FRS 105 Investment Property

There has been a lot of confusion in treatment of Investment Property under FRS 105. At the hind sight, professionals are used to revaluing Investment property at market value under FRSSE, which was only for small companies, and adopting the same concept under the new UK GAAP - FRS 105.

FRS 105 is not an alternative to FRSSE but an alternative to companies adopting Micro-entities regime. FRS 105 does not allow Fair Value adoption hence the treatment for Investment Properties is way different.

Some important points to consider while accounting for Investment Property under FRS 105:

1.      Investment Property cannot be revalued or shown at open market value.

2.      It should be depreciated based on useful life though the asset has the nomenclature of Investment Property.

3.      Market values based on past revaluations cannot be considered as Deemed Cost.

Accounting for Investment Property on the date of transition becomes all the more difficult if it has been revalued in prior years, with appreciation in the value sitting in Revaluation reserves.

In brief, an Investment Property has to be shown at historical cost after providing for depreciation on yearly basis. Having said this, the next question arises is, how to do the accounting entries on the date of transition. To make things easy to understand let’s take an example below:

Example:

Aarohi Ltd is a micro-entity adopting FRS 105 for the first time, having its year ending on 31 December 2016.

In the comparatives of 31 December 2014, which would be used for date of transition(i.e. 01 January 2015), it had a property called Mital House shown at open market value of £1,000,000 and a revaluation reserve of £200,000. Mital house was purchased on 01 January 2013 at a price of £800,000. The Valuation report on the date of purchase stated the land value to be £600,000.

For accounting, it would be advisable to divide the entries in two parts, on the date of transition & after the date of transition. After date of transition, is simple accounting which we adopt for all Fixed Assets, i.e. Depreciating the cost at a fixed rate of depreciation over the estimated useful life of the asset.

For accounting on the date of transition, we would have to adopt a step by step approach.

Accounting Entries:

Step 1:

Revaluation reserve to be reversed

Dr – Revaluation Reserve £200,000

Cr – Investment Property £200,000.

That would bring the investment property to £800,000 which is its original cost.

Step 2:

Dividing the cost of the Investment Property into two parts, viz land & building.  In current scenario, land value accounts for 75% of the cost which cannot be depreciated. Presuming an estimated life of 50 years we can adopt a depreciation rate of 2% p.a. on Straight Line Basis and depreciate the building.

Depreciation per year would be (800,000-600,000) X 2% = 4,000

Depreciation upto date of transition would be £8,000

Dr – Accumulated Profit & Loss a/c £8,000

Cr – Accumulated Depreciation £8,000

That would bring an additional ledger in the books, accumulated depreciation, having a credit balance of £8,000.

Step 3:

After accounting for above entries, the WDV of the Investment Property on the date of transition would be £792,000 (Cost £800,000 and accumulated depreciation £8,000). Going forward it would be depreciated at 2%.(Excluding land value of £600,000).

Step 4:

This step is required only if the Investment property has a major component which has an useful life different from the building. I consider them to be complex scenarios

To make our simple example complex, let’s consider Mital House having an elevator system (existed on the date of purchase) which would need replacement in 5 years time from the date of transition. In such case, we would have to find the current cost to replace the elevator, say its £40,000.

WDV arrived in step 3 would be divided in two parts

Part 1 Investment property (£792,000 – £40,000) £752,000. Going forward depreciation would be at £ 2% of £152,000(£752,000-£600,000).

Part 2 Elevator system £40,000 which would be depreciated at 20% (considering estimated life of 5 years).

Accounting treatment adopted for Major component in Step 4 is based on exemption provided in paragraph 28 of FRS 105. Have reproduced the extract below for better understanding of the readers, paragraph 12 is about the investment property and paragraph 28 is about transition to FRS.

Extract of FRS 105:

A first-time adopter is not required to retrospectively apply paragraph 12.15 to determine the depreciated cost of each of the major components of an investment property at the date of transition to this FRS.  If this exemption is applied, a first-time adopter shall:

i.      Determine the total cost of the investment property including all of its components. Where no depreciation had been charged under the micro-entity’s previous financial reporting framework, this can be calculated by reversing any revaluation gains or losses previously recorded in equity reserves.

ii.      The cost of land, if any, shall be separated from buildings.

iii.      Estimate the total depreciated cost of the investment property (excluding land) at the date of transition to this FRS, by recognising accumulated depreciation since the date of initial acquisition calculated on the basis of the useful life of the most significant component of the item of investment property (e.g. the main structural elements of the building).

iv.      A portion of the estimated total depreciated cost calculated in paragraph (iii) shall then be allocated to each of the other major components (i.e. excluding the most significant component identified above) to determine their depreciated cost. The allocation should be made on a reasonable and consistent basis.  For example, a possible basis of allocation is to multiply the current cost to replace the component by the ratio of its remaining useful life to the expected useful life of a replacement component.

v.       Any amount of the total depreciated cost not allocated under paragraph (iv) shall be allocated to the most significant component of the investment property.

Caveat

The opinions expressed are those of Mr. Devendraprasad Kankonkar (Deva). The material is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for yourself as the advice may change based on your circumstances.

FRS 102 - Inter Company Loans and Director Loans

INTER COMPANY LOANS

FRS 102

Inter-Company loans

As Fair Value (FV) concept kicks-in, it’s a challenge not only to define the maturity periods of the inter company loans but also allocating the rate of interest. Though defining the maturity period would always be the responsibility of the management, the rate of interest would surely be the headache of professionals.

FRS 102, debt instruments, including loans, should be measured at amortised cost using the effective interest method. Debt instrument at market rate of interest will not result in any differences to the current accounting treatment. However, discounting the value based on Net Present Value would be certainly necessary where it is below-market rate.

Accounting treatment for similar transactions would differ from entity to entity based on the relationship between two companies. Before we proceed with accounting treatment lets understand Net Present Value.

Net Present value

FRS 102 has specific requirements for transactions that, in effect, constitute a financing transaction. Such transactions must be measured at the present value of future cash flows, discounted at a market rate of interest that would apply to similar debt instruments.

Adopting a standard rate for discounting would not be advisable as the rate of interest charged by the lending institutions is usually dependent on their risk exposure. In my opinion a 3 Tier formulae would be advisable where Rate of Interest can be allocated based on High, Medium or Low Risk.

In an example of Interest free loan of £100,000 repayable in 1-5 years’ time:

If the market rate for such a loan was, say, 10% considering High Risk then the NPV would be:

For Loan maturing after Year 1 = 90,900; Year 2 = 82,640; Year 3 = 75,130; Year 4 =68,300; Year 5 = 62,090.

Discounting factor for ROI = 10% : Year 1 = 0.9090; Year 2= 0.8264; Year 3 = 0.7513; Year 4 = 0.6830; Year 5 = 0.6209.

However FRS 102 does not contain any requirements about how the financing shortfall between the actual loan and the discounted value should be accounted for on FV recognition. Below are some scenarios which would give an idea on various options available on accounting the shortfall.

Accounting for the difference/ shortfall

The financing shortfall is either interest income or an interest expense on the date of recognition of FV with the other effect going to Creditors or Debtors. The interest receivable or payable would be reversed as the discounting unwinds.

However, this approach would not take account of the relationship between the lender and borrower. In order to correctly reflect the impact of the relationship between the lender and the borrower the below treatment would be advisable.

Loan from Subsidiary Company to Parent Company

Where a Subsidiary Company makes an interest-free loan to a Parent Company, the shortfall given to the parent should be shown as distribution of income by the subsidiary. In the books of the Parent Company it should be shown as Income.

Loan from Parent Company to Subsidiary Company

Where a Parent Company makes an interest-free loan to a Subsidiary, the shortfall on recognition of FV should be accounted as an increase in the cost of investment. In the books of the Subsidiary company it should be shown as Capital contribution by the Parent Company.

Loan from Subsidiary Company to another Subsidiary Company within the same group

IF the loan is given on instructions of the parent then it the lender should show it as distribution of income and the borrower should show it as a Capital contribution.

IF the loan is not on the instructions of the Parent Company then the shortfall should be treated as interest expense in the books of the Lender and interest income in the books of the Borrower.

LOANS TO/FROM DIRECTORS AND SHAREHOLDERS

We can adopt similar principles when interest free funds are borrowed/lent from/to a Director or Shareholder.

Loan To/From a Director

IF loan is given to a Director who is not a shareholder, the shortfall should be accounted for as interest expense. IF loan is received from a Director then the excess should be accounted as interest income.

Loan To/From a Shareholder

IF loan is given to a Shareholder who is not a Director, the shortfall should be accounted for as distribution of income. If loan is received then the surplus should be shown as capital contribution from the Shareholder.

Example

Let’s take an example wherein Company XYZ has Mr. A as a shareholder Director. The company is adopting FRS 102 for its accounting year ending on 31 December 2015. The Date of Transition therefore would be 01 January 2014.

XYZ has taken a loan of 100,000 at the beginning of 2013 interest free from Mr. A for a fixed term of 4 years. Let’s consider the market rate of interest at the time (2013) would have been 10%. We will have to go back to the date of inception in 2013 to establish what the accounting would have been from the start. We would have to do the below presentation of the loan in the accounts under FRS 102:

Year                Op. Balance              Interest @10%                      Closing Balance

2013               68,300                                    6,800                          75,130

2014               75,130                                    7,513                          82,643

2015               82,643                                    8,264                          90,907

2016               90,907                                    9,100                          100,000

The 2013 closing value of 75,130 will be used as the carrying value of the liability on the date of transition (Balance sheet at 01 January 2014) and the accounting continues from there.

As there would be difference of 24,870 on the date of transition, the question that arises is, how should this difference be accounted for? In the above example, Mr. A should recognise the additional amount as part of the cost of investment in XYZ. The Company XYZ should recognise the loan liability at 75,130 and record the difference of 24,870 in equity as a capital contribution from the Director.

The maturity amount of the Loan would be correct at the end of 4 year term as the discounted loan unwinds coming closer to maturity.

Caveat

The opinions expressed are those of Mr. Devendraprasad Kankonkar (Deva). The material is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for yourself as the advice may change based on your circumstances.

FRS 105 - A Sleeping Dragon

FRS 105 - The Financial Reporting Standard applicable to the Micro-entities Regime is the new accounting framework available for companies much smaller in size.

Once considered untouchable by practicing professionals due to sheer small size of the Financial statements & difficulty in justifying fees to their clients.

Considering the limited knowledge on FRS 102 & FRS 102 (1A), it has come into limelight for professionals for quick adoption due to paucity of time. Exemption from adopting Fair Value’s and Limited Disclosures is making it popular among the business fraternity.

Effective date:

FRS 105 is effective for periods beginning on or after 1 January 2016. Early adoption is permitted.

Date for early adoption:

FRS 105 is permitted for early adoption for accounting period starting on or after 1 January 2015. For periods prior to 2015, you may adopt The Small Companies (Micro-Entities' Accounts) Regulation 2013.

Eligibility:

A company should satisfy ALL the conditions given below:

1.    It is a company established under company law;

2.    It qualifies as a micro-entity in accordance with section 384A of the Act; and

Which means:

The group headed by it as a parent is a small group.

Qualifying conditions are met in the first year. If its not the first year then the qualifying conditions are met in Previous year & for that year.

3.    It is not excluded from being treated as a micro-entity under section 384B of the Act.

Which means:

It should not be a company excluded from Small company regime.

Not part of an ineligible group.

The company does not prepare group accounts if it’s a parent or its accounts are not included in consolidated group accounts if it’s a subsidiary.

Qualifying conditions:
Any two of the following three conditions in a financial year:

1.    Turnover < = £632,000 (Pro-rated if the period is not 12 months)

2.    Gross assets < = £316,000(Pro-rated if the period is not 12 months)

3.    Average number of employees: Not more than 10.

The company should meet these conditions in two consecutive years to qualify as a micro-entity.

Major differences between FRS 102 and FRS 105:

1.    Micro entity do not have a choice of accounting policy as available in FRS 102.

2.    Micro entity cannot adopt the fair value principle.

3.    Micro entity do not have to provide for Deferred tax.

4.    Micro entity accounts are only required to provide limited disclosures and are presumed to give a true and fair view.

5.    Micro entity have to follow simple recognition & measurement requirements.

6.    Micro entity to use contracted rates to translate foreign currency assets and liabilities where a forward contract exists.

7.    Micro-entities are only required to prepare a balance sheet and profit and loss account and not any other statements required for other companies such as Directors Report, strategic report, etc.

Areas of concern:

1.    If a micro entity is a start-up or is expected to grow at a rapid rate, it might not be advisable to adopt this standard.

2.    Expenditure such as development cost or borrowing cost cannot be capitalized. Micro entities have to write off such costs through their Profit & Loss account instead.

3.    Micro entities cannot revalue their tangible fixed assets or investment properties.

Disclosures

Only two mandatory disclosures according to Section 6 Notes to the Financial Statements in FRS 105 are
1. Advances, credit and guarantees granted to directors. and
2. Financial commitments, guarantees and contingencies as required by Small Companies Regulations.

The notes to the financial statements are included at the foot of the balance sheet thus restricting the size of the financial statements.

Caveat

The opinions expressed are those of Mr. Devendraprasad Kankonkar (Deva). The material is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for yourself as the advice may change based on your circumstances.

Difference between FRSSE 2008 and FRSSE 2015

Yes it's true, FRSSE 2008 cannot be used for accounting period starting from 01.01.2015 hence FRSSE 2015. It's also true that FRSSE 2015 cannot be used for accounting periods starting from 01.01.2016.

FRSSE 2008 v/s FRSSE 2015 - Differences

IN FRSSE 2015:

1. Assets are to be assessed annually and impaired based on the fair value.

2. Maximum life of intangible assets, including goodwill, is deemed to be five years unless more than five years can be justified. Under FRSSE 2008, the maximum life was 20 years.

3. Related party transactions and key management personnel definitions have changed drastically and are in line with FRS 102.

4. Exemption from disclosure of intra-group related party transactions where any subsidiary to the transactions is 100% owned by the group has been added.

Once a decision has been made you must follow FRSSE 2015 in full, you cannot pick and choose parts of FRS 102 and parts of the FRSSE 2015.

Apart from the above there are no changes for small company accounts.

Areas not covered by FRSSE 2015 and which will require references to FRS 102 are:

a.    Accounting for associates and joint ventures.

b.    Basic Financial Instruments.

c.    Donated goods and services.

d.    Donations, grants, legacies, etc.

e.    Heritage assets

f.      Mergers

Caveat

The opinions expressed are those of Mr. Devendraprasad Kankonkar (Deva). The material is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for yourself as the advice may change based on your circumstances.

FRS 101 qualifying entity

The New UK GAAP FRS 101 would be applicable for accounting periods starting from 01.01.2016 however early adoption prior to that date is available if selected voluntarily by the entity.

FRS 101 can be adopted by entities meeting the following criteria:

1. The company must be a qualifying entity (See Note 1 below); 

2. The shareholders of the company must have been notified in writing and make no objection to use of the exemption; and 

3. The company must state in its financial statements:

i)   A brief narrative summary of the exemptions adopted

ii)  The name of the parent in whose group financial statements it is consolidated; and

iii) From where those group financial statements may be obtained.

Under FRS 101, a charity may not be a qualifying entity. FRS 101 cannot be applied in consolidated financial statements.

Note 1 - A qualifying entity is a member of a group where the parent of that group prepares publicly available consolidated financial statements which are intended to give a true and fair view (of the assets, liabilities, financial position and profit or loss) and  that entity must be included in the consolidation.

Caveat

The opinions expressed are those of Mr. Devendraprasad Kankonkar (Deva). The material is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for yourself as the advice may change based on your circumstances.

FRSSE 2015 effective date

UK GAAP introduced with prime purpose of replacing FRSSE 2008

SCOPE:

The FRSSE may be applied to all financial statements intended to give a true and fair view of the financial position and profit or loss (or income and expenditure) of all entities that are:

(a) small companies or small groups as defined in companies legislation preparing Companies Act individual or group accounts; or

(b) entities which are not registered with Companies House but would also qualify under (a) if they had been incorporated under companies legislation, with the exception of building societies.

DATE EFFECTIVE FROM:
Its applicable for accounting periods starting from 01.01.2015 and available only for 1 year. You can call this GAAP a stop gap arrangement for transition from old UK GAAP to new UK GAAP. It is not available for accounting periods starting from 01.01.2016.

NOT APPLICABLE TO:-

FRSSE does not apply to:

(a) large or medium-sized companies, groups and other entities;

(b) public companies;

(c) companies preparing individual or group accounts in accordance with international accounting standards;

(d) companies preparing individual or group accounts in accordance with the fair value accounting rules for certain assets and liabilities set out in Section D of Schedule 1 of Regulation 2008/409 to the Companies Act 20065 ;

(e) a company that is an authorised insurance company, a banking company, an emoney issuer, an MifId investment firm or a UCITS management company or a company that carries on insurance market activity;

(f) a person (other than a small company) who has permission under Part 4 of the Financial Services and Markets Act 2000 (in the UK) to carry on a regulated activity or, notwithstanding the definition of a small company in the legislation, companies authorised under the Investment Intermediaries Act 1995 (in the Republic of Ireland); or

(g) members of an ineligible group. 

A group is ineligible if any of its members is:

 (i) A public company;

(ii) A body corporate (other than a company) whose shares are admitted to trading on a regulated market in an EEA State;

(iii) A person (other than a small company) who has permission under Part 4 of the Financial Services and Markets Act 2000 to carry on a regulated activity;

(iv) A small company that is an authorised insurance company, a banking company, an e-money issuer, a MifId investment firm or a UCITS management company; or

(v) A person who carries on insurance market activity.

Caveat

The opinions expressed are those of Mr. Devendraprasad Kankonkar (Deva). The material is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for yourself as the advice may change based on your circumstances.