25 May 2023
RSM comments on the proposed changes to UK GAAP in FRED 82 in response to the Financial Reporting Council’s (FRC) second periodic review of FRS 102 and other Financial Reporting Standards.
This article shares our views on the proposals for IFRS alignment, whether the FRC could have gone further with these, and whether the proposals give sufficient consideration to specific sectors and small entities.
With the aim of the FRC being alignment of UK GAAP with IFRS accounting where possible, we agree that for the most part, the proposals strike the right balance between IFRS alignment and proportionate accounting requirements for preparers and users of UK GAAP accounts. Nonetheless, we would have liked to see further consistency with IFRS, less rewording of the requirements in IFRS and additional consideration of application issues affecting some sectors.
IFRS alignment for revenue, lease accounting and the expected credit loss model
The proposed effective date for the amendments is accounting periods beginning on or after 1 January 2025 and we agree that this is the right time to align with the IFRS ‘five-step’ revenue recognition model and the IFRS ‘on-balance sheet’ lease accounting model for lessees. The proposed transitional provisions that prohibit restatement of prior periods for lease accounting and permit, but do not require, restatement for revenue recognition make 2025 a realistic implementation date.
Most of the proposed simplifications to the IFRS requirements for revenue recognition and lease accounting will benefit preparers without comprising the information needs of users.
On revenue recognition, proposals to replace ‘performance obligations’ with ‘promises’, reword the conditions for recognising revenue ‘over time’ and introduce new criteria for ‘principal versus agent’ considerations could have unintended consequences and rather than simplifying the IFRS requirements, may create practical application challenges for preparers. We have asked the FRC to revert to direct alignment with the wording used in the applicable IFRS in these areas. The accounting policy choice to expense costs of obtaining a contract is a beneficial and workable simplification, as are other proposed simplifications proposed to address more complex areas of accounting, including contract modifications and options.
On lease accounting, the FRC has addressed the complexities of using the lessee’s incremental borrowing rate to discount lease payments by proposing that the lessee’s “obtainable borrowing rate” may be used as an alternative. For most entities, this rate will be easier to determine, and a workable alternative provided the FRC gives clarification on its application and whether group borrowing rates can be used. We also welcome the following simplifications:
- extend the low-value lease exemption;
- include rebuttable presumptions for the consideration of lease extension and termination clauses; and
- remove some of the complexities in accounting for lease modifications.
On the expected credit loss model, we are pleased to see any proposals to adopt this model, deferred until further outreach has been completed. Given the complexities of the model, it should only apply to those financial assets where the benefits to users outweigh the implementation costs.
Making the IFRS-based conceptual framework and fair value framework succinct
We support the proposal to align with the single framework for measuring fair value in IFRS, subject to some clarity on the use of mid-market pricing and commend the FRC on how succinctly these requirements have been expressed. The approach adopted to align with the IASB’s 2018 Conceptual Framework for Financial Reporting would, in our view, benefit from further brevity and segregation of those concepts and principles that are more relevant to standard setters than preparers.
Urging the FRC to go even further with IFRS alignment
For revenue and leases, the proposals could go further to provide efficiency within groups by giving entities included in an IFRS consolidation the option of using the recognition and measurement requirements of IFRS for lease accounting by lessees and revenue recognition, especially since a similar option is already permitted for financial instruments. This would allow those entities to use figures prepared for consolidation purposes in their separate UK GAAP financial statements.
Accounting for government grants came to the forefront when Covid-19 support measures were issued and RSM would have liked to see this accounting aligned with IFRS, in order to remove the complexities many entities faced in considering the two alternative accounting models currently included in UK GAAP. That said, the performance model for government grant accounting should be retained for Public Benefit Entities, where the SORP requires it.
Further alignment with IFRS on the definition of a ‘business’, recycling of exchange differences relating to foreign operations and fair value measurement for contingent consideration arising on a business combination would provide more useful information to users of FRS 102 accounts.
Application challenges in the pensions sector
We would have liked to see further consideration of challenges faced by the pensions sector in applying the requirement to recognise annuity policies at fair value and to provide disclosures about market risk and credit risk. These areas were covered in the firm’s response to the FRC’s original Request for Views in this consultation, to reconsider whether they provide benefits to users of pension scheme financial statements that outweigh the preparation costs.
Considering the needs of small entities
For smaller entities, we believe that the mandating of encouraged disclosures in Section 1A will provide users with more relevant and useful information alongside the expected change in legislation that will require small and micro-entities to file an income statement on the public record. We have however pushed back on the addition of disclosures that are simply cross-referenced into the main body of FRS 102, as we believe Section 1A should be a one-stop shop for small entity disclosures.
Very small charities could face challenges in applying the proposed IFRS alignment for revenue recognition and lease accounting for lessees, as they do not meet the definition of a ‘micro-entity’ to apply FRS 105. It is anticipated that these challenges will be considered by the SORP working party.
We will be analysing the final amendments to FRS 102 and other UK Financial Reporting Standards when they are published later this year, at which time we will be offering solutions to assist entities with the next steps of implementing the changes and assessing the impact on and beyond the financial statements.
Businesses can start preparing now by revisiting agreements that refer to the financial position or to performance measures, which could be affected by the proposals, particularly by the fundamental changes to both the revenue recognition model and on-balance sheet treatment of leases for lessees. Such measures are often included in lending covenants, earn-out agreements, and bonus arrangements. Entities should also be mindful of the potential impact of the proposals on distributable profits and dividend policies.
If you would like to discuss our response or require further information, please get in touch with Danielle Stewart OBE, or your usual RSM contact.