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FRS 102 medium accounts

FRS 102 Medium Accounts

It can be all too easy when preparing a client’s FRS 102 medium accounts to assume that your proprietary accounts preparation software will do the majority of the heavy lifting. In reality, this might not always be the case, and there are two main reasons for this.

Firstly, the accounts produced by proprietary software are necessarily generic, and disclosure notes will sometimes require editing to capture the entity-specific details needed to give the true and fair view.

Secondly, the outputs of the accounts software can only be as good as the inputs, and if the accounts preparers do not have a good understanding of what they are trying to achieve in the preparation of the financial statements, then the output from the software may also suffer.

The Front End

It can be tempting as the preparers or auditors of a company’s accounts to pay little attention to the Strategic and Director’s Report. After all, they’re not actually part of the financial statements themselves, and it’s up to the Directors to get the narrative right – right?

Well, technically yes, but the Directors may need a little guidance from their advisers to ensure that they’re providing appropriate narrative and sufficient detail.

Companies Act 2006 section 414C dictates the content of the Strategic Report. In summary, the report must contain a fair review of the company’s business and description of the principal risks and uncertainties faced, commensurate with the size and complexity of the company.

In reality, the quality of this report varies enormously. Once received from the directors, it is worth taking a step back to consider whether the review is suitably balanced – taking account of both the positives and challenges faced – and whether it fairly addresses both performance and year end position. A couple of sentences stating the fact that revenue has gone up but profit margin has gone down will not be sufficient.

Key Judgements and Sources of Estimation Uncertainty

One area of disclosure that proprietary software alone can never fully address is the requirement to explain the key sources of judgement and estimation uncertainties.  This disclosure can often prove surprisingly challenging to get right.

Firstly, it’s worth establishing what is a judgement and what is a source of estimation uncertainty.  An accounting judgement involves interpretation of an accounting standard and/or application of and accounting policy.  I often use a simplified description, which is to say that a judgement is something that happens before you start performing calculations.  Examples include the classification of a lease or determining whether the company acts as principal or agent in a revenue transaction.

A source of estimation uncertainty specifically arises where assumptions/estimates calculated by management are exposed to the effects of uncertain future events.  This might be particular valuations or provisions, for example.

Proprietary software often unhelpfully lumps key judgements and key sources of estimation uncertainty together.  FRS 102 requires that key sources of estimation uncertainty not only be identified and explained, but that the carrying amounts of assets or liabilities affected should also be provided.

It is also worth noting that the specific requirement with regards to sources of estimation uncertainty is to identify those estimates “that have a significant risk of causing a material adjustment to the carrying amounts of assets within the next financial year”.  So, for example, whilst there may well be estimation uncertainty associated with the useful economic lives of fixed assets, it is unlikely in many cases that there would be a significant risk of adjustment arising within one year.

Accounting Policies

It is a common theme of regulator feedback that accounting policy notes should not just be boilerplate, but should instead be specific to the circumstances of the entity. The purpose of accounting policy notes is to assist users in understanding how significant transactions and balances have been determined and reflected in the financial statements. Simple repetition of the wording of the accounting standards adds little to no real value.

A common bugbear of audit cold file reviewers in this regard is the revenue recognition disclosure. Policy notes frequently quote FRS 102.23 to a lesser or greater degree, but fail to really identify the key point – for this particular business, when are the requirements for recognition typically met? On delivery? Upon shipping? Over the course of the contract? Specific information about the point of recognition for the main revenue streams of the company is what will add value for the users of the financial statements.

Of course, there is an understandable commercial angle to be taken here. Proprietary accounting software will input generic policy notes to the financial statements, and it can be a laborious process to then edit these. So if the generic versions are acceptable, then why rock the boat?

I suppose the answer here is that we should not be striving for mere acceptability. Going above and beyond to provide useful information about accounting policies may just be worth the additional investment in time.

In summary…

It is important that both accounts preparation and audit teams have a strong understanding of the disclosure and presentation requirements of both FRS 102 and Companies Act, and are able to identify from reviewing accounts where additional intervention may be needed once the initial draft has been produced from the accounts software.

Join me on November 22nd for FRS 102 Medium Accounts End to End, in which we will work through some of the key disclosure and presentation challenges for a standard set of FRS 102 accounts.

James Charlton, October 2022

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