A very common question from practitioners on courses about new UK GAAP at the current time concerns the choice between FRS 105 (the new standard for micro entities) and FRS 102 Section 1A (for small entities).
Some are reluctant to advise their clients to apply FRS 105 if it means that two different standards are both being used for accounts production purposes within the same firm. However, all the indications are that it will be important to be open minded, as the following frequently asked questions indicate:
Won’t applying two standards make life difficult?
Not necessarily. The bookkeeping processes that firms will follow will essentially be the same and the trial balance will look very similar under FRS 102 and FRS 105 for many simple businesses. It’s just the financial statements production process that will be a little different and good accounting software is likely to make this process relatively painless.
Is FRS 105 really that much more straightforward than FRS 102?
Although FRS 105 is aligned to FRS 102, there are a few notable differences which might make life somewhat easier when it is applied.
For example, unlike FRS 102, FRS 105 provides no choices regarding accounting policies. It also specifically prohibits the inclusion of deferred tax and revalued amounts (fair values) in financial statements.
These limitations may not appeal to everyone, but they will be attractive to some. A recent course delegate had a client who regularly acquired new investment properties and put each one into a separate limited company. Applying the requirements of FRS 102, each property would have to be regularly valued for accounting purposes and deferred tax provided on any resultant gain. In the absence of significant borrowings in the companies concerned, the prospect of applying the simpler FRS 105, where the properties would be accounted for at depreciated cost with no adjustment for deferred tax, was very appealing. Horses for courses!
How different are the disclosures? Doesn’t FRS 102 Section 1A ‘dumb down’ disclosures anyway?
FRS 102 Section 1A does dumb down disclosures, but FRS 105 takes things to a different level! The only accounting disclosures required by FRS 105 relate to directors’ advances, credit and guarantees and financial commitments.
So won’t clients feel they’re getting ripped off?
If clients want to ‘pay by the page’ of statutory accounting information, this regime may not work for them. But if they can divorce what needs to be done for statutory filing purposes from the management information that their accountant might produce more regularly to add value to their business, there could be a major appeal.
Maybe as we move towards the ‘making tax digital’ era, the idea of the accounting year end being a major milestone in the financial calendar when lots of information is produced and submitted to different regulatory authorities will become a thing of the past?
I’ve heard that FRS 105 can’t be used for unincorporated businesses. Is that true?
No. Although unincorporated businesses such as sole traders and partnerships don’t actually have to produce statutory accounts, HMRC has confirmed to ICAEW that it will accept calculations of trading profits for income tax purposes prepared under FRS 105 if two out of three of the relevant size criteria have been met.
These size criteria are £632K turnover, £316K total assets and 10 employee numbers.
If HMRC wants more information, doesn’t it mean FRS 105 is a waste of time?
In the first instance HMRC doesn’t require more information unless the company wants to provide it, though it has made clear that submitting a detailed profit and loss account prepared for internal management purposes may aid HMRC’s risk assessment and could avoid it opening a compliance check and requesting additional information. That’s still not particularly hard given that the basic bookkeeping processes will allow this information to be easily produced though.
What will the banks make of FRS 105 accounts?
The short form P&L and balance sheet and limited notes will make FRS 105 accounts potentially unappealing to bank credit departments.
We have anecdotally heard that where FRS 105 accounts are accepted, providing a more detailed breakdown on the face of the balance sheet of the composition of current assets and liabilities might help.
As a rule of thumb though, where banks need year-end financial statements for analysis purposes, it may well be that FRS 102 Section 1A is a better choice.
A further concern on courses in recent months has been that the very limited information in a set of FRS 105 accounts might adversely affect a company’s credit rating. This could be true. Again, horses for courses!
Could additional information not be added?
Additional information could certainly be appended to FRS 105 accounts, maybe at the back after a statement which says ‘the following information is not part of the statutory accounts’. This could provide crucial additional analyses for both shareholders and banks, without the relevant information being filed as part of the statutory accounts.
Another idea to explore here might be to ‘overdisclose’ in the statutory FRS 105 accounts. FRS 105 makes clear that if additional disclosures not strictly required by the relevant legislation are to be included, the entity should have regard to any requirement of FRS 102 Section 1A that relates to that information. Not necessarily a major chore though, given how ‘light touch’ FRS 102 Section1A is on disclosure anyhow!
Could we have two sets of statutory accounts – one for filing and one for the bank?
Although this gets asked lots, the answer must be no. If FRS 105 appeals to a micro-entity but it still needs to balance the information needs of external stakeholders, it should either opt for FRS 102 Section 1A or FRS 105 with additional ‘management pages’ as outlined above. Producing two separate sets of statutory accounts is simply not an option.
Isn’t Brexit likely to render FRS 105 redundant anyhow?
Absolutely not. The UK was never obligated to adopt the micro-entity rules when they were introduced in 2013 but we wholeheartedly embraced them. Micro-entity rules and FRS 105 are definitely here to stay!