit or loss.
Under FRS 102, intangible assets can be held under the cost model or the revaluation model. The SMEs Standard does not permit the revaluation model.
Business combinations and goodwill
According to FRS 102:
- Negative goodwill (where the fair value of the net assets acquired exceeds the consideration) is recognised on the statement of financial position immediately below goodwill. It should be followed by a subtotal of the net amount of goodwill and the negative goodwill.
- The subsequent treatment of negative goodwill is that any amount up to the fair value of non-monetary assets acquired is recognised in profit or loss in the periods in which the non-monetary assets are recovered. Any amount exceeding the fair value of non-monetary assets acquired must be recognised in profit or loss in the periods expected to be benefited.
Under the SMEs Standard negative goodwill is recognised immediately in profit or loss.
Government grants
Under FRS 102, two methods of recognising government grants are allowed:
- The performance model
– If no conditions are attached to the grant, it is recognised as income immediately.
– If conditions are attached to the grant, it is only recognised as income when all conditions have been met.
- The accruals model
– Grants are recognised as income on a systematic basis, either as costs are incurred (revenue grants) or over the asset’s useful life (capital grants).
Under the SMEs Standard only the performance model for recognising government grants is allowed.
Borrowing costs
Under FRS 102, an entity may capitalise borrowing costs that are directly attributable to the construction, acquisition or production of a qualifying asset. Under the SMEs Standard all borrowing costs are recognised as an expense in profit or loss.
Under FRS 102, the projected unit credit method must be used to estimate the defined benefit obligation.
In contrast, the SMEs Standard allows some simplified estimation techniques if an entity is not able, without undue cost or effort, to use the projected unit credit method to measure its obligation and cost under defined benefit plans. Entities are permitted to:
- ‘ignore estimated future salary increases
- ignore future service of current employees
- ignore possible in-service mortality of current employees between the reporting date and the date employees are expected to begin receiving post-employment benefits’ (SMEs Standard, para 28.19).
Related parties
FRS 102 permits an additional exemption from the disclosure of related party transactions than the SMEs Standard. FRS 102 states that disclosures need not be given of transactions entered into between two or more members of a group, provided that any subsidiary which is a party to the transaction is wholly owned by such a member.
Income tax
The income tax section of FRS 102 differs significantly from the SMEs Standard.
- Profit or loss/statement of financial position:
– FRS 102 adopts a profit or loss approach to the recognition of deferred tax. Timing differences are defined as differences between taxable profits and total comprehensive income as stated in the financial statements that arise from the inclusion of income and expenses in tax assessments in periods different from those in which they are recognised in financial statements.
– FRS 102 makes an exception to this rule. It states that deferred tax should also be recognised based on the differences between the tax value and fair value of assets and liabilities acquired in a business combination.
– In contrast, the SMEs Standard conceptualises deferred tax through the statement of financial position. The standard states that deferred tax should be accounted for based on differences
‘between the amounts recognised for the entity’s assets and liabilities in the statement of financial position and the recognition of those assets and liabilities by the tax authorities’ (SMEs Standard, para 29.9).
- Permanent differences:
– FRS 102 uses the concept of permanent differences. Permanent differences arise because certain types of income and expenses are non-taxable or disallowable, or because certain tax charges or allowances are greater or smaller than the corresponding income or expense in the financial statements. Deferred tax is not recognised on permanent differences.
– The SMEs Standard does not use the terminology ‘permanent difference’. Instead, it says that deferred tax assets and liabilities are recognised for ‘temporary differences’.
4 Companies Act
Examinable Companies Act requirements
The UK syllabus for P2 specifies that candidates must know the basic Companies Act requirements surrounding when single and group entity financial statements are required and when a subsidiary may be excluded from the group financial statements.
Single entity financial statements
A company is exempt from the requirement to prepare individual accounts for a financial year if:
- it is itself a subsidiary undertaking
- it has been dormant throughout the whole of that year, and
- its parent undertaking is established under the law of an EEA State.
Group financial statements
A company subject to the small companies regime may prepare group accounts for the year.
If not subject to the small companies regime, a parent company must prepare group accounts for the year unless one of the following applies:
- A company is exempt from the requirement to prepare group accounts if it is itself a wholly-owned subsidiary of a parent undertaking.
- A parent company is exempt from the requirement to prepare group accounts if, under section 405 of Companies Act, all of its subsidiary undertakings could be excluded from consolidation.
Exclusion of a subsidiary from consolidation
Where a parent company prepares Companies Act group accounts, all the subsidiary undertakings of the company must be included in the consolidation, subject to the following exceptions:
- A subsidiary undertaking may be excluded from consolidation if its inclusion is not material for the purpose of giving a true and fair view (but two or more undertakings may be excluded only if they are not material taken together).
- A subsidiary undertaking may be excluded from consolidation where:
– severe long-term restrictions substantially hinder the exercise of the rights of the parent company over the assets or management of that undertaking
– the information necessary for the preparation of group accounts cannot be obtained without disproportionate expense or undue delay
– the interest of the parent company is held exclusively with a view to subsequent resale.
5 Question practice
UK focus question – Stream
Stream is a medium sized company which has invested in several smaller companies. The draft profit after tax in the consolidated statements for the year ended 31 December 20X1 is $5 million. However, advice is required about the following transactions:
- During 20X1, Stream spent $500,000 on development activities. These activities are still ongoing as at 31 December 20X1. However, the Directors of Stream firmly believe that this development will lead to future economic benefits. Stream has adequate resources to complete the development. The cash spent to date has been recognised as an intangible asset.
- On 1 January 20X1, Stream took out a $10 million 6% bank loan to finance the construction of a new head office building. Construction commenced on 1 January 20X1 and was still ongoing at the year end. Interest on the loan for the year has been charged as an expense.
If a choice of accounting treatment exists, the Directors of Stream wish to select the policy that will maximise reported assets.
Required:
Calculate the revised consolidated profit after tax for the year ended 31 December 20X1 assuming that Stream prepares its accounts using:
- The SMEs Standard
- FRS 102
Solution
| (a) SMEs Standard | (b) FRS 102 | |
| $000 | $000 | |
| Draft profit | 5,000 | 5,000 |
| Issue (i) | (500) | – |
| Issue (ii) | – | 600 |
| ––––– | ––––– | |
| Revised profit | 4,500 | 5,600 |
| ––––– | ––––– | |
| Explanations |
- According to the SMEs Standard, expenditure on development activity must be recognised as an expense. Therefore, if accounting under the SMEs Standard, the development asset currently recognised must be written off.
Expenditure on development can be capitalised under FRS 102 if relevant criteria are satisfied.
- Borrowing costs must be expensed under the SMEs Standard.
According to FRS 102, borrowing costs can be included within the cost of a qualifying asset. Therefore, if Stream accounted under FRS 102, it would be able to reverse out the interest expense of $600,000 ($10m × 6%) and instead recognise it as part of the cost of its property, plant and equipment.
UK GAAP
UK focus question – Sofa
Sofa is a company that has a number of investments. Sofa exercises control over some of these investments and significant influence over others.
Required:
Advise the Directors of Sofa as to the key differences between the SMEs Standard and FRS 102 that would impact the consolidated financial statements of the Sofa group. Where possible, discuss the potential impact that these differences would have on profit.
Solution
Under the SMEs Standard, negative goodwill is recognised immediately in profit or loss. According to FRS 102, negative goodwill is recognised on the statement of financial position as a deduction against goodwill.
- If a company acquires ‘negative goodwill’, the treatment under the SMEs Standard would lead to higher reported profits in the year of acquisition.
Under FRS 102, the cost of an associate should include transaction costs. These are excluded from the cost of the investment under the SMEs Standard and are instead written off to profit or loss.
- Under the SMEs Standard, profits will be lower in the year when an associate is acquired than under FRS 102.
- The lower carrying amount of the associate under the SMEs Standard may mean that impairments are less likely in the future.
UK focus question – FRS 105
You advise a client who is in the process of incorporating a new UK-based company. The company would qualify as a micro-entity and, as such, could apply FRS 105 The Financial Reporting Standard applicable to the Micro-entities Regime. Alternatively, it could apply FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland.
Required:
What factors should be considered when establishing whether the client should use FRS 105?
Solution
FRS 105 requires far fewer disclosures than FRS 102. This will reduce the time and cost burden of producing financial statements. However, consideration should be given to whether the users of the financial statements will find this lack of disclosure a hindrance to making economic decisions. This is unlikely in the case of such a small company.
FRS 105 does not permit property, plant and equipment, intangible assets or investment properties to be held at fair value. This will have a big impact on perception of the company’s financial position.
Accounting policy choices allowed in FRS 102 have been removed in FRS 105. For instance, borrowing costs and development costs must be expensed. Profits reported under FRS 105 may be lower than if FRS 102 was applied.
If the company is expected to grow quickly, it might be easier to simply apply FRS 102 from the outset. That way, it will avoid the burden of transitioning from FRS 105 to FRS 102 at a later date.
