For those who want clarity on the new SME Financial Reporting Requirements (FRS1)

3 May
Bean Counter

What balance sheet reconciliation looked like before computers were invented.

Summary – FRS 1, reduced disclosure requirements for SMEs and subsidiaries

Many of the changes will not have a major impact, because though they reduce the reporting burden for subsidiaries, the stats in question will still need to be included in the consolidated group reports. Some are significant, and practitioners should read the guidelines carefully because there is a difference between the FRS 1 regulation standards, and the EU-adopted IFRS. The FRC has used its prerogative to make such adjustments as it sees make more practical sense and ensure the directive is in keeping with UK statute and common law.

  1. Capital management disclosures, such as compliance with external capital requirements, will not be necessary and left between company and regulator. Also now extraneous are “quantitative data on what the entity regards as capital”. While assets, liquid or illiquid, are still disclosed, a firm’s cash flow structure will not. Investors will not be informed about the state of its cash reserves, sinking fund or, say, emergency repairs capital allocation. They will thus be less informed of its ability to meet its obligations to creditors and to meet all necessary expenses.
  2. On the flip side, the FRC is holding firm on disclosures about results from discontinued operations; where EU-adopted IFRS lets firms bury these in the annual report notes, the UK Regulations state the profit or loss before taxation, turnover, and tax arising from extraordinary activities of the assets let go be accounted for in the statement of comprehensive income.
  3. Where the EU-IFRS has banned the reporting of any expense or earning as an “extraordinary item”, the UK’s FRS 1 recognises the concept might on occasions be necessary. Instead it redefines the term in a way which means it must be a one-off event lying outside ordinary business operations, or even the ordinary factor influencing them e.g. political and environmental. In short, it must be extraordinary.
  4. An interesting concession was that on ‘non-amortisation of goodwill’, which let companies preserve the amount of goodwill (from the enhanced price of an acquisition), rather than the current practice of amortising it over a period of time selected by the directors. This must, however, be explained and justified, as to why this approach constitutes a “true and fair view”. Can brand value be preserved after a merger or acquisition, and continue to be reflected in the share value and market capitalisation?
  5. A change that seems intended purely as a measure to reduce the number of pages in a report is the removal of the obligation to include the previous year’s results for a number of metrics, including statement of financial position, and of profit or loss and other comprehensive income, for comparison.
  6. A helpful measure that could vastly reduce the volatility of a firm’s balance sheet, especially while making quarterly adjustments, is that stating financial instruments constituting liabilities do not need to be measured at fair value. Unless, that is, they meet one of three conditions: they are part of a trading portfolio; they are derivatives; they are among those listed as being optional to include at fair value, according to the international accounting standards adopted by the EU on or before 5 Sept 2006. So any loans or receivables originated by the firm, and not held for trading purposes, will be priced at par value with no adjustment for the current market price of the debt. Similarly, fixed income produces held to maturity will need no fair value adjustment.

NB: there are different standards for financial institutions, which carry much more detailed reporting obligations

  1. For contingent considerations[1], probably because they are considered to originate on the date of the contract and must maintain a constant value in keeping with this contractual obligation, the FRC’s Regulations have gone against the EU-IFRS standard and said they must not be measured at fair value unless they are a derivative.
  2. Another commonsense adjustment – Regulation IAS36 prohibits reversal of impairment losses for goodwill. The FRC quite sensibly has found this illogical: “The Regulations require the reversal of a prohibition for diminution in value of a fixed asset, if the reason for the provision has ceased to exist.”
  3. Note that in the UK there is a different treatment of loan maturity date: under the Regulations, a loan is treated as due for repayment on the earliest date on which a lender could require repayment. A firm’s debts are thus treated as a more urgent concern than under EU-adopted IFRS, where the due date is based either on when the entity expects to settle the liability (the reporting company classifies the urgency of the claim), or when it has no unconditional right to defer payment.
  4. The final conflict of principles is over government grants, where IAS 20.29 allows the option of deducing government grants when reporting the expense of assets purchased as a result. Counteracting items representing expenditure against items representing income is not permitted under FRS1 (with some exceptions if “permitted or required” by the regulator.

Several alt. options:

  • Instead the expense is recognised in the value of the item purchased, deducting the value of the grant
  • The grant is recognised as deferred income that is recognised in the profit or loss, at regular reporting intervals, over the useful life of the asset.

This latter, less simplistic approach, also helps track the net effect of expenditure on assets (and the effectiveness of government subsidies)

[1] Payment that is to be paid by the buyer if some event, which is specified in the contract, occurs within a pre-defined time period


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